Keep Morgan Stanley Wannabes away from my Medicare

In a previous posting, “Shouldn’t we be careful what we feed to growth stocks?", companies using a high growth stock performance strategy were shown to be a questionable choice as the core of an intentionally stable and low risk market such as the residential mortgages. One could convincingly argue that aggressive pursuit of the growth model in the wrong industry brought on the accounting scandals when Fannie Mae, MCI, and ENRON manufactured growth in earnings by way of accounting fraud. These companies could not deliver the “promised” earnings so they made them up and helped usher in Sarbanes-Oxley.

Innovation is applauded as the indispensable ingredient to economic progress. Financial innovation in a lightly regulated market produced some unexpected and undesirable results in the run-up to 2006. The identity of those who actually benefited from financial innovations wasn’t always obvious but it’s probably not a very large group. Who incurred the collateral damage when the experiment went wrong is even less clear but is bigger and more diverse collection of people. When financial innovators explore a profitable but mature and stable business, it’s unlikely that the typical customer will benefit from the encounter.

Innovation itself may be over-rated. As Paul Volker said about recent financial innovation, the only useful one he had seen in the last 30 years was the automated teller machine (ATM) (http://www.telegraph.co.uk/finance/economics/6764177/Ex-Fed-chief-Paul-Volckers-telling-words-on-derivatives-industry.html).

Innovation is certainly indispensable if we are to find technical fixes to widespread problems: most obviously in energy production and storage. But it can’t be the excuse for tolerating wide divergence between client needs and shareholder preferences.

Health care alternatives

Last year’s health care “debate” featured the role of private sector for-profit companies as a legislative “deal breaker”. A government-run “public option” was contrasted with private health insurance companies: DMV versus IBM. The private choice was, for the most part, represented by the currently operating array of private health insurance companies. These companies are, on a region-by-region basis, functioning with relatively little competition. They manage profit growth by restricting their customer base (through filtering out certain pre-existing patient conditions) and controlling costs by denying treatment. This works for the senior management and the shareholders, but doesn’t serve well as a model if universal service is your objective.

The health care reform negotiations exposed several conflicts between lowering health cost and the likely behavior of the companies currently engaged in health care products and services. It’s difficult to imagine where a growth company fits into the health care delivery set out in anyone’s health reform scheme designed to expand coverage and reduce unit costs.

For instance, leading drug companies should not be counted on to produce cures, especially for “minor diseases”. The preferred product for a growth company has an increasing and long term revenue stream: a drug you have to take for the rest of your life subject to price increases, for instance, the cholesterol pills you see advertised on TV.

Among the least appealing revenue profile would be a cure that can be completed in a single cheap treatment: exactly what you’d want if your aim is to reduce overall costs.

Growth stock producers won’t be low cost source for medical devices such as scanners or for hospital management and health insurance. We currently have care providers that are motivated to increase revenue for each unit of production, whether they are doctors or expensive scanners located in a hospital. The doctor is expensive because she is trying to recover her cost incurred since entering medical school. The maker of the scanner is trying to make a high profit on top of recovering research and development costs. The hospital thinks it needs the scanner to compete for patients and then has to use it as much as possible to pay for it.

“Growth” companies may be good for some purposes, but they just won’t always give us what we consumers need. It’s a public policy error to assume they usually will.

It’s easy to point out ineffective management by government agencies, but operating under the assumption that profits will always drive in the direction of public interest has no foundation. In fact the banking collapse should be serving as a harsh warning.