Friday, May 19, 2017

Russiagate moves ahead

A new post appears here.

Friday, May 12, 2017

The Hedge Fund Economy

This week I read Black Edge by Sheelah Kolhatkar, a reporter, about the battle between the SEC and the New York US Attorney's Office on the one hand, and SAC Capital, the hedge fund run by Steven Cohen, on the other.  Although no one seems to want to talk about it very much (including Terry Gross and Kolhatkar when the author appeared on Fresh Air), the story is obviously the inspiration for the superb HBO series Billions, which just finished its second season.  The book offers extraordinary insight into the world of hedge funds, which have become so important within our whole economy.  Rather than review it in detail, I am going to talk about the biggest lessons that I learned from it.

Although I also read a history of hedge funds by Sebastian Mallaby and blogged about it here, I am still quite unclear as to how this key new financial institution got off the ground and became so powerful.  Kolhatkar indicates that regulators allowed them to operate far more freely than banks, on the assumption that their investors would be wealthy enough to take risks. Many of their investors, of course, hvae turned out to be institutions like pension funds.  In any case, many of the funds--led by SAC Capital--generated extraordinarily, Madoff-like returns for decades.   The returns vastly exceeded the growth rate of the economy, and thus contributed to the growth of inequality in our society.  The question that hangs over the book, and became key to the prosecutions of various hedge fund traders, was exactly how they did it.

It is impossible, sadly, to disaggregate the answer to that question, but it is clear that many of the profits came from inside information.  The old model of investing, represented by Lou, the GI character played by Hal Holbrook in Wall Street, involved identifying a promising company and investing to secure a share of its profits.  That model seems to be moribund, if not dead.  A more common model involves bets on a sudden rise or fall of a stock, based on an event such as the release of an earnings report or the results of a clinical trial of a drug.  It doesn't matter whether the news is bad, what matters is to know what the news will be before it is public, in order to short the company's stock or buy more of it before the news has moved the market.  Traders are gamblers, and all gamblers prefer to bet on sure things.  The problem, of course, is that such trading on inside information has been illegal, for good reason, for more than 80 years.

In a rational world moved by civic virtue, I think, a Congressional committee would long ago have done a multi-year investigation of hedge funds in an effort to find out roughly how much of their profits come from illegal inside information.  I have no idea exactly what it would find, but it could be high enough to suggest that a law making their operation illegal would be in the public interest.  What Kolhatkar does show is that information has become a huge business.  Entire stand-alone firms have formed to become intimate with firms in various industries.  Hedge funds pay them retainers for their information.  They evidently feel that they are getting their money's worth.  I got the impression that these firms, as well as some traders, work more like intelligence agents than anything else, trying to win the confidence, or intimidate, or corrupt sources of valuable information by any available means.  We shall return to this issue in a few minutes, after looking at the ennvironment within the funds

I am increasingly depressed by the lack of institutional loyalty in today's world.  From academia through the financial world and into medical care, politics, and government, fewer and fewer people, it seems to me, seem to care about the long-term future of the institutions they work for, or for their fellow employees.  Most care only about what they can get out of their institution.  I have to admit that I have been a devoted fan of Survivor since it began, even though I am always depressed by the inability of most of the contestants to focus on the interests of their particular tribe, even in the first stage of the game when individuals' fortunes depend largely on the fortunes of their tribe.  And this tendency has if anything gotten worse as Millennials, who were supposed to be team players, replaced Gen Xers in the contestant pool.  This is the way many hedge funds are organized as well.  Cohen at SAC gave individual traders huge leeway and did not oversee their operations closely--but he expected them to provide him with their best information and allow him to profit from it.  That kept him at one remove from the information itself, and that is what in the end saved most of his fortune and his freedom from the US Attorney's office.

What is so maddening about the story of the insider trading prosecutions, to those of us who care about the law and have a reasonably good head for figures, is that insider trading is anything but difficult to detect.  Like large-scale bets on a fixed sporting event, the evidence is unequivocal and obvious.   To cite a related example, in the early 1980s, the Pennsylvania daily lottery was fixed to as to produce the number 666 by infiltrators into the TV studio that drew the number with the help of numbered ping pong balls.  On the afternoon before the drawing law enforcement received numerous calls from illegal numbers brokers predicting the fixed outcome--which was the only possible way to explain the deluge of bets they were receiving on 666.  A sudden, large purchase or short of a stock just days before important information about the stock reaches the public is virtually a confession of guilt.  But the courts do not accept that kind of evidence--it is necessary to show exactly whom the information came from and how it was acquired.  

Cohen was implicated in two trades. The first involved a leak of an earnings report from the computer manufacturer Dell.  An SAC trader named Michael Steinberg was indeed convicted of insider trading in that case.  But in a catastrophic decision in a similar case in December 2014, an appeals court overturned another insider trading case, rebuked Southern District prosecutor Preet Bharara for an overly aggressive strategy, and declared that traders who used inside information that they obtained from a third party, rather than from some one in the firm involved, were not guilty.  That led to the dismissal of Steinberg's case as well.  The Supreme Court has repudiated that decision, but the state of the law remains very unclear.   The second case, which was widely publicized, involved an Alzheimer's drug trial.  An SAC trader named Matthew Martoma had spent years cultivating an elderly University of Michigan Med School professor, Sid Gilman, who was involved in the trial.  (Martoma, it turned out, had previously forged his Harvard Law School transcript to try to get a prestigious clerkship.)  Gilman had collected hundreds of thousands of consulting fees from the financial industry, and eventually provided Martoma with his power point presentation on the disappointing results of a clinical trial.  Martoma had emailed these results to Cohen, who had promptly shorted the drug company's stock on a large scale.

Martoma, who refused to cooperate with the government and testify against Cohen, was convicted and received a long sentence.  But after a long conference with Cohen's well-heeled attorneys--essentially, a dry run for a trial, without judge or jury--Bharara's office decided not to risk a trial that they might lose.  Cohen escaped with a fine that, while huge by ordinary standards, represented a fraction of his assets.  He also had to shut down SAC capital but continues to trade on his own behalf.  (This was exactly the deal that "Axe," played by Damian Lewis, turned down during the first season of Billions.)  Martoma had actually sent Cohen an email just before Cohen began shorting the drug company's stock, but the prosecutors were worried that they could not prove that he had read it.  It has become notoriously easy for prosecutors to put any poor person in jail that they choose, by threatening them with draconian sentences if they will not plea.  Black Edge and the history of the Obama Administration and the big banks show that it is nearly impossible to put the superrich behind bars.

I was most struck, in all this, by the ethos--or pathology--that seems to rule the hedge fund world.  Everyone wants a spectacular result, and inside information is the easiest way to get one.  But when you have done it once, it seems, you feel greater pressure to do it again, forcing you to look harder for the next coup.  These traders, who siphon many billions out of our economy every year to inflate the high end housing and art markets, are addicted to large sums of money, which function, for them, like opiates for millions of their fellow citizens.  They are addicted to huge sums of money.  The cure is simple, and it is one that the country tried from about 1940 until 1964: 91% marginal tax rates above a certain amount.  But under current tax law hedge fund traders pay lower taxes than the rest of us, through the carried interest loophole.  We are all feeding their addiction.

And what it means for addicts to have such power was succinctly stated by Gus Fring, played by Giancarlo Esposito, in my favorite moment of Breaking Bad, when Walter White and his partner Jesse came to meet Gus at Pollos Hermanos, but waited all day without making contact.  Jesse eventually left, and Walter took the bull by the horns, went up to the counter, and confronted Gus.

Gus explained why he didn't want to work with Walter. "I don't think you are a cautious man, Mr. White," he said.  "Your partner was late. And he was high. He's often high, isn't he?"

Walter replied that while that was true, his partner was someone that he could trust.

"You can never trust a drug addict, Mr. White," Gus replied.

Saturday, May 06, 2017

Whom is health insurance for?

I was not planning to make another post this weekend, but my New York Times this morning includes an op-ed by a physician and medical school professor named Marc K. Siegel.  [Don't miss the post on Trump and Andrew Jackson, below.]  Dr. Siegel ran into an ambush when his thoughts reached my eyes, because he said something in simple, clear language, which had already occurred to me as the dirty secret of the Republican health care bill in general and the issue of "pre-existing conditions."  This is what he said.

"In addition to limiting the menu of essential benefits, the House bill would let states create high-risk pools for patients with pre-existing conditions who had let their insurance coverage lapse, and who could then be charged premiums more in keeping with their health care needs. This is the only way to make insurance affordable for most consumers; pre-existing conditions will continue to drive up premiums if everyone is compelled to pay the same price."

Now my idea of health insurance is that we all pay into it because we will all become sick from time to time, and we may become very seriously ill.  Many of us will never need extremely expensive treatments, but many will, and we can't tell who they will be. Thus our investment is very bit as reasonable as our investment in fire insurance.  But Dr. Siegel has a very different view.

What, in fewer syllabus, as a "patient with a pre-existing condition?"  Answer: a sick patient, one who needs treatment right now, and may need it for a long time. Alternatively, it may be someone whose medical history substantially increases the likelihood that they will get sick and need treatment in the future.   And I had realized as I read a news story about the House bill last week that this was the key to debate.  The insurance industry, bless their hearts, loves insuring healthy people but hates insuring sick people.  Like just about every other corporation in America they are focused on their bottom line, which healthy people improve and sick people make worse.  Somewhere in the course of his medical career Dr. Siegel seems to have forgotten the point of health insurance: to pay for treatment when people need it.  He doesn't think that healthy people's premiums ought to be high enough to pay for treatment for people who are actually sick. [Incidentally, Dr. Siegel, if this post comes to your attention and you want to reply to it here, you can have all the space you want.)

I have heard other stories over the years about the insurance industry's point of view.  A dear friend of mine who co-owned a thriving small business got cancer many years ago, and needed an expensive procedure.   The procedure was an unqualified success in the short and medium run, and he survived for 8 years of happy and productive life as a result.  But no sooner had he initially gotten well, than the insurance company that provided a group plan for his business (of a couple of dozen employees) hit the company with a tremendous increase in its premium.  Now that he had turned out actually to need the insurance, they wanted him and the company, in effect, to pay the claim.  Fortunately he was able to get insurance through his spouse instead, which solved the company's problem.  

Now, of course, if people waited, as many do, to seek  insurance until they are already sick, that's a problem about which insurers have the right to complain.  One solution is a mandate requiring them to buy it, which Obamacare includes but the new Republican bill does not.  A second solution which the Obama administration did not try to adopt is the Medicare solution in which payroll taxes (or conceivably other taxes) fund the health care system.  But the idea of "high risk pools," even if they work--which they generally have failed to do--is in my opinion a travesty that ignores the whole point of health insurance, by separating those who really need it from the rest of us.

It is quite possible that the Obamacare premium increases over the last couple of years reflected the need to include sick people, as well as the end of some payments to make such coverage more affordable that apparently ended after 2014.  And it is certain that health insurance is too expensive because of problems inherent in American medicine that Dr. Siegel also mentions, such as the cost of new devices.  (He does not mention overdiagnosis and overtreatment, or the enormous amounts spent on end-of-life care.)  Attacking those problems should have come next on our list.  But the fantasy that we can solve the health insurance problem by taking sick people out of the normal health care system needs to be abandoned.  It is unworthy of a civilized society.

Thursday, May 04, 2017

Is Trump really like Andrew Jackson?

Andrew Jackson is getting a lot of attention lately, none of it favorable.  Meanwhile, President Trump, while rather vague on certain details of American history, has expressed admiration for him.  And many commentators have argued that they are, in fact, similar in important ways.  All this is hard for me to assimilate, because when I was growing up, Andrew Jackson was something of a liberal hero, if not quite of the stature of Jefferson or Lincoln or FDR.  He believed in more direct democracy, he hated financial privilege, he was supported by a coalition of workers and farmers, and Arthur Schlesinger Jr. had specifically painted him as a kind of prototype for FDR.  Now, of course, we are paying more attention to Jackson's status as a slave owner, and his involvement in the removal of Indian tribes to the west of the Missisippi.  I decided to spend a few minutes to try to rediscover who Jackson actually was--with particular reference to the question of whether he in fact had anythng in common with Donald Trump.

Neither time nor space permits an exhaustive examination of this question, but it didn't take long to find some interesting excerpts in his lengthy, careful annual messages to Congress.  This one comes from his first, in December 1829--and calls for direct popular election of the President! Here are Jackson's words.

"To the people belongs the right of electing their Chief Magistrate; it was never designed that their choice should in any case be defeated, either by the intervention of electoral colleges or by the agency confided, under certain contingencies, to the House of Representatives. Experience proves that in proportion as agents to execute the will of the people are multiplied there is danger of their wishes being frustrated. Some may be unfaithful; all are liable to err. So far, therefore, as the people can with convenience speak, it is safer for them to express their own will.

"The number of aspirants to the Presidency and the diversity of the interests which may influence their claims leave little reason to expect a choice in the first instance, and in that event the election must devolve on the House of Representatives, where it is obvious the will of the people may not be always ascertained, or, if ascertained, may not be regarded. From the mode of voting by States the choice is to be made by 24 votes, and it may often occur that one of these will be controlled by an individual Representative. Honors and offices are at the disposal of the successful candidate. Repeated ballotings may make it apparent that a single individual holds the cast in his hand. May he not be tempted to name his reward? , , ,

" I would therefore recommend such an amendment of the Constitution as may remove all intermediate agency in the election of the President and Vice-President. The mode may be so regulated as to preserve to each State its present relative weight in the election, and a failure in the first attempt may be provided for by confining the second to a choice between the two highest candidates. In connection with such an amendment it would seem advisable to limit the service of the Chief Magistrate to a single term of either 4 or 6 years. If, however, it should not be adopted, it is worthy of consideration whether a provision disqualifying for office the Representatives in Congress on whom such an election may have devolved would not be proper."

The abolition of the electoral college has become a favorite liberal demand, all the more so because Jackson's proposal, had it been embodied in the Constitution, would have kept both George W. Bush and Donald Trump out of the White House.  I don't have time to find out exactly how and why Jackson's proposal failed of adoption, but it appears to mark him as a genuine champion of the people's rule, albeit, of course, within the framework of his time, in which women were not allowed to vote and slavery still existed in 15 states.  There is, however, another aspect to this proposal, which casts it in a different light.

Jackson was in effect complaining that he was only in his first year in the White House instead of his fifth.  The party system had broken down in 1824 and he had run for President against three other candidates from the Democratic Party: William Crawford, John Quincy Adams, and Henry Clay.  Jackson had won the popular vote handily, but he had not won a majority in the electoral college and the election had gone to the House of Representatives.  There he had been bested by Adams, to whom Clay had thrown his support.  Then Adams made the great political blunder of his career by naming Clay Secretary of States, and cries of "corrupt bargain!" rang through the land.  Rather than tweeting that he had been the real winner, Jackson was more discreetly referring to these events in his address.  He may have been a sincere Democrat--but he could also hold a grudge.  Many years later, in retirement, he reportedly said that he had only two regrets--that he had never been able to shoot Henry Clay, or to hang John C. Calhoun.

A year later, in December 1829, Jackson commented on the quick, nearly bloodless revolution that had replaced the conservative Bourbon monarchy in France with the more liberal and constitutional rule of Louis Philippe.  He put this development in the context of world history, in which the United States was now playing a key role,

"The important modifications of their Government, effected with so much courage and wisdom by the people of France, afford a happy presage of their future course, and have naturally elicited from the kindred feelings of this nation that spontaneous and universal burst of applause in which you have participated. In congratulating you, my fellow citizens, upon an event so auspicious to the dearest interests of man- kind I do no more than respond to the voice of my country, without transcending in the slightest degree that salutary maxim of the illustrious Washington which enjoins an abstinence from all interference with the internal affairs of other nations. From a people exercising in the most unlimited degree the right of self-government, and enjoying, as derived from this proud characteristic, under the favor of Heaven, much of the happiness with which they are blessed; a people who can point in triumph to their free institutions and challenge comparison with the fruits they bear, as well as with the moderation, intelligence, and energy with which they are administered -- from such a people the deepest sympathy was to be expected in a struggle for the sacred principles of liberty, conducted in a spirit every way worthy of the cause, and crowned by a heroic moderation which has disarmed revolution of its terrors. Not withstanding the strong assurances which the man whom we so sincerely love and justly admire [I do not know to whom this referred] has given to the world of the high character of the present King of the French, and which if sustained to the end will secure to him the proud appellation of Patriot King, it is not in his success, but in that of the great principle which has borne him to the throne -- the paramount authority of the public will -- that the American people rejoice."

On the eve of his death only four years earlier, Jefferson had reiterated the hope that liberty, as expressed in the Declaration of Independence, would come to the whole world.  Jackson's remarks, praising the French step down this path, were in this tradition.  Two years later Britain also took a small step towards popular rule, when the Reform Act of 1832 became law.  Today our President is also praising a worldwide political trend--but this time the trend is towards authoritarianism, not towards democracy.  The President's long-standing admiration for Vladimir Putin is well known, but in recent weeks he has congratulated the Turkish President Erdogan on a vote that gave him even more power, invited the murderous President Duterte of the Philippines to Washington, and offered to meet with Kim Jong Un.  His Administration shows signs of becoming the first American administration specifically to endorse a trend towards authoritarianism--the opposite of what Jackson and other 19th century Presidents did

In the same message Jackson mentioned that the government had had to put down a rebellion, or independence movement, among the Choctaw and Chickasaw tribes in Alabama and Mississippi, and endorsed their removal to Indian territory in what is now Oklahoma.  But he made no attempt to conceal the hardship involved in these measures, while trying to put them in historical context.

"Humanity has often wept over the fate of the aborigines of this country, and Philanthropy has been long busily employed in devising means to avert it, but its progress has never for a moment been arrested, and one by one have many powerful tribes disappeared from the earth. To follow to the tomb the last of his race and to tread on the graves of extinct nations excite melancholy reflections. But true philanthropy reconciles the mind to these vicissitudes as it does to the extinction of one generation to make room for another. In the monuments and fortifications of an unknown people, spread over the extensive regions of the West, we behold the memorials of a once powerful race, which was exterminated or has disappeared to make room for the existing savage tribes. [He appears to be referring here to the Mound Builders.] Nor is there any thing in this which, upon a comprehensive view of the general interests of the human race, is to be regretted. Philanthropy could not wish to see this continent restored to the condition in which it was found by our forefathers. What good man would prefer a country covered with forests and ranged by a few thousand savages to our extensive Republic, studded with cities, towns, and prosperous farms, embellished with all the improvements which art can devise or industry execute, occupied by more than 12,000,000 happy people, and filled with all the blessings of liberty, civilization, and religion?

"The present policy of the Government is but a continuation of the same progressive change by a milder process. The tribes which occupied the countries now constituting the Eastern States were annihilated or have melted away to make room for the whites. The waves of population and civilization are rolling to the westward, and we now propose to acquire the countries occupied by the red men of the South and West by a fair exchange, and, at the expense of the United States, to send them to a land where their existence may be prolonged and perhaps made perpetual.
Doubtless it will be painful to leave the graves of their fathers; but what do they more than our ancestors did or than our children are now doing? To better their condition in an unknown land our forefathers left all that was dear in earthly objects. Our children by thousands yearly leave the land of their birth to seek new homes in distant regions. Does Humanity weep at these painful separations from every thing, animate and inanimate, with which the young heart has become entwined? Far from it. It is rather a source of joy that our country affords scope where our young population may range unconstrained in body or in mind, developing the power and faculties of man in their highest perfection."

Today, our universities have for decades been preoccupied with the faults of western civilization and the injuries that has inflicted upon other regions of the world, with the implication that history's course should certainly be held in place, if not reversed.  And a great many Americans have come to regard their nation's founding and growth as a crime.  I would suggest that it was almost impossible for an American of Jackson's age (born in 1767) to hold that view. They had experienced the Declaration of Independence, the Constitution, the Louisiana Purchase, and the formation of many new states.  They saw all this as a great human experiment in which they were the leading actors. And when Jackson pointed out that Indian civilizations had warred against one another even to the point of extinction before the arrival of the Europeans, he was only speaking the truth. I shall let my readers make their own judgments about Jackson's words and actions, and how they fit into the whole history of the United States.  But I do think today's US citizens might ask themselves if they truly repudiate what our ancestors did in creating the United States as it now is--keeping in mind that so many of us, white, black, brown and yellow, would never have existed had they not done so, since our ancestors would have been so unlikely to have met elsewhere.

I turn now to Jackson's most famous state paper, his veto of the renewal of the charter of the Bank of the United States in July 1832.  The Bank enjoyed special privileges under the law that created it which turned it into the equivalent of a European central bank, and Jackson complained that it had used those privileges to accumulate enormous power over the banking system, and enormous wealth at the expense of ordinary Americans.  He continued:

"It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes. Distinctions in society will always exist under every just government. Equality of talents, of education, or of wealth can not be produced by human institutions. In the full enjoyment of the gifts of Heaven and the fruits of superior industry, economy, and virtue, every man is equally entitled to protection by law; but when the laws undertake to add to these natural and just advantages artificial distinctions, to grant titles, gratuities, and exclusive privileges, to make the rich richer and the potent more powerful, the humble members of society--the farmers, mechanics, and laborers--who have neither the time nor the means of securing like favors to themselves, have a right to complain of the injustice of their Government. There are no necessary evils in government. Its evils exist only in its abuses. If it would confine itself to equal protection, and, as Heaven does its rains, shower its favors alike on the high and the low, the rich and the poor, it would be an unqualified blessing. In the act before me there seems to be a wide and unnecessary departure from these just principles."

It was this message, more than anything else, that established Jackson as the heir to the tradition of both political and economic democracy that was begun by Jefferson and elaborated upon by Wilson,  Franklin Roosevelt, and Lyndon Johnson in the twentieth century.  Today that tradition survives in Bernie Sanders and Elizabeth Warren--but they represent only one wing of the Democratic Party.  Donald Trump, needless to say, is completely outside that tradition and he and the Republicans in Congress want to destroy it.

It will not have escaped the reader's attention, meanwhile, that Andrew Jackson possessed a command of the English language of which Donald Trump never dreamed, and that he took his duties as President of the world's leading republic with a seriousness of which Trump would never be capable.  It has become fashionable to judge historical figures according to simple, binary moral standards, in which acts that even recognize, much less further, racism or sexism automatically mark men as evil.  I have attempted to suggest that Andrew Jackson is one of many figures from our history to whom these rules do less than justice.  And I have attempted to show clearly that any similarities between Trump and Andrew Jackson are far outweighed by enormous differences of political outlook and goals.