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California Printing its own Money

2009-07-02T11:56:00.004-04:00

Published by clickbroker.blogspot.com

Watch out Ben Bernanke, the Federal Reserve now has competition in the currency game. California is planning to create its own money in the form of IOUs, just like the Fed. What is the California IOU – currency or an interest bearing note?

Officially the IUOs will be called “registered warrants”. State Controller John Chiang planned to issue $3.4 billion, maturing on Oct. 1 to replace state payments. The interest rate is set to be determined on Thursday, but cannot exceed the statutory limit of 5%.

San Jose Business Journal “California banks ponder their stance on state IOUs” reports that banks are equally perplexed about whether to accept the IOUs and how to process them. But the banks are loath to upset the state with the largest economy in the nation; the state capable of generating the largest investment banking fees.

Bank of America (BAC) issued a statement saying they will honor the IOUs through July 10. Wells Fargo (WFC) and JP Morgan (JPM) have not decided. The smaller banks were mixed.

California’s ingenuity poses an interesting dilemma for the Fed. The IOUs would be structured as short-term tax-free bills, but trade like cash. Banks are being asked to accept the IOUs and advance customers interest. Should the Fed sanction alternate forms of money?

Disclosures: Author is long BAC and WFC.

Pharmaceutical Dollar Rationing by Results

2009-06-30T16:24:00.002-04:00

Published by clickbroker.blogspot.com

Bloomberg’s “Lilly Erbitux Cancer Drug Not Worth Price, U.S. Scientists Say” and The Wall Street Journal’s “Cost-Effectiveness of Cancer Drugs Is Questioned” report on a study published by NIH oncologist Tito Fojo and NIH bioethicist Christine Grady questioning the cost effectiveness of high cost cancer drugs. Most of the cancer drugs approved in the last 4 years cost over $20,000 without consistently extending survival.

It looks like the controversial British National Health Service (NHS) methodology for determining the value of pharmaceuticals might be crossing the Atlantic. The UK National Institute for Clinical Excellence (NICE) advises the NHS on the cost-benefit of drugs. In general, Britain has valued a “quality-adjusted life year” at £30,000.

The study’s authors cite an average survival increase of 1.2 months for Eli Lilly (LLY) and Bristol-Myers Squibb’s (BMY) Erbitux, costing $80,000 for a course of treatment. Similar results were found for Roche’s (RHHBY) Avastin and Nexavar, costing $34,000. Nexavar is co-marketed with Bayer and Onyx (ONXX). Given that each treatment targets cancer differently, an effective cocktail is beyond the affordability of any health insurance plan – public or private.

Like most healthcare dilemmas, there are multiple sides to this controversy. Despite rhetoric to the contrary all sides involve rationing. The British ration on the payment side; only paying for the drugs that produced quantifiable results on a patient by patient basis. The pharmaceutical companies capitulated rather than be excluded from reimbursements. The NHS must be rebated when an expensive cancer drug does not produce results for an individual patient.

The British system is particularly effective when a high cost drug can produce extraordinary results in a small subset of patients. Given that the cost of manufacturing pharmaceuticals is a very small fraction of their selling prices; this model can very be effective for the companies as well. But the wide operating margins are not enough to convince the companies to change their business model in the US.

The US private insurance companies ration high cost drugs through co-pays and coverage caps. Biological and other high cost drug are often classified as “level 4” with little or no reimbursements. The result is that doctors must limit patient access to one high cost drug at a time without knowing if the one they picked would be effective.

This drug lottery serves no one. The patient would be better served by giving the doctor the freedom to experiment with multiple drugs either separately or in combination. The likelihood of putting the cancer in remission certainly would be greater, and more companies would have access to selling their drugs to each patient. The drug companies would have to agree to share the revenue allocated to the cocktail for each patient.

The drug companies are vigorously defending the status quo in the US. Instead of adapting their business models to “pay for performance” or shared revenue for a course of treatment, they have embarked on an elaborate public relations scheme. The companies claim that most patients don’t pay the “benchmark or average wholesale price” and besides if the patient cannot afford their medicines, the companies will help. Many patients have gone bankrupt with this kind of help. And even if the patients do not pay full price, it is often because the rest of the insurance pool chips in through high premiums.

The American method of rationing high cost drugs leads to Russian Rolette for the patients. Until sufficient genetic or diagnostic testing is available, why not make all cancer drugs available to all patients and reimburse drug companies for results? Just like one private insurer cannot give guaranteed issue policies without adverse selection, the pharmaceutical industry must act in concert to support revenue sharing.

No disclosures.

Nothing is ever “Off the Books” in the Financial World

2009-06-28T16:58:00.002-04:00

Published by clickbroker.blogspot.com

Several articles came out last week pointing to Morgan Stanley’s (MS) purchase of a controlling interest in Citigroup’s (C) Smith Barney via a joint venture and Bank of America’s (BAC) purchase of Merrill Lynch might have been misguided. Bank of America often called Merrill’s retail operation its crown jewel, and Morgan Stanley stressed the need for mass in wealth management. Despite Bank of America’s touting Merrill’s recent profits, the core profitability driver of full-service retail brokerage is waning.

The Wall Street Journal’s “Reconsidering Wealth Managers” reports that a Merrill Lynch Global Wealth Management and Capgemini Group survey showed that more than 25% of high net worth individuals withdrew funds or entirely closed their wealth management accounts. Wealthy clients have moved over half of their balances to simpler, lower margin investments such as cash and bonds. Smaller and regional banks were the beneficiaries. Capgemini says the business remains profitable as the full-service firms strive to increase assets under management.

The lifeblood of the retail operations is pumping highly profitable structured products to individual investors. Value adding through packaging and “access” to alternative investments had been the brokers’ mantra. It is here where the firms are trying to create an extraordinary resuscitation to again begin attracting both high net worth and institutional clients.

Bloomberg’s “Ambac Cut to Junk as Main Unit ‘In Runoff,’ S&P Says” suggests the market for structured products continues to be sick. The very same investment banks that are trying to retain investors’ interest in structured products are suing to prevent Ambac (ABK) and MBIA (MBI) from allocating capital to restart their municipal bond insurance businesses. The banks are scared the monolines won’t have enough capital remaining to back insured CDOs. The monolines are in turn suing the underlying mortgage originating banks for breach of warranties.

The Wall Street Journal’s “Repackaging by Banks Helps CMBS” reports that Bank of America, Citigroup and Morgan Stanley are repurchasing the highest tranches of unloved CMBS to sell them again with credit enhancement increased from 30% to 50%. They hope to rekindle institutional interest and make profit from a reduced spread over treasuries.

At the other end of the spectrum, the Financial Times’ “Banks rush to rescue of credit card trusts after record defaults” is reporting that American Express (AXP), Bank of America, Citigroup and JP Morgan (JPM) are buying the lowest tranches of credit card securitizations so they can absorb the first losses instead of investors. JP Morgan is even replacing some lower quality WaMu credit card loans with its own to reduce the loss ratio in certain trusts.

Keeping the credit cards trusts viable is particularly important to banks because as consumers prepay balances, the trusts’ capacity is recycled into new loans. If losses reach a certain point, investors can accelerate payments reducing the capacity of banks to issue credit card debt. Banks are trying every manipulation possible to prevent that from happening.

Changes in accounting rules might force banks to include off balance sheet trusts (or securitizations) back on their books. The deciding factors include control and risk of loss. This could make the all of these efforts to revive the shadow backing system irrelevant. Fed Chairman Bernanke should take note. Add to this the proposed Consumer Financial Protection Agency (CFPA) warning retail investors about the dangers of structured products and alternative investments.

Where does this leave our mega banks? Their investing banking businesses will become more dependent on traditional capital raising and trading, and their commercial operations will become more dependent on funds processing and traditional banking. When everything remains on the books, the whole operation becomes less profitable, including their prestigious retail wealth management chains.

Disclosures: Author is long ABK, BAC, C and MBI.

The Post Office, FedEx and UPS Model for Health Insurance

2009-06-23T19:30:00.001-04:00

Published by clickbroker.blogspot.com

The New York Times posted the transcript of President Obama’s Tuesday, June 23 news conference. I though he expressed the right balance on Iran’s political situation and was refreshingly articulate and direct on the need for a government run health insurance plan for consumers. The President used the Republicans own logic to defend the need for a government option.

President Obama: “Why would it drive private insurance out of business? If -- if private -- if private insurers say that the marketplace provides the best quality health care; if they tell us that they're offering a good deal, then why is it that the government, which they say can't run anything, suddenly is going to drive them out of business? That's not logical.”

President Obama: “But just conceptually, the notion that all these insurance companies who say they're giving consumers the best possible deal, if they can't compete against a public plan as one option, with consumers making the decision what's the best deal, that defies logic, which is why I think you've seen in the polling data overwhelming support for a public plan.”

The President came just short of refusing to sign legislation that did not contain a public option, indicating he will be expending unlimited political capital to get it. The logical extension of his argument would be if FedEx (FDX) and UPS (UPS) have prospered by competing with the Post Office, why can’t Aetna (AET), CIGNA (CI), Humana (HUM), UnitedHealth Group (UNH) and WellPoint (WLP) annihilate any competition from government run health insurance. Consider that FedEx and UPS are winning after the Post Office had over a 100 year head start.

The need to make a profit did not hinder the success of FedEx and UPS, and all these private insurers have a running start on the government. If profits are a disadvantage in competing than why did state governments allow nonprofit Blue Cross plans to be converted into the for-profit WellPoint colossus? If WellPoint cannot compete with the government than let Blue Cross go back to being nonprofit. Was WellPoint’s argument that a for-profit insurer can provide better service and more value to the consumer than a nonprofit invalid?

Medicare has an extremely low overhead for the level of insurance it writes. Yes it does incur a great deal of fraud, but more money is saved in overhead than spent in fraud. Private insurers can thrive alongside of a government plan if they balance the cost expenditures of enforcement with the cost savings of enforcement, and run leaner operations. The private insurers can leave the marketing and sales to the proposed exchanges, eliminate medical underwriting and start contracting with medical providers by the patient rather than by the service.

A certain amount of enforcement is necessary to prevent excessive fraud, but private insurers waste far too much money on administration for the benefits they provide. This is why they can only survive in an environment where their competitors do the same. The President wants to break this cycle using a government run health insurance plan as his tool. Once the environment changes, the private insurers will change and continue to be profitable.

The President’s argument could be equally applied to the pharmaceutical companies spending more on sales and marketing than research. But President Obama is not yet ready to slay that horse.

The real question the private insurers must answer is whether Medicare is more competitive because of lower overhead or lower payments to providers? I believe the emphasis on lower provider payments is far overstated. Medicare is more competitive than private insurance because it has far less fat.

No disclosures.

Big Pharma’s Divide and Conquer Strategy

2009-06-22T14:49:00.001-04:00

Published by clickbroker.blogspot.com

Multiple recent polls have indicated that Americans want a government run health insurance option and President Obama seems to be holding the line. Republicans say the people cannot be trusted because they don’t understand that they would be getting a “pig in a poke.” Liberal Senator Dianne Feinstein appears to have sold out to the health insurance lobby saying that the Democrats need to spend more time on costs and the government’s role. How could the Democrats not be ready? Are the Democrats slowly caving?

We have the good and the bad, so here’s the ugly. Both Bloomberg’s “Obama to Appeal to Public on Health Care as Senate Struggles” and the Financial Times’ “Obama health plan gets boost from drugmakers“ are reporting that the large pharmaceutical companies are offering about $80B in savings to the Medicare drug insurance beneficiaries. The companies are offering discounts of up to 50% for seniors to purchase medications in the benefit donut hole between $2700 and $6153 in expenditures. It does not speak well of the President to embrace this disingenuous attempt to divide the American people.

The pharmaceutical companies have excelled at charging Americans the highest prices in the world by offering strategic discounts to Medicaid, Medicare, and to a lesser extent certain pharmaceutical benefit managers and private insurers. They have attempted to garner public sympathy through the Montel Williams commercials touting “if can’t afford your medications, we might be able to help.” At the same time, drug companies are continually increasing prices to retail consumers.

President Obama, I call on you not to be entrapped by the rhetoric of the past. If you are looking for “green shoots” of industry cooperation to help sell healthcare reform, I can understand. But this is not one of them and it is unlikely that the CBO will score this favorably. The benefit does not go to the government.

Helping some of the people has long been a successful tactic used by the medical establishment to maintain the status quo. We cannot emerge from healthcare reform a divided nation. We cannot allow some members of our society to pay more or less than others based solely on age or the state they happen to live in. Each attempt to divide us puts one more nail in the coffin of real healthcare reform.

Reverse Converts Kill Retail Investors

2009-06-17T10:23:00.003-04:00

Published by clickbroker.blogspot.com

The Wall Street Journal’s “Reverse Converts: A Nest-Egg Slasher?” tells another sad story of retail investors being sold products they did not understand. Should we have the same sympathy that we had for buyers of Auction Rate Securities (ARS)? I think not. Reverse converts (or as JP Morgan (JPM) calls them Reverse Exchangeable Notes), promise returns of up to an annualized 17.25% on a 6 to 12 month deposit. Investors, retail or not, should clearly understand this is not simply interest.

At least ARS were bonds at their core. Whether any investor truly understood how ARS operate is another matter. What the Journal is calling interest on reverse converts is actually the combination of a small amount of interest added to a large put premium. This structured product is really just a very inefficient way for a retail investor to sell a put.

The Journal cites Barclays (BCS) and Citigroup (C) as large banks issuing these securities. But I was only able to find the JP Morgan Term Sheet for Reverse Exchangeable Notes due December 31, 2009 through Incapital LLC’s Structured Investments website.

The basic concept is the purchaser or investor of a reverse convert is issued an unsecured note from the issuer in $1,000 increments. The investor is paid a coupon much higher than prevailing interest rates, but can lose some or all of their investment. The return of capital is based on the price performance of a single reference stock. The upside is limited to return of capital at par plus the monthly coupon.

JP Morgan’s term sheet specifies 3 notes linked to the price performance of Deere (DE), Wells Fargo (WFC) and Whole Foods (WFMI). The coupon rates are 13.75%, 17.25% and 12.25% annualized for 6 months. But the allocations between “interest on deposit” and “put premiums” are 9.75% and 90.25%, 7.77% and 92.23%, and 10.94% and 89.06%. The effective interest that investors are being paid is just about 1.34% for all three. When commissions and “hedging fees” of up to 6% are added in, it’s a pretty expensive way to sell a put. The hedging is for the benefit of the issuer.

The sequence of dates is critical to understanding the product: pricing date, settlement date, observation date and maturity date. Notice the pricing date comes before the settlement date and the observation date precedes the maturity date. Each of the notes has a protection amount: 30%, 40% and 40% of the reference stock price on the pricing date. The shares per note are calculated by dividing the par value ($1,000) by the pricing date closing stock price.

The monitoring period extends from the pricing date to the observation date. If the reference stock’s price falls below the protection amount at any time during the monitoring period, the investor loses protection of their principal. Once protection is lost, return of capital at maturity is the lesser of the note par value or the value of the shares per note on the observation day. JP Morgan’s term sheet gives excellent examples of many different scenarios.

Coupons are paid regardless of whether protection is lost. But if protection is lost, the issuer can return capital at maturity as either the actual shares in the reference stock or the cash equivalent. The cash equivalent is the pricing date shares per note multiplied by the observation date stock price.

The reference stock’s company has no obligation to the investor. The investment is only backed by the credit of the reverse convert issuer (JP Morgan in this example). Think what happened to retail investors in Lehman structured products.

Let’s compare reverse converts to directly buying the reference stock or selling (shorting) a put on the reference stock. The reverse convert has no upside if the stock advances, a fixed exercise price if the stock falls, no stock dividends and limited liquidity. Buying the stock provides dividends, liquidity and upside. Selling the put allows the investor to earn interest on his proceeds as well as the cash maintained for exercise, the transaction can be closed before expiration, and is far more liquid than reverse converts. All three investments have equal downside, so the added liquidity of the second two differentiates.

Whether you buy a reverse convert or sell a put, you have to be willing to be exercised at the strike price. Retail investors will have to maintain enough funds in their brokerage accounts for the exercise to sell a cash covered put, so the upfront is the same. Option contracts are for 100 shares, the amount of shares in a reverse convert will vary by share price on the pricing date.

The key lesson for investors is you are really selling a put, not buying a bond when investing in a reverse convert. And your transaction costs are much higher than simply selling a put.

After all this, I asked myself is this the reason we needed to save the thundering herd of Merrill Lynch (BAC) and Morgan Stanley Smith Barney (MS)? Just like the Federal Reserve and Treasury are trying to recreate the shadow banking system, the full-service/high cost brokerages are trying to create the retail high-margin structured products business.

Reforms, what reforms?

Disclosure: Author is long BAC, BCS, C and WFC.

The New and Improved Auction Rate Securities

2009-06-15T19:33:00.003-04:00

Published by clickbroker.blogspot.com

Wall Street’s ability to reinvent itself along with the premise that any package can be sold for more than the sum of its parts is just as dependable as the unveiling of the new and improved Tide (PG) laundry detergent each year. Most of Wall Street’s packaged goods are no more valuable to their clients than the faux improvements to consumer packaged goods. But profits in packaging are the reason both exist, not to create real value for Wall Street’s or Main Street’s customers.

The Wall Street Journal’s “New Security Shifts Risk to Borrower” reports that Citigroup (C), Goldman Sachs (GS) and Morgan Stanley (MS) have introduced the new and improved auction rate securities (ARS) to the municipal bond market. They just cannot believe that long-term debt can’t be masqueraded as short-term debt for a profit. The target audience is the tax-free money market funds. These funds are rightfully skeptical.

I have a history of commenting on the original ARS: "Auction Rate Securities: Who’s to Blame?", "Retail Investors stuck with Auction Rate Securities", "Auction Rate Bonds are not Cash Equivalents" and "Mechanics of Auction Rate Securities". Although, none of these commentaries have been favorable, I found the mechanics of the products fascinating.

The new twist is that the municipalities (borrowers) must buyback (repay) the loans if the money market funds (lenders) want to withdraw (sell). This makes the loans putable if the funds are not satisfied with the weekly “auction.” The municipalities would have between 7 and 12 months to refinance.

Theoretically the municipalities would be paying a variable interest rate based on short-term debt for a long-term commitment. But the commitment is very much one-sided; the municipalities bear both the interest rate risk and refinancing risks. The lenders only bear the credit risk. Why wouldn’t the municipalities just sell long-term variable or fixed rate debt and eliminate the early put option? If their credit rating falls, the municipalities might not even be able to refinance. The only possible advantage for municipalities would be a slightly lower interest rate as the cost lenders would be willing to absorb for the put option.

The interest rate would be reset every week based on a short-term municipal debt index, rather than an actual auction. So there is no risk of a failed auction. With the risk removed from the underwriters the fun can really begin. I’m sure there will be all types of protection available for sale to both the borrowers and lenders. Interest rate swaps that the municipalities cannot hope to comprehend would just be the beginning.

Surprisingly, the SEC has approved this product for money market funds. Apparently the temptation of the pay-option ARM for irresponsible behavior has taught our regulators nothing. Are our municipal and state governments any more sophisticated or smarter than boom era homebuyers in resisting loans they don’t understand?

These products present unneeded risks to both borrowers and lenders with little value added for the trouble. The only difference this time around is the investment banks appear to be trying to immunize themselves.

Disclosure: Author is long C.

Penske Automotive’s far from Virtual Saturn

2009-06-09T13:34:00.000-04:00

Roger Penske is no lightweight; a former champion race car driver and now CEO of the Penske Automotive Group (PAG). PAG is the second largest publicly traded automotive retailer with 310 showrooms divided almost equally between the US and UK, along with 25 collision centers and the exclusive Diamler Smart car distributorship in the US. The $11B+ revenue company specializes in foreign and luxury nameplates. Penske is also the driving force behind several non-publicly traded businesses including Penske Racing and Penske Truck Leasing.

USA Today interviewed Roger Penske for “Roger Penske: 'We're going to build a Saturn team'”. PAG’s purchase of General Motor’s Saturn brand is expected to close in October. PAG will be buying the brand, the 350 dealer distribution network and the parts inventory; but no manufacturing. GM has committed to supply the Aura sedan and Vue and Outlook SUVs for 2 years. Other Saturn models will be dropped. The PAG press release gave no details as to how many of GM’s Saturn employees and which GM assets will travel with the brand.

Buying the Saturn brand is very much more complex and risky than being the national distributor for Diamler’s Smart or JM Family Enterprise’s Southeast Toyota. JM Family, a private company, is the sole remaining independent Toyota distributor in the US. Owning the Saturn brand means that PAG will theoretically have to design and subcontract the assembly of vehicles in addition to distribution and dealer support.

Penske talks optimistically about being freed from manufacturing and the ability to source models worldwide, giving PAG a distinct cost advantage. But just like the semiconductor foundry business, customers must cover the fixed costs when they commit to a production volume. Also it is likely that PAG will have to finance the parts inventory for its manufacturing subcontractors and commit to certain volumes, like Dell (DELL) and Hewlett-Packard (HPQ). PAG will have to purchase or lease any equipment, dies and fittings required to customize other manufacturers’ vehicles for the Saturn brand.

While the new Saturn’s capital outlays and long-term labor commitments are less constraining than fully integrated manufacturers, they are far from nonexistent. The operation is not quite as virtual as it first appears and is highly dependent on continued overcapacity in automobile manufacturing. Advanced Micro Devices (AMD) similarly trying to run a virtual operation might find the cost of committing manufacturing an impediment to competing with its rival. Though completely different industries, there are many parallels between the AMD and PAG business plans.

I believe PAG’s greatest difficulties will go beyond financing manufacturing and getting commitments to the highest quality plants. First, can PAG design vehicles with a consistent theme or message that instantly distinguishes them as Saturns? Will contract manufacturers be willing to build cars with the plastic shells that make Saturns distinctive? Will manufacturers be willing to rebadge their best products for Saturn?

If the new Saturn can shop the global parts bins to build high quality unique vehicles, they could be successful. But the vibes I’m getting is that Penske wants to shop the world market to rebadge the lowest cost products for Saturn’s high customer satisfaction dealerships. This is an explosive combination and not very value adding. As the number of vehicle sources proliferate, so will the dealership parts and service complexities. And customer satisfaction will soon fade if quality is not consistently high.

This case study is just beginning and it is difficult to know how PAG will balance the design vs. rebadge question. But the migration toward electric cars speaks well for the new Saturn’s ability to be a nimble designer and distributor in the future. PAG must be very careful not to reach for the bottom of the barrel in the last few years of the gasoline age. Doing so will kill it before the Saturn brand can truly prosper in the easy to assemble electronic age.

No disclosures.

Is it as Simple as New-GM vs. Old-GM?

2009-06-02T22:09:00.005-04:00

Picture the 1970’s; we’re cruising down the boulevard of dreams in our softly suspended land yacht when suddenly we hit the sand like a beached whale. Gas becomes tight and GM quickly downsizes its fleet with disastrous results. Too bad it was only a false alarm and GM was able to enter the 1980’s back to its gas guzzling ways.

Instead of fighting the Japanese midsize and large car advance heading into the 1990’s, GM once again did a side fake to SUVs. GM has a history of avoiding the distasteful competition with either total avoidance or lame attempts to meet the competition. CEO Fritz Henderson touted a few of GM’s stellar products, leaving us thinking that they moved little from mediocrity. Just watch those full-size cars float up and down on the highway and image how well they handle.

Two things puzzled me when I listened to both President Obama and Fritz Henderson’s speeches on Monday, June 1, 2009. The first was that neither told us what customers can expect in the products from the new GM. The second was how can GM be easily split when there is a matrix relationship between products and factories?

Henderson said GM’s product development needs to be less scatterbrained; fewer new vehicles introduce with more successes. But Henderson did not tell us what would compel a customer to buy a GM car. Along with that we need to know from GM what separates a great car from a mediocre one. And what defines GM across all its vehicles. Until GM can answer those questions, they are still lost. No amount of government money, great engineers, frugal accountants and conscientious hourly workers can save them.

Let’s assume miraculously, some customers still find GM relevant in the future. After all, even the Republicans still have a small remnant of Karl Rove’s famous base. Does GM still build highway cruisers and SUVs to please its shrinking base or does it create a few high performance cars with great handling? Henderson implies both during his speech. A little halo covers over a lot of mediocrity. You can see that there will be no new GM in the customers’ minds.

Companies can only reinvent themselves when they are willing to give up their core constituency and define themselves to a new audience. It requires letting go of the security blanket and clearly defining yourself in the characteristics of every brand and every product you sell. GM cannot define itself because it still wants to be all things to all people. Reducing the number of brands does not change that.

So if there is no new GM in the products and the customers’ minds, then the only benefit left is cost reduction. The work force is being reduced and wages are dropping significantly, but it is happening at a huge cost. The pension plan still needs to be funded and government is forcing the new GM to fund the retirees healthcare with a $6.5B preferred paying 9%. And workers are not being let go, they are being bought out. GM will be reacquiring certain Delphi parts factories that it jettisoned years ago. It looks to me like a combination of a UAW jobs and retiree social welfare program with an AIG-like (AIG) pass through to save the auto parts industry.

Now we realize that while the workforce and wages will be reduced most legacy costs will still remain. While GM’s unsecured debt will exchanged for equity, GM still has plenty of other debt and obligations remaining. Just think about the cost of winding down and closing plants, and the environmental liabilities that will remain. That leads to the question of whether the creation of a new GM will hold up in bankruptcy court.

Removing Pontiac from the GM lineup does not mean that GM can simply just close the Pontiac plant, because there is no such thing. GM has always produced multiple brands in the same factories. So moving Pontiac to the old GM is meaningless. Likewise, to close a plant that produces Chevy and Pontiac models would mean the costly moving of gigantic equipment and realigning computer systems. So the question of which GM owns which plants is just the start, then comes which GM owns what equipment inside the plant starts the real quagmire. Does the old GM produce parts and assemble cars for the new GM? Do the two GMs have to cooperate to the detriment of the old GM? What do the creditors of the old GM think? And lastly is the old GM a continuing entity or does it just go into liquidation when the new GM no longer wants it?

Some creditors have already appealed the formation of the new Chrysler. Chrysler was a cleaner separation because all of its brands moved. But certain creditors felt that the sale of select assets to the new Chrysler was just a standard reorganization thinly disguised to benefit some creditors over others. With Chrysler at least a new party, Fiat, is a participant in the “purchase.” This does not leave much justification for GM when the owners of the new GM and are just a subset of the creditors of the old GM.

All told the GM bankruptcy journey has just begun, and it won’t be short and certainly not sweet. I see no product plan, no manufacturing plan and no appeasement of the creditors. All I see at this point is President Obama implementing social policy and trying to protect the Pension Benefit Guarantee Board.

Disclosure: Author is long AIG.

Should Starbucks have been more Cost Conscious during the Boom?

2009-06-01T10:24:00.003-04:00

Bloomberg’s “Starbucks Pushing Landlords for 25% Cut in Cafe Rents” got me thinking about when is the right time for a growth company to start being concerned about operating costs? For years Amazon (AMZN) told us not to worry about profits while they were in a hyper growth phase and they turned out to be right. As the online retailer matured, its investments in efficient operations have lead to sustained profitability. Now I believe that the Kindle e-book reader is a loss leader that too will become sustainably profitable.

Both the basic Amazon and the Kindle have invented their own ecosystems, in a way very much like Apple’s (AAPL) iPod and iPhone. The Kindle can download e-books wirelessly from anywhere. Starbucks has also created its own ecosystem, based on the combination of its captive prepaid card and competitively addicting coffee. The key difference between these players goes beyond industry. Amazon and Apple are constantly pressured for increased efficiency to provide competitive consumer pricing whereas Starbucks (SBUX) was counting on steadily increasing consumer pricing.

Home Depot (HD), Starbucks and Whole Foods (WFMI) all are recovering from the growth at any cost syndrome. Just like the home builders during the bubble, their attitudes were that they had a limited amount of time to dominate their markets.

During many Home Depot conference calls this past decade, management said it was okay for a new store to cannibalize an older one down the block as long as the two together had increased sales and total profits. Lower margins were the price of expansion. By the time former CEO Robert Nardelli left, retired plumbers and other craftspeople had been replaced by inexperienced salespeople in a desperate attempt to save costs. Likewise Circuit City sacrificed its most knowledgeable and best performing salespeople as a desperate attempt to cut costs before bankruptcy.

As Home Depot’s new CEO has stopped its expansion and is improving the customer experience with new experienced craftsmen and better skilled salespeople, Starbucks can take solace that it has never sacrificed its talent. But Starbucks was a big player in the game of cannibalizing its existing stores with new stores. They would often open stores on opposite sides of the same street or multiple floors in the same mall to the catch that marginal customer.

Starbucks and Whole Foods both belonged to the cult of pay any price for the best locations. This has always puzzled me because both were prestige bands capable of driving traffic to the benefit of any shopping center or mall. During the boom, many mixed use developments touted these retailers as amenities to their condos, offices and apartments. Why didn’t Starbucks and Whole Foods use this leverage to achieve advantageous leases years ago?

As the economy worsened, both Starbucks and Whole Foods started playing hardball with landlords of their abandoned and future stores in development. They had buyer’s remorse just like preconstruction condo buyers in Miami and Las Vegas. They are trying any means from legal to economic threats to break leases.

Bloomberg reports Starbucks is now directly negotiating with landlords, and realtors are telling their landlord clients that they should capitulate. Quiznos (with over 1000 restaurants) has successfully reduced rents by 15% to 20% by offering landlords extending leases. Starbucks is looking for more.

These are all very different companies that all shared enormous growth. All but Amazon were profitable early on, and all but Amazon disregarded costs for growth. History has already told us the winner of this race. Only Amazon has managed its fixed costs and efficiency from the start.

No disclosures.

As Detroit Rusts, Silicon Valley will Take Over the Auto Industry

2009-05-30T15:12:00.005-04:00

President Obama is trying to save General Motors (GM) and Chrysler as part of his plan to reindustrialize America. But this is missing the point in the same way that the Treasury and Federal Reserve are trying to recreate the shadow banking system. China has recognized that both the automotive and financial worlds have changed; what are we waiting for?

China’s banking system has largely avoided the complexity of financial innovation and sees no need to catch the history it missed. So too is China ready to jump past the high complexity of sophisticated internal combustion engines and zillion speed automatic transmissions. As far as I know Toyota’s (TM) hybrids and Lexus’ 8 speed auto-trans are leading or beating the Germans in the useless complexity wars. China is bold enough to say that with all-electric cars, complexity is reduced to such an extent that there are no longer any barriers to entry in the world automotive scene.

What will be differentiating factors between vehicles if China is right? Electric motors and batteries will become available off the shelf, and complex transmissions will no longer be needed. Most steering and suspension parts along with digital and analogue computerized controllers, will become more standardized and also be available off the shelf. Of course branding, quality of fit and finishes, and quickly adapting to the fashion of the moment will continue to be important. But the key differentiating factor will be each brand’s software controlling how the standardized parts feel in unison to the driver.

We are already seeing hints of this today. Most auto companies have shared the development of the new breed of 6+ speed auto-trans hardware. But from the driver’s perspective, some shift harsher or much too often. The difference is the software. Drivers would have no idea their cars share the same transmission hardware.

Now take it to next level where there becomes virtually no hardware differentiation between vehicles. And the complexity becomes balancing power consumption and recovery, and battery life. Performance is now driven by the sophistication of the controlling software, thus software is the new horsepower.

Do we have to retain the assemblers for America to be dominant player in the world automotive industry? Is that not the same as saying Dell (DELL) contributes more to the American and world economies than Intel (INTC) and Microsoft (MSFT)? The answer to both questions is obvious. And that does not even consider the risk that assemblers such as GM and Dell face in managing changes in consumer preferences.

Readers could argue that auto parts makers have been squeezed hard by the assemblers, and many are already bankrupt. It can also be said the disk drive and memory manufacturers have lower margins than the box makers. But that misses the point that America does not have to focus on the commodity parts business in any industry. There is plenty of value adding profit to be made in the new auto electric motors, electronic controllers and most of all software.

Historically America has been a nation of innovators, positioned in the most value adding parts of the food chain. We need to be less concerned about the low value adding assemblers and more focused on designing and building high value parts and very high value software. We do not need Ford (F), GM and Chrysler for America to make a lot of money and create a lot of high paying jobs in the auto industry.

Don’t be surprised to see “Intel Inside” on Chevy’s trunk lid.

Disclosures: Author is long INTC and MSFT.

Character Based Banking as Credit Enhancement

2009-05-28T20:40:00.006-04:00

Published by clickbroker.blogspot.com

The Wall Street Journal’s “Activist Financier 'Terrorizes' Bankers in Foreclosure Fight” is juicy enough to qualify for the E! Network’s (CMCSA) True Hollywood Story or CBS’s (CBS) 60 Minutes. When you cut through the sensationalism, Bruce Marks’ Neighborhood Assistance Corp. of America (NACA) is executing an elaborate form of brand building for his niche of the mortgage market. He combines a $34.5M federally funded nonprofit mortgage counseling service with a captive mortgage brokerage.

Marks is marketing a club in much the same manner as Costco (COST), Sam’s Club (WMT) and even Abercrombie & Fitch (ANF). Though the Journal paints a much more unsavory picture of a cult rather than a club. Just like a cult, many members might not feel comfortable with the organization they joined. Members get the benefit of applying for low cost mortgages without being held back by moderate or poor credit scores. The price members pay is that they are forced to actively promote the NACA brand, and be associated with activities that include protests and a website calling certain bank executives “predators”.

NACA has agreements with Bank of America (BAC), Citigroup (C), JP Morgan (JPM) and Wells Fargo (WFC) to fund their mortgages and accept their counseling efforts on loan modifications. Marks focuses what the Journal calls “terror” on the banks that aren’t cooperating – HSBC (HBC), Barclays (BCS) and Credit Swiss (CS). Though unsavory, I think the Journal’s characterization of terror might be too strong.

The banks love/hate relationship with NACA centers on the 1977 Community Reinvestment Act (CRA). Banks are forced to issue mortgages to patrons with weaker credit in less desirable neighborhoods where they have branches. The bank solution of charging more interest for high risk often does not totally mitigate credit losses. NACA offers an unusual form of credit enhancement that makes the CRA borrower an equal to or a better credit risk than prime borrowers according to Bank of America. Banks pay NACA a fee of $2500 for each loan originated.

NACA originated $367M mortgages in 2008, insisting the all borrowers pay the same interest rate. The current rate is 4.875%. Each borrower must participate in extensive training on the responsibilities of home ownership and pay NACA dues for the life of their mortgage. Bank of America says few organizations prepare their borrowers as well. But the most important aspect of the credit enhancement is that members are required to participate in group protests and volunteer in the offices. This creates a cult-like environment where a member’s deviation from sound use of credit could be averted by group pressure.

Marks’ theory is that all credit risks are equal after education, so all members should pay the same interest rate and are entitled to a no down payment mortgage loan. NACA tries to insure that borrowers are not overreaching as part of its underwriting process. Marks’ logic is that borrowers past sins will not be repeated, so they should not be punished for them. Part of the membership dues goes toward helping members with mortgage payments when they temporarily are unemployed. The Journal gives few details on the performance of NACA originated loans.

My real interest is not in the good or bad of what I call NACA’s branding activities. Readers can go to the Journal and pass their own judgment. The real question is can banks emulate the best of NACA in a character based lending system on their own, and do they even want to?

NACA’s organization and brand building activities are very labor intensive and are not practical to as Intel (INTC) says “copy exactly.” But banks can implement required home ownership education and continuing group credit counseling in exchange for lower interest rates and fees. Perhaps give PMI rebates as long as borrowers attend monthly credit checkups or audits. Even experienced homeowners could benefit. The refinancing bubble has shown that the distance between responsible and irresponsible use of credit is short.

The want question is more difficult. Creating the excess baggage of group pressure on a bank’s customers could be a competitive disadvantage during times of easy credit. NACA’s business declined during the subprime bubble, even though they offered much greater value to buyers of moderate to lower priced homes. And during good times realtors are likely to steer clients to banks and mortgages brokers that accept both their good and bad credits hassle free.

It all boils down to whether reduced credit risk is an important competitive advantage in a weaker shadow banking environment. With the mortgage securitization market currently limited to Fannie Mae (FNM), Freddie Mac (FRE) and FHA, banks need to start sowing the seeds now for a more trusted mortgage securitization product. Perhaps there is something to be learned from Bruce Marks.

Disclosures: Author is long BAC, C, FNM, FRE and WFC.

Congressman Paul Ryan’s Republican Healthcare Alternative

2009-05-25T13:28:00.003-04:00

Published by clickbroker.blogspot.com

The conservative TV pontiffs and their print counterparts, including The Wall Journal editorial page, are saying all hail the free market alternative to the Democrats government takeover of our uniquely American healthcare system. The Republicans are eager to admit that the current system is broken, but reform should not destroy it. After all, for those that can afford it or get unlimited care from the government or their employers, the care is the best in the world.

Republican Congressman Paul Ryan’s “Patients' Choice Act” is a thinly masked rehash of "McCain Healthcare: An Evil Play on Words". Both the Ryan and Senator McCain plans depend on the states, out of the goodness of their hearts, to provide “guaranteed access.” Neither plan actually forces private insurance companies to eliminate medical underwriting, nor provides for enforceable state high risk pools or for a government plan to insure the people a private insurer rejects.

Ryan’s “Patients' Choice Act Q&As” helps us dissect the illusion of guaranteed access. Guaranteed access was never intended to be confused with or imply guaranteed issue. First, consistent with McCain, Ryan would move the tax advantage from employers to employees and individuals. Next, the same type of voluntary insurance exchanges would be regulated at the state level, as would any high risk pools. Each state would act as a laboratory of innovation in cost control and adverse risk redistribution amongst private carriers.

Individuals would be guaranteed access to any plan in their state’s exchange. Any plan licensed in their state is eligible to join their state’s exchange as long as it meets minimum federal standards. Each state has the freedom to establish a high risk pool or develop any other means to fairly redistribute or reinsure the risk between the exchange’s plans. But nothing is actually required along the lines of community rating, or eliminating any form medical underwriting in determining premiums. The participating plans simply “are prohibited from discriminating based on prior medical history or existing conditions and must provide annual open enrollment periods to enroll newly eligible individuals.” The words discriminate and eligible are yet to be defined.

So the implication is that individuals are guaranteed issue of a health insurance policy, meeting at “least the same standard health benefits made available to Members of Congress”, at some undetermined price from their state’s exchange. But the kicker is that each private insurer can chose which (if any) of their plans to make available to each state’s exchange and at what price. While each state can manage, if they chose, adverse selection within each of their exchanges, they cannot manage adverse selection between plans within and outside their exchange.

Individuals will be granted a refundable tax credit to purchase insurance whether they acquire plans from within or outside their state’s exchange. Given that no rules apply outside the state exchanges, full medical underwriting would lead to a large price discrepancy favoring plans outside the exchange. This would lead to only the worst risks migrating to the state exchanges. The only consumer advantage of the exchanges is that plans within must meet minimum federal standards.

The exchanges adverse selection potential relative to external plans would outweigh any process to redistribute risk within each of states’ exchanges. But even more basic, no private insurer might chose to participate in a given state’s exchange. Remember, neither insurers are mandated to offer plans on the exchanges nor are individuals mandated to purchase health insurance at all. So some states might end up offering nothing in their exchanges. And with no government health insurance plan option and a closed high risk pool, states like Florida would offer no reform at all.

The Ryan plan actually offers nothing concrete. Just the dream that states might want to reform health insurance on their own. Many decades of experience has already proved Ryan wrong.

The Faux Demand for Foreclosed Homes

2009-05-21T11:51:00.002-04:00

Published by clickbroker.blogspot.com

The Wall Street Journal’s “Investors Pounce on Distressed Homes” implies that when 38% of April single family home sales in Phoenix were all cash, as was 67% in Punta Gorda, FL and 39% in Las Vegas, investors must be controlling the market. At the same time Barclays Capital estimates that foreclosed inventory won’t peak until mid to late 2010 at roughly 1.3M units, investors are currently outbidding end users on the approximately 765.5K foreclosures currently in inventory. When this investor owned inventory returns to the market, end user demand will truly be tested.

The Journal cites Hudson-Cross Financial, Gorilla Capital and smaller funds with $6M to $30M to invest in single family homes at prices difficult to resist. These big time speculators are managed by alumni from major firms such as Deutsche Bank (DB), Morgan Stanley (MS) and D.R. Horton (DHI). Banks find them attractive REO customers because they make all cash offers for homes in bulk (10 to 200 units). After the purchases, the funds then hope to finance up to 50% of their purchases to keep the ball rolling.

The speculators expect a small positive rental return until the housing market improves and they can sell their inventory at a profit. This story sounds similar to the "Big Time Buying in Foreclosed Single Family Homes" article I wrote about Silver Portal’s ventures in the San Diego area. I did not think that a large fund could find the profit in single family home rentals the way experienced mom and pop operators have.

The numbers did not seem to add up, but Silver Portal’s Managing Principal Burland East emailed me to vigorously disagree with my assumptions on occupancy rates, taxes, maintenance and operating expenses. East claimed rents of $1900 per month were factual, a 98.5% lease rate in the San Diego area single home market, an estimated net yield on rentals of 8.8%, and a projected IRR at sale in 5 years of 25% to 30% with 50% leverage. East expects “that prices will not recover in 5 years, they will get back about half the loss since 2005.”

To be fair, The Wall Street Journal’s “Plying the Foreclosure Market” reported that East was looking for moderately priced homes in desirable neighborhoods, so he had a reasonable chance at achieving appreciation success. But in a second email to me East said I should not base my modeling assumptions simply on a newspaper report.

I do not dispute East’s corrections to my previous article for his market, but in general I still do not see how a financial firm can efficiently manage discrete single family rentals. I believe most of these funds will be operating cash flow negative without even considering the value of the money. In order to hope to break even on rentals, their purchases would have to be in the neighborhoods least likely to appreciate quickly.

In property selection, the criterion for a profitable rental is far different than the criteria for strong appreciation. California’s overbuilt far east bay communities are not the equivalent of the San Francisco peninsula or the Silicon Valley. Some neighborhoods are unlikely to ever appreciate back to boom levels.

Now all the TV pontiffs, including CNBC’s financial comic Jim Cramer are citing the bottom of the housing market. They claim the increase in foreclosures and other distressed transactions is leading to price discovery and great opportunities for first time home buyers. I disagree. The anecdotal evidence that I see in southeast Florida is that any properties in stronger hands are holding out, and distress sales reflect marginal or less desirable neighborhoods.

The press likes to talk about the two extremes, multimillion dollars mansions dropping 30% or more and way out xburbs like California’s central valley homes losing more than half their value. But the stable middle class suburbs have yet to capitulate.

With the Fed flooding the mortgage market with liquidity, artificially low interest rates are creating artificial affordability. But what the Journal is telling us is that this affordability is stuck in refinancing, not contributing to the end user purchases of homes. The efforts of these single family home investment funds are equivalent to rearranging the deck chairs on the Titanic.

Price discovery won’t be achieved until the majority of single home buyers actually plan to live in the purchases.

No Disclosures.

The Inflation of Cap and Trade

2009-05-20T07:00:00.002-04:00

Published by clickbroker.blogspot.com

Now I finally understand the concept of how cap and trade is supposed to fight global warming and the way the politics are playing out in Congress. The best explanation I found has come from the Financial Times editorial “Cap and trade or coach and horses.”

President Obama’s original idea was to auction permits granting a finite allowance to emit greenhouse gasses to the highest bidders. The supply of permits or allowances would be capped at the level of pollution the government wants to allow. The purchasers of the allowances could then sell them in the open market, thus the trade component.

The Administration should more aptly call the program cap and tax, since the President’s real objective was to pay for his middle class tax cut, healthcare reform, and other social and economic programs. The President’s hands-off policy towards Congress is allowing the real horse trading to take over, and plenty of companies will be able to generate their manure for free.

Just like Bernanke’s Fed is printing money with reckless abandon, the current House proposal will give away 85% of the allowances for free. The idea is to assist consumer friendly electric utilities and punish big bad oil. The beneficiaries would theoretically pass the savings on to consumers.

With 85% of the allowances generating no revenue for the federal government, the temptation to inflate the supply of allowances will be too difficult to resist. If the market does not trust that the supply will be limited, their value will be questionable. Traders will not want to keep any allowances in inventory. Brokers only act as agents and the market would be held back by a lot of friction.

Without an auction and the belief that the supply of allowance will truly be managed, neither the revenue nor the global warming goals of the President will be realized. Inflating the allowance supply will destroy its currency, a lesson neither Bernanke nor Greenspan seemed to grasp.

General Electric’s Virtual Healthcare Economics

2009-05-19T12:22:00.007-04:00

Published by clickbroker.blogspot.com

The Wall Street Journal’s “How Washington Rations” opinion piece, subtitled “ObamaCare omen: a case study in 'cost-control’”, opens a worm’s nest into rationing vs. choice. As usual, the Journal is only choosing the juiciest worms to reel in the healthcare reform whale. The Journal would like its readers to believe they are entitled to unlimited choices in healthcare without any economic consequences. And in the payer choice vs. the patient choice argument, the government should not be the chooser even when they are the payer.

The Journal extrapolates Medicare’s decision not to reimburse for virtual colonoscopies to the inevitable rationing of care when or if the public “Medicare for All” health insurance option becomes available. Medicare noted in its ruling, "if there is a relatively high referral rate [for traditional colonoscopy], the utility of an intermediate test such as CT colonography is limited." The Journal interprets this as “duplication would be too pricy.”

Given that Cigna (CI), UnitedHealth Group (UNH) and other private insurers reimburse for the added comfort of virtual colonoscopies, the Journal implies that rationing does not exist in the private sector. When you consider deductibles, co-pays, limits and other traps in private insurance, the rationing argument can go both ways. But one thing is as clear today as in the future; very few real healthcare choices exist within insurance plans. Healthcare has always been and will always be rationed. What will change is just the allocation formula.

The almost hidden revelation at the end of editorial is that General Electric (GE) and Siemens (SI), makers of the big iron CT technology, are exerting pressure on both Medicare and Congress to stop curtailing use of their equipment for virtual colonoscopies. As healthcare reform evolves, more of the purely comfort choices will have to be funded completely out of pocket by patients. This will force not only medical equipment manufacturers, but also the pharmaceutical and medical device industry to prove their value directly to consumers. Political pressure will become less effective.

GE Healthcare appears to be evolving and should not be wasting its resources and good will defending its big iron. It has already admitted that funding has dried up for purchases of high cost imaging equipment. GE is in essence following IBM’s (IBM) decades’ old transition from mainframes to servers to desktops to laptop to netbooks to smart phones. The computer big iron still exists, but it got much cheaper. While IBM subsequently gave up the commodity devices and never ventured to the lowest tiers, this is where GE could shine. All GE has to do is convince consumers (patients) that the comfort and convenience their imaging equipment provides is valuable enough to pay for.

The new form of rationing as the Journal likes to call it will provide great opportunities for private insurers and providers in the truly free market for equipment and medical services not covered by the universal healthcare initiative. I agree with the Journal that the government will decide on the standard of care for basic insurance, and there will be exclusions based on cost. But that will leave an entirely new market for supplemental equipment and services that can be priced with only free market restraint.

Each manufacturer and service provider can choose whether to accept the price restraints of standardized health insurance or take their chances in the unreimbursed free for all. Going back to virtual colonoscopies, the Journal neglected to say that GE, together with the hospitals and the radiologists, could choose to price their equipment and services low enough to mitigate the cost of duplication. Cost controls and restrictions are not all bad; they simply give companies the choice of lowering prices or increasing value.

Disclosure: Author is long GE.

The Structure of Healthcare Reform Emerging

2009-05-15T12:07:00.006-04:00

Published by clickbroker.blogspot.com

Bloomberg’s “House Democrats Consider Mandate for Employer Health Insurance” gives us some strong hints on the emerging structure of healthcare reform. Readers can go directly to Bloomberg for the he said/she said, but the compromises are pointing to a laddered (3 layer) approach to making health insurance available to all Americans. The key word seems to be available, not mandated which is consistent with Obama’s presidential campaign.

The foundation will continue to be employer provided health insurance and all employers would be required to play or pay. This would be enforced through a payroll tax. Small employers would be able to purchase insurance though a national exchange from the start. Employees of larger firms that don’t offer health insurance will have access to the national exchange at some unspecified time after the start.

The government will set guidelines for the product offerings and price levels of the exchange plans. Non-employee consumers, otherwise known as the individual market, might not have access to the national exchange.

The second layer will be the expansion of Medicaid to more lower-income people. The third layer is what the private health insurance industry calls the nuclear option, the government plan. Pricing will vary by geography and coverage levels, but the government will set the standards of coverage. Whether private insurers can participate in the government plan similar to Medicare Advantage, has not been disclosed.

Bloomberg’s stating “the public option would be available to some consumers lacking insurance and would operate separately from the health exchange” implies the government plan should be viewed as insurance of last resort or high risk pool. The bipartisan comprise is to move the highest risk applicants to the government plan, allowing private insurers to still medically underwrite, and not enforcing any individual mandates.

The insurance industry appears to have won on their threat of no enforceable mandate means no guaranteed issue. The political will for an individual mandate is waning. Private insurers also have a partial victory with the tight limitation on access to the government plan.

With this more or less business as usual, there is little chance of cost reduction. The New York Times’ “Health Care Leaders Say Obama Overstated Their Promise to Control Costs” is reporting medical service providers are already backing down on their commitment to reduce the growth in healthcare inflation by 1.5%. If the removal of high risk applicants from the private insurers’ pools does not reduce premiums, look for a cram down on healthcare providers after healthcare reform gets started.

Lilly CEO Opines Cost Effectiveness Stifles Innovation

2009-05-14T14:33:00.003-04:00

Published by clickbroker.blogspot.com

Pharmaceutical giant Eli Lilly & Co. (LLY) CEO John C. Lechleiter’s Wall Street Journal opinion “Health-Care Reform and the 'Innovation Test'” attacks the establishment of a government health insurance option for all Americans. The subtitle “Government-run insurance plans have curtailed access to new medicines” is not even supported in the text, unless he is implying that America is on the path to adapting the European model for cost-benefit reimbursement screening.

First I will address why a government health insurance option is imperative for healthcare reform, and then discuss each of Lechleiter’s arguments. Private insurance includes many risks beyond preexisting condition exclusions, medical underwriting and policy rescissions. Each policy contains a wide array of limits and restrictions such as the number of doctor visits per year on co-pays, maximum annual and lifetime benefits by finally divided subcategories and overall, pre-approvals, and network restrictions.

Let’s say you are one of the few that has read and understands the hundreds of pages in your health insurance policy and thought you did enough homework to fully comply. You obtain your preapproval, and your hospital and surgeon are in your insurance policy’s network. Then you’re disheartened to learn that your pre-op lab tests were sent to an out of network lab without your knowledge and the radiologist whom you never met, does not accept your plan. To make things worse, the hospital assigns an out of network anesthesiologist for your surgery, without you approval.

As you can see in this example, even with high quality health insurance you cannot stop medical providers from gaming the system at your expense. The private health insurance industry says that new regulation is needed for consumers to regain trust. I say the government option is the only way to set the standard for trust. Under a private only insurance environment, no one is totally secure.

Now let’s exaggerate our example: You are sent by ambulance to an out of network hospital. Your plan only covers 50% of the policy’s predetermined rates for medical services. Your responsibility is the other 50% of the predetermined rates plus any charges in excess of the predetermined rates. The insurer does no negotiation on your behalf. Contrast this with standard Medicare where seniors always only pay 20% of Medicare’s dictated rates. Which leaves you feeling more secure?

In general, Lechleiter claims that private companies are the engine of medical innovation and government inhibits innovation. He fails to distinguish between basic research and application, and does not acknowledge that the government through the NIH and university grants funds most basic research. Most biotech companies are started by professors incubated in the university system, funded by government grants. Further, the NIH and US Military directly fund the most cutting edge research and clinical development at small biotech companies. Vical’s (VICL) DNA plasma based H1N1 flu vaccine is an example.

Lechleiter conveniently leaves out that the pharmaceutical industry spends far more on marketing, sales and promotion than research and clinical development. Instead he wails out against the possibility of the government dictating prices on branded medicines; claiming any type of cost control will stifle innovation. Yet Lilly and other innovative pharmaceutical companies are operating very profitably in Europe, and show no signs of leaving. Does Lechleiter believe Americans should pay more for pharmaceuticals than Europeans?

Lastly, Lechleiter asserts that “private insurers and patients tend to control costs by insisting on value -- forcing companies to demonstrate how the effectiveness or broader savings generated by their product justifies its price.” If this were true, pharmaceutical product life cycle management would be ineffective and healthcare inflation would be well controlled. As I wrote in “GM and UAW Retiring Viagra and Nexium”, private insurers have no incentives to either seek value or manage costs.

Just as the private insurance industry is realizing they cannot survive by simply rejecting any customer that might incur medical expense, big pharma also must come to terms with the fact that innovation cannot exist in a vacuum without the gravity of cost. Only the government has the resources and motivation to determine cost effectiveness. Is one month of life worth $10K, $20K, $30K or $100K?

Don’t let the pharmaceutical industry scare you into believing cost effectiveness will bring rationing. Rationing exists now. When high cost medicines are included in insurance policies, consumers are rationed out by the price of insurance. Only the government can provide an effectiveness basis for rationing. I know this will impact pharmaceutical industry profitability, but they must adapt. The industry will only create value if they have to.

The government subsidizing private insurance will only increase the profits of both the insurers and drug companies, with no real cost containment. Lechleiter just wants more customers while maintaining the status quo. Lilly is joining Merck (MRK), Pfizer (PFE) and UnitedHealth Group (UNH) with their heads in the sand.

Disclosure: Author is long PFE and VICL.

GM and UAW Retiring Viagra and Nexium

2009-05-13T22:19:00.005-04:00

Published by clickbroker.blogspot.com

Car sales won’t be the only thing going limp for the UAW retirees. Bloomberg’s “GM Union Retirees Said to Cede Dental, Prescription Benefits” is reporting that General Motors (GM) 522,000 UAW retirees could lose reimbursements for dental care, and certain drugs such as Pfizer’s (PFE) Viagra and AstraZeneca’s (AZN) Nexium (“The Purple Pill”). The loss of vision care and higher co-pays for doctor visits and the drugs that remain in the formulary are also in the works. Only the 62,000 active workers vote on the retirees’ fate.

The two hard hitting issues surfacing: First, almost 8.5 retirees for every active production worker is unsustainable no matter how the Obama Administration slices and dices the numbers. Second, why are the UAW retirees getting any health benefits after they become eligible for Medicare at age 65?

Beyond the above two obvious questions, let’s look at the implications for the pharmaceutical industry. The proposed agreement seems to be segregating drugs by their implied necessity. This is a major step beyond Merck (MRK) and Pfizer reporting weakness in cholesterol drug sales and trouble with getting patients to visit the doctor when they don’t feel ill.

Merck and Pfizer think they just need more advertising to convince patients that they can be ill without feeling ill, so don’t let a bad economy keep you from regularly visiting your doctor. Success in such a campaign is unlikely. The pharmaceutical industry concentration on “preventative” drugs for cholesterol, high blood pressure and pre and post cardiac events over the last two decades has made it vulnerable to deep swings in the economy.

Very few employees get drugs for free anymore. So with no immediate pain, these drugs become expendable when money is tight. And the doctor visits to follow up on cholesterol and high blood pressure treatments are also expendable.

The formulary changes are a bigger issue. The UAW is being forced to make choices for the first time. Not every medicine advertised on TV will be available to them with a subsidy. The process is starting with drugs that help avert inconveniences such as requiring more time for romance, and a little indigestion.

Disappointments aside, the next step will be for unions and employers to start evaluating the cost-benefits of drug choices for real illness. As the true payees, they can be far more successful than private insurance companies have been in the past. The insurers simply raised premiums rather than sustain lawsuits from unhappy policy holders. Now that employees know they cannot have it all, they will be far more open to healthcare rationing of all kinds.

The drug companies are fighting government funding for the comparative cost-benefit analysis of drugs. The pharmaceutical industry should fear voluntary rationing by employers, unions and other employees far more than America replicating Britain’s NICE. The UK’s health service primarily questions the benefits of very expensive drugs. Here we are starting by eliminating fringe drugs. But these fringe drugs have become the lifeblood of big pharma.

It won’t long before employers and employees raise the cholesterol and high blood pressure bar instead of constantly lowering it. Image that – payees realizing they’ve been duked by faux medicine. Add now patients are doing exactly what the free market drug companies don’t want them to do – making choices.

Disclosure: Author is long PFE.

Starbucks Begging for Sympathy

2009-05-11T14:56:00.005-04:00

Published by clickbroker.blogspot.com

Toyota’s (TM) Prius sales are dogging, Whole Foods (WFMI) is losing its cache, the solar panel business is hemorrhaging, and Starbucks (SBUX) is retrenching. Even The New York Times reported that Abercrombie & Fitch (ANF) is “Losing Its Cool at the Mall”. And now McDonald’s (MCD) and Wal-Mart (WMT) are the hot stocks. Holly organic, what’s happening? Has our green turned to mold? Has “club retailing” lost its in-crowd?

Abercrombie’s refusal to adapt to “austerity is cool” has certainly taken its toll on sales. They saw discounting as a sure path to brand degradation. But, the new austerity doesn’t have to mean cheap prices. It just means projecting an ostentatious image is out and pretending to sacrifice is in. The new feel good is sacrifice, whether the customer needs to or not.

Sacrifice is different than value. Getting a Coach (COH) bag cheaply is not today’s image. Being seen at McDonald’s instead of The Cheesecake Factory (CAKE) is, even though The Cheesecake Factory might actually be a far better value. No one ever said taking the family to McDonald’s was cheap.

The trick is finding something that you actually want buy at Kmart (SHLD), Wal-Mart or Target (TRG). Starbucks actually does have beverages that customers want to buy, but they haven’t found the level of comfortable austerity that their customers are seeking. The sophisticated consumers are becoming less metro and more manly or womanly. To get them to campout at Starbucks will require an entirely new atmosphere. The faux loft store design is as yesterday as dialup internet.

Yet Starbucks won’t give up on their old formula. The third place, between home and office ended with the real estate bust. Instead of creating an atmosphere where customers feel like they’re roughing it a bit while drinking their $4 coffee, Starbucks has introduced some mild discounting and a ridiculous advertising campaign.

McDonald’s is promoting value, Dunkin’ Donuts taste, and Starbucks feel good in the coffee arena. I can’t speak for McDonald’s, but I think Dunkin’ Donuts and Starbucks regular coffee are equally good. The image of sacrifice is working for McDonald’s, not value as they would like to think. Dunkin’ Donuts counter service has become cool in a retro kind of way. But the Starbucks feel good is yesterday’s brew.

Starbucks’ message is that with your coffee you are buying healthcare for the baristas, fair trade coffee beans, and comfy chairs in a nice atmosphere. Starbucks is begging customers to be sympathetic for all the good they do their employees and the rest of the world. Trouble is their customers might no longer be getting healthcare themselves and lost their own fair trade wages. No matter how much advertising Starbucks pays for, their message is uselessly out of date. And to add to that, Starbucks has been completely silent on universal healthcare.

No one wants to drink $4 coffee amongst Wal-Mart’s complete austerity and lack of cleanliness, but Starbucks is encamping in the better Target stores. Starbucks will have a delicate balance in creating a cool kind of ruggedness, a sophisticated more warehouse – less loft look.

Even in this economic climate, Starbucks can maintain its prices if they create an atmosphere where customers can comfortably sacrifice. Too bad Starbucks is too smooth and packaged for its own good. As Starbucks begs for sympathy, customers just stopped caring. Starbucks is on the way to irrelevance.

No disclosures.

Banks Seeking Short Sale Deficiencies

2009-04-30T15:18:00.006-04:00

Published by clickbroker.blogspot.com

A new form of restraint is evolving on future residential real estate bubbles that goes way beyond more stringent lending standards and better due diligence on borrowers. The Wall Street Journal’s “A Short Sale May Not Mean You're Home Free” reports that banks, mortgage servicers and mortgage investors are becoming more aggressive in recovering the remaining loan balances after a short sales and foreclosures. The inclusion of a promissory note might not be directly obvious in the short sale agreement, as the clause might be hidden in the small print.

States vary in their laws for allowing additional recovery after foreclosures, and forcing the borrowers into bankruptcy might or might not benefit the lender. But short of foreclosure and bankruptcy, the lender has complete discretion on the amount of forgiveness to bestow on the borrower. Dept forgiveness by the primary mortgage holder does not imply forgiveness of any secondary leans. The Journal pointed to a former WaMu borrower granted a short sale with forgiveness on the first mortgage only to have JP Morgan (JPM) demand payment on the second mortgage.

Walk away borrowers are starting to be actively pursued if they have a job and any assets. At this point it’s an economic decision based on cost and expected recovery. But as the courts and bankruptcy laws continue to be tested, more standardized out of court settlements should evolve.

The important question is how will an active pursuit of deficiencies effect real estate buyer behavior and their appetite for risk? Will future buyers fully understand that their obligation to repay their loan is independent of the collateral they post? In this case, I hope the states move to a legal framework that obligates borrowers beyond the value of their collateral.

Educating mortgage borrowers to their repayment obligation might put a drag on home sales and lenders might once again become complacent about the value of residential real estate as sufficient collateral. But adding risk to the borrowers, beyond their down payments, would create a more even real estate market. This should fit in well with President Obama’s call for the end of severe bull and bust cycles.

Think about how many times Federal Reserve Chairmen Greenspan and Bernanke adjusted interest rates in the last two decades to try to fine tune the economy. Neither being successful, but in desperation Greenspan proclaimed booms and busts were necessary to promote innovation.

The President is trying to focus consumers on understanding and intelligently using credit, from mortgages to credit cards, and being treated fairly in the process. We cannot depend on a consumer economy to the detriment of the consumers themselves. The new thinking goes against everything both Greenspan and Bernanke stand for. But the pursuit of mortgage deficiencies is certainly one of the primary steps in whipping the consumer back into shape.

Fair lending practices must include consumer responsibility for all their debts and being fully knowledgeable of their obligations before signing. As difficult as it is for the banks to digest, consumers must be told that they may never get out from under a credit card debt with a 30% interest rate.

The consumer economy has relied far too long on disguising the traps of consumer debt. The financial system must first end usury interest rates, and then aggressively pursue all obligations, so that consumers are scared straight. The Fed be damned.

No disclosures.

Dendreon’s Provenge: Scientifically Intriguing, Commercially Nonsensical

2009-04-29T21:29:00.008-04:00

Published by clickbroker.blogspot.com

I know that Dendreon’s (DNDN) groupies are an enthusiastic bunch. Now Wall Street has joined the party, at least until they get the fees from Dendreon’s inevitable secondary stock offering needed to fund Provenge’s launch. Dendreon doesn’t plan on filing for FDA marketing approval until sometime in Q4, and then the FDA could take up to an additional 6 months to contemplate the amazing data. The company refused to be any more specific as to when in Q4 or why the delay in filing.

Opportunism is the hallmark of the company’s CEO, so between now and year-end the FDA cannot say that the supplemental NDA filing is insufficient. That’s right; this is an add-on to the prior rejected NDA. Dendreon cannot chance the FDA rejecting its paperwork early. This provides the company with a risk free window to raise cash. They plan to commercialize Provenge in the U.S. themselves.

Adam Feuerstein in TheStreet.com “Dendreon's Provenge: A Behind-the-Scenes Look” and Catherine Arnst in BusinessWeek “Dendreon's Prostate Vaccine Validated with Drama” give us some background into the medical and economic benefits of Provenge.

Provenge was tested against placebo, not the standard of treatment Taxotere. Provenge’s survival benefit over placebo was about a median 4 months (25.8 vs. 21.7), but it had only about a median 1 month survival benefit over Taxotere. The company’s management tried to convince analysts that while Provenge was not measured against Taxotere, patients would find Provenge less invasive to administer. But they also told us that both have side effects over placebo.

Three urologists interviewed by Feurstein doubted “Provenge’s survival benefit in relation to the drug’s high price.” Dendreon refused to comment on price, except to say that it should be judged equivalent to other advanced cancer treatments. The urologists further stated that Provenge showed no measurable positive effect on time to progression.

Feurstein said Dendreon bears had to cover their shorts and some have turned around and gone long. Analysts are predicting certain FDA approval and a $1B to $2B annual sales base on $60K to $80K for a course of treatment. Feurstein says that a $30K price is ridiculous compared to Avastin and Erbitux.

While Wall Street is preparing for the road show, their logic is simply nonsensical. First, Provenge won’t be launched for at least another 18 months, if at all. The manufacturing and processing operation for this patient customized medicine will face intense FDA scrutiny. More importantly, all of these sales estimates are based on the American drug marketing and reimbursement model remaining static. With the current momentum in President Obama’s healthcare reform, that’s like sticking your head in the sand.

The U.K. has restricted Avastin (Roche) based on limited benefit for the cost and required that the government be rebated for patients not benefiting from Velcade (Takeda). The National Institute for Clinical Excellence (NICE) advises the NHS on the cost-benefit of drugs. Despite the industries disbelief that the cost-benefit of pharmaceuticals will come to America, it is a key plank in the President’s healthcare platform.

It is unlikely that a 1 month survival benefit with no additional quality of life benefit will ever be worth $60K under American healthcare reform. Beyond that is the ethical issues related to the distribution of care. If you go with the premise that most of Provenge’s target audience will be government subsidized through Medicare, how can you justify taxing a working person struggling to pay a $100 doctor bill to give a senior 1 month of life?

Some try to argue that healthcare reform will bring rationing of care for the first time to America. Anyone with high deductible insurance plans knows it already exists. The reality is that America actively rations care in favor of those with high priced insurance and seniors. Provenge expects to take advantage of the current system of rationing.

The swine flu scare is teaching America that it is only as healthy as its entire people. The healthcare have-nots can easily infect the healthcare haves. Potential epidemics from SARS to bird flu are happening as often as financial black swans. Likewise the once in one hundred year storms seem to appear every few years.

Dendreon CEO Mitch Gold wants his stock to steady long enough for major mutual funds to take interest. But he is selling the same fantasy that healthcare reform will not affect business as usual as Merck (MRK), Pfizer (PFE), Humana (HUM) and UnitedHealth Group (UNH) tried to do on their Q1 conference calls.

What the healthcare industry needs to learn from the banks is that companies that depend on the government can get TARPed and feathered. Humana depends on Medicare Advantage for 40% of its members. Just like the defense industry, government is their biggest customer. And Obama has not been afraid to shakeup the defense contractors.

The clear lesson to Dendreon bulls is to model Provenge under the stress of full blown healthcare reform based on the U.K. cost benefit model. If Provenge cannot pass the Federal Reserve’s bank stress test, sell Dendreon now before the hype subsides.

In my previous Dendreon article “Dendreon’s Troubles Beyond Provenge’s Potential FDA Approval”, I was concerned with whether their form of customized medicine was commercially viable. With the data release on April 28, my new concern is drug price realization. Clearly the expectations are overblown.

If Gold gets his wish and the stock steadies, puts might get cheap enough to bet on the downside. I think we may have to wait a few months. Hang on tight for a wild ride.

Disclosure: Author is long PFE.

Merck’s Position on Healthcare Reform

2009-04-23T19:00:00.009-04:00

Published by clickbroker.blogspot.com

Merck’s media relations representative Ronald Rodgers sent Click Broker a form letter objecting to the article “Merck and UnitedHealth Group Unprepared for Obama’s Healthcare Reform”. The purpose of my article was to highlight that Merck (MRK) and UnitedHealth Group (UNH) did not really believe significant change would happen and were unprepared if it did. Rodgers recommend that I read Merck’s Public Policy Position and Merck’s President of Global Human Health Kenneth C. Frazier’s speech before the FDA-CMS Summit for Biopharm Executives (12/04/2008) to correct the record.

Rodgers’ form letter contends: “We believe your significant misstatements of fact are based on a lack of awareness of Merck's positions on health care reform. The fact is Merck supports comprehensive healthcare reform in the U.S. While much work remains to be done, we believe healthcare reform is the right path forward for the patients we serve, our company and our industry.”

The documents make it clear that Merck and their trade group PhRMA wanted a seat at the healthcare reform table. The Wall Street Journal’s “Business Spends Less, Unions More on Lobbying” reports the Pharmaceutical Research and Manufacturers of America increased lobbying 12% in Q1 2009 to $6.9M. But the majority of their effort is focused on health insurance rather than reforming the practices of the pharmaceutical industry.

Merck’s recommendations center on maintaining the current public-private system with the following insurance reforms: play or pay for employers, mandated catastrophic coverage for individuals, guaranteed issue, community rating by age, eliminating pre-existing conditions with continuous coverage, and equal tax treatment for individuals and businesses. Merck is against any “Medicare for All” options. But Medicaid should be available for individuals up to 100% of the federal poverty level. Subsidies should be provided for private plan participants with incomes up to 300% of the federal poverty level.

Merck claims they support The Comparative Effectiveness Research Act of 2008, along with “more research and public dissemination of cost and quality”, and more transparent pricing. But Frazier really is not interested in the government determining cost effectiveness of drugs, only “comparative effectiveness” (efficacy). Merck does not want the government to say that the slight benefit of one drug over another is not worth the cost difference, or a drug is not worth its cost at all. This is a critical area were consumers need help.

Merck chooses not to address any of the pharmaceutical industries practices that drive up the cost of healthcare: direct to consumer advertising, life cycle management, and the ever expanding use of cholesterol and other lifestyle drugs. Direct to consumer advertising has created diseases and consumer fears where often no treatment is required. The idea is to create awareness that a slight pain or ache is really a serious problem. The advertisements say one disappointing evening leads to dependency on ED medications, or too many trips to the bathroom can spoil your day. Fortunately, the recession has stunted the effectiveness of direct to consumer advertising.

Life cycle management is a far more sinister version of the new and improved Tide syndrome. First, once a drug is approved, price increases one or more times a year are common. After the R&D and manufacturing startup costs are fully amortized, there is no free market explanation for price increases. The pharmaceutical market lacks any free market discipline; it functions more like an oligopoly. Merck is staunchly against the re-importation of drugs and Medicare Part D directly negotiating drug prices. Merck must believe that Americans should pay the highest price in the world for drugs.

Life cycle management part two is even more difficult to defend. The year before a drug’s patent is due to expire and be subject to generic competition its price is raised significantly. The new and improved version is much cheaper to attract all of the new prescriptions. Patients on the new and improved drug cannot easily be switched back to the generic form of the old drug. This transitioning severely weakens generic competition. A true free market would never support the volume of branded statins with so many generics available.

Lifestyle drugs for cholesterol, high blood pressure, asthma inhalers and others have been the lifeblood of the traditional pharmaceutical industry for the last two decades. Each year the disease delineation line for cholesterol and blood pressure are systematically lowered so more Americans fall into the group that needs treatment. Merck does not want the government to challenge the cost effectiveness of constantly expanding the target audience for lifestyle drugs. Pfizer (PFE) sees this ending and is dropping out of the cholesterol business once the patents for Lipitor expire.

Drug pricing has become much like the due diligence of corporate compensation committees. Drugs are priced to equal their peers, not compete against their peers on price. Competition is the roles of sales and marketing, in a world where cost is of no object.

In conclusion, Merck has not told us specifically how they are preparing to be a more cost effective participant in healthcare reform. Can Merck maintain its profitability as a low cost drug producer? Can Merck withstand world pricing coming to the American market? What changes in marketing and distribution would be required for Merck to compete under President Obama’s vision of healthcare?

Disclosure: Author is long PFE.

Merck and UnitedHealth Group Unprepared for Obama’s Healthcare Reform

2009-04-21T21:47:00.000-04:00

Published by clickbroker.blogspot.com

In two Tuesday Q1 earnings conference calls, one at 8:30 AM and one at 11:00 AM, I got the notions of Alice in Wonderland and an ostrich with its head in the sand. Neither Merck (MRK) nor UnitedHealth Group (UNH) really believes that President Obama and the Democrats can actually pull off a healthcare revolution. Both half heartedly said that some type of reform is coming, but neither showed any deviations from business as usual as they continue to deteriorate.

Let’s look at Merck first. Overall sales dropped 8% and sales of Gardasil dropped 39%, Vytorin dropped 28%, and Fosimax went generic. And Merck still believes that the Schering-Plough (SGP) merger still makes sense. According to Merck, it’s just the economy and distributors running down inventory. Consumer behavior has not really changed and their lobbyists will never allow Congress to pass funding for efficacy and cost effectiveness drug comparisons.

As soon as the distributors start restocking, Merck will be fine their thinking goes. Merck did admit that consumers appeared to be delaying doctor visits, but they intend to ramp up direct to consumer advertising to remedy that. Apparently, Merck was not listening to Larry Summers this Sunday when he said that comparative analysis of medical procedures and pharmaceuticals could save the nation up to $700B over a decade.

Gardasil is on the way to becoming a flop, and Vytorin is just another me-too statin. If Merck cannot provide true cost effective value during the healthcare revolution, it will become a generic of itself. Maybe that’s the idea behind Merck BioVentures.

Here I go again ranting that UnitedHealth just does not get it. Membership dropped by 1.5M due to job losses, but government programs (Medicare and Medicaid) were steady. UnitedHealth has not seen any evidence of adverse selection through COBRA, however analysts were concerned.

The economy has not caused their 3M high-deductible plan members to cut back on usage so far. So UnitedHealth will start feeling the impact once the deductibles are broke. UnitedHealth tried to make sure analysts understood the seasonality of deductibles. UnitedHealth touted these plans as private sector initiatives to save money, but did not recognize that the political climate has changed and President Obama wants everyone to be covered by comprehensive health insurance.

In defending their Medicare Advantage plans, UnitedHealth stated that their selection of superior doctors and hospitals prevented far more readmissions than standard Medicare. Again, President Obama doesn’t see any statistical evidence of better outcomes from Medicare Advantage. Although Medicare Advantage reimbursements were reduced 5% this year, UnitedHealth believes they will be able to negotiate a better deal. This is further evidence that UnitedHealth will be buried next year.

UnitedHealth provided mixed answers when questioned on their preparation for the government plan option for consumers. They said the “Medicare for All” plan is just a concept so they could not analyze the impact. UnitedHealth might benefit as an administrator was the initial response. Then their political hack lambasted a government plan saying Medicare-like price controls would mean a 29% reduction in hospital reimbursements and a 19% drop in doctor reimbursements. Sorry UnitedHealth, sharp cost reductions is exactly what President Obama wants.

Both Merck and UnitedHealth are inefficient Goliaths of the statin pumping generation. Think of the wrenching changes IBM (IBM) went through to evolve from the mainframe generation and you’ll understand what Merck and UnitedHealth must do to survive and become economically viable in the healthcare revolution.

No disclosures.

Fed’s Backdoor to Negative Interest Rates

2009-04-20T16:05:00.002-04:00

Published by clickbroker.blogspot.com

By now, every living cable viewing being has seen the P90X infomercial touting the fitness benefits of “muscle confusion.” Their theory is that bulk building plateaus when your muscles get used to the same movements. The secret goes, mix up your routine and you’ll get extraordinary results. Faster results than you ever dreamed possible.

From the YouTube videos of the P90X cult followers, we get the real life before and after pictures by week for the first 90 days. You may want to hide your eyes. While the laptop cam reality players haven’t lost their enthusiasm, they admitted they are having trouble keeping up with the program. And confused or not the reality players don’t match the muscle tone or bulk of the infomercial actors.

The confusion that Federal Reserve Chairman Ben Bernanke has created over the last two years has not done anything to improve the nation’s brain tissue bulk or toning either. Even a man of substantial physical and mental bulk, former Federal Reserve Chairman Paul Volcker has verbally challenged Bernanke’s 2% inflation target. If Volcker doesn’t get it, than there is little hope for the rest of us.

That is until The New York Times’ “It May Be Time for the Fed to Go Negative” explains Bernanke’s logic. The Fed has already lowered short-term interests to zero, and the numerous other credit creation programs are doing little to motivate consumers to actually spend. Increasing the supply of credit is like leading the horse to water, but as the say goes, getting the horse to drink is another matter.

Asking consumers to accept the bank charging them for their savings account or CD is as fortuitous as borrowing $100 from the bank and only having to pay back $97. Bank of America (BAC) CEO Ken Lewis said in the Q1 conference call that deposit interest rates needed to attract savers have reached their cycle low, so the NYT example of a negative 3% interest rate will never happen. Savers would keep their money in a safe deposit box and lenders just wouldn’t lend. Just like the behavior of gold.

Helicopter Ben is not one to be stopped by the constraints of mere mortal behavior. The Fed has historically lowered interest rates below inflation to motivate spending. And we have had negative real interest in many periods of our financial history. What is different this time is that nominal short-term interest rates are already at zero, so even Bernanke has to admit that they cannot be lowered any more.

So if Bernanke cannot lower nominal interest rates, but still wants to cut real interest rates further what does he do? The NYT hit the jackpot; create the belief of sustained inflation for the foreseeable future. Higher perceived future inflation implies greater negative real interest rates and greater enticement for businesses and consumers to spend now. So you see my dear Watson, interest rates really can go below zero.

In order for Bernanke to motivate spending, the inflation fear has to be large enough and sustained enough to overcome the hoarding instinct in times of economic fear. Sorting through the confusion of Bernanke’s mixed messages cannot be any clearer. Sustained and increasingly negative real interest rates for the next decade is the message to the finically astute. And excess liquidity will be removed before inflation starts is the message for the politicians and the general public. Trouble is Volcker caught Bernanke and his cohorts with their shoes untied.

Bernanke’s P90X program is perfectly clear: The Fed is bulking up on inflation, whether its muscles are confused or not.

Disclosure: Author is long BAC.