Archive: Jul 2009


For about six weeks, from the beginning of June to the middle of July, I didn’t write a word for Economic Sociology, interrupting my steady two-posts-a-month rate.  I wasn’t on vacation, but instead spending a lot of time with German doctors, trying to figure out why I suddenly couldn’t walk, sleep or eat without pain. I was sick, unable to walk a single step without holding onto something for support, and just miserable 24/7. It would have been a drag in any context, but trying to get help in a foreign language, in a country that is not exactly warmly disposed toward foreigners, made the whole situation very difficult.

One of the best parts of the experience, however, was a very small thing that made seeking medical help a lot less stressful: the segregation of the business part of a medical practice (the part that does billing and takes in payments) from the care-giving part. That means when you go to a doctor’s office, everyone from the office staff to the physician’s assistants to the doctors are focused on the same things that you are as a patient: dealing with what ails you. That’s what people in the business school world call “alignment of interests,” and it works very well in terms of minimizing the roadblocks between people in need of care and those who can provide it.

This separation of business from care in medicine also has a surprisingly comforting aspect emotionally, particularly if you’re used to a system in which the business part of medicine is inextricable from the care part. Though they are intertwined, they don’t work very well together. I think this is because, as Viviana Zelizer pointed out years ago in her article “Payments and Social Ties” (1996), the notions of “care” and “payment” are essentially antagonistic.

Probably every American has a story about the ways that the business part of a medical practice obstructed his or her ability to get care. I once knew a woman who, despite being well-insured, was harassed in her hospital bed by a billing department employee demanding to know how she–still groggy and in pain from an operation to save her life–was going to pay for her treatment; the hospital employee strongly implied that the woman would be “evicted” from her bed if she couldn’t prove that her bills would be paid. That apparently seemed like reasonable behavior to the hospital employee, “just doing her job” by looking out for the hospital’s business interests; the ethics of badgering an ill and vulnerable woman just out of surgery–in other words, the ethic of care–didn’t enter into the discussion.

For a few more–documented!–stories of this type, and an articulate, compelling discussion, check out “Health Care and Profits Don’t Mix” by Elizabeth Mika. (And try not to get mauled by a bear.)

These anecdotes do not argue against compensation for doctors–or any other caregivers, professional or otherwise. Rather, the point is that the motivations and incentives in relationships mediated by payment are often at odds with the motivations and incentives that we think are supposed to govern relationships defined by the term “care giving.” This is one reason many people have such a strong negative emotional response to the idea of paying stay-at-home spouses for their housework: the spouses are supposed to keep house, and possibly rear children, out of love and caring, not a desire to get paid; plus, there’s the fear that if stay-at-home spouses were paid, their emotional attachments to family members would deteriorate, replaced by a more impersonal employer-employee dynamic.

Back to Germany: Doctors certainly get paid for their services here, and seem to make a nice living. But when you walk into the reception area of their practices, you don’t see any apparatus for handling money: no credit card runners, no cash registers, nothing. All that is outsourced to firms located outside the doctors’ offices, often in different cities. Those outsource firms send a bill to your insurance firm, or–if you’re like me and have to pay every penny out of pocket–to you, the patient. Surprisingly, this doesn’t create the kind of snarled bureaucratic nightmare I would have expected: when I had questions about a bill from one of those outsource firms, I took the bill and the questions directly to my doctor, who called in his office assistant, and together they got on the phone with the billing firm and straightened things out for me on the spot.

This means that when you visit a doctor in Germany, the whole event is aligned around care from start to finish. That doesn’t make medicine a charitable undertaking, as some of the straw-man arguments in the US health care debate might lead you to think. Doctors here show no signs of having a forced choice between “doing well” and “doing good;” that distinction was also long held inviolate in the world of investing, and while the evidence has been around for over 15 years showing it to be a crock, it’s one of those snippets of economic ideology that seems impervious to reality.

Nor do patients face “rationing” of services in this system–apparently, the kinds of “socialized medicine” horror stories that Americans hear so often when we start talking about health care reform are drawn primarily from models like the NHS in Britian. Based on accounts from NHS patients, doctors and British politicians, that horror seems well-founded.

But not all “socialized medicine” is created equal, as it turns out. This came as a big surprise to me, child of the Reagan 80s, when I spent a year of high school in France and realized that a) it was being governed by the socialist party, and had been for some time, and b) people there had a much higher quality of life than most people I knew back in my suburban Chicago milieu. And nobody, ever, complained about the quality or availability of health care. So it wasn’t surprising to learn recently that independent studies by the United Nations and academic institutions (outside of France) ranked the French health care system the best in the world:

So this year [2008], two researchers at the London School of Hygiene and Tropical Medicine measured something called the “amenable mortality.” Basically, it’s a measure of deaths that could have been prevented with good health care. The researchers looked at health care in 19 industrialized nations. Again, France came in first. The United States was last.

Germany only made it to 12th on that list, but still–in nearly three years here, I have never heard a peep against the health care system, and certainly nothing remotely like the tragic litany of needless suffering (emotional and physical) and death that we hear in connection with the US system.

The French and German health care systems have another thing in common: they involve money (indeed, they are quite costly), but people living under both systems seem perfectly content to pay for the care they get, whether they do so out of pocket (like me) or through income taxes and health insurance premiums (like the majority). A big reason for that is quality: generally, people are willing to pay when they perceive they are getting value for their money. At the same time, in both systems as I’ve experienced them, the actual business of payment is kept physically separate from the provision of care.

I’m arguing that this segregation of business and care in medical services is not incidental to the subjective experience of quality and value on the part of the patient. Not having to deal with the “show me the money” issues up front, when you come to a doctor’s office or an ER in pain, makes a huge positive difference from a patient’s perspective. I hope that more Americans will get to test my claims for themselves, on home soil, rather than having to come to Europe to experience the enormous difference that such a simple change can make.

"¿Quién es más macho?"
"¿Quién es más macho?"

This post was inspired by an exchange I had last month with my friend Steve Murphy, who used to work on the NYSE and is one of the most informed, thoughtful, up-to-date people I know on world affairs. He regularly mass-mails his musings on political events to a select list of friends—I like to call them Murph-o-Grams—and the one on Kim Jong-Il generated a discussion about the ways in which things like North Korea’s nuclear shenanigans get priced into the market.

One hears with some frequency about events, particularly risky ones, being “priced into the market,” but what does that actually mean? Who does the pricing? And how?



Here is the original Murph-o-Gram:


Kim Jong Il-tempered


How does one deal with an impudent baby who threatens to hold its breath until it dies? You let it. And so it is with North Korea’s Kim Jong-Il. Granted, his temper tantrums could have much more serious global consequences.

The “Dear Leader” is up to his same old tricks. The US has become better at ignoring his tactics and addressing his neighbors, who offer him the hope of refuge if he goes too far: China and Russia.

China has much to fear from a destabilized North Korea: millions of desperate refugees, a new government that may be even less responsive, loss of face internationally. Russia has much less to lose unless it turns out it belongs to the international network that has helped North Korea buy nukes. Even then, Russia seems not to care too much what the international community thinks.

The US seems to accept that North Korea is merely a stubborn regime that keeps its people unnecessarily impoverished. So long as we keep a close eye on it, allow China to determine whether action is taken, and do not give Russia an opportunity to feel superior, we have little to fear.

But this strategy of letting China take the lead in dealing with Kim Jong-Il has made it difficult for American political leaders to address the very real concerns of our allies, South Korea and Japan: they are playing along, but nuclear toys so close to home are not easily ignored. Obama is trying to do better than his predecessors by taking the issue to the UN…though considering the UN’s track record in dealing with bullies and megalomaniacs, Kim Jong-Il probably knows he has little to fear.

The financial markets mostly shrugged off the goings-on in North Korea, as well they should. Compared to everything else going on in the world, North Korea’s still-limited nuclear capabilities no longer rattle world markets, While the first nuclear tests conducted there did fray a nerve or two on global exchanges, repetition has dulled their impact.

North Korea only becomes a serious problem if it mishandles its nukes, or if China loses patience with Kim Jong-Il’s brinksmanship. So far, neither event has come to pass. What really matters in the markets now are signs of a rebound in GDP growth. As long as Dear Leader’s shenanigans pose no threat in that regard, North Korea remains little more than a carny sideshow as far as the financial world is concerned.


And here is the dialogue that followed:

Could you explain something to me in slightly more detail: why isn’t Wall Street more spooked by the prospect of a madman waving nukes around like a kid with a water pistol? Why is there such a heavy discount on the nuclear threat from Kim Jong-Il, when a nuclear strike would seem to harm the world economy WAY more than WorldCom fudging its books by 1 cent to meet earnings expectations. (Not that WorldCom was right, but that Dear-Leader-with-the-Nukes is so wrong.)

: To answer your question, I was kind of surprised myself. I came up with several reasons:

  • Boy who cried wolf syndrome
  • Pattern of only going so far also suggests a certain amount of rationality
  • Supply chain from South Korea/Japan is less important than it used to be
  • North Korea still cannot launch nukes successfully
  • Lack of alarm on the part of the US military (even during the North Korean launch a couple of months ago US military leaders were non-plussed)
  • Nuclear threat already priced into the market (based on nukes in Pakistan)

As for the WorldCom comparison, the standard financial analysis models in use at the time the scandal broke were highly dependent on the accuracy of SEC reports and on the trustworthiness of management. Outlier events like nuclear strikes were not given much weight in those models because they were (and still are) seen as a systemic risk—that is, part of the risk you are willing to bear just by entering the market. Finally, WorldCom did more than fudge a number—the company did not match revenues with liabilities, so the fear in the market was that there was more to the story.

As an observer, I agree with you: I am more concerned about loose nukes than I am about loose books, mostly because I never believed in the accuracy of accounting in the first place.

: Is there an economic solution to this problem? Any leverage the US (or the world community) can place on a guy who prints his own $100 bills by the stack?

: Any “solution” runs into the same road block: China. China does not want a regime change in North Korea unless it can control it. Right now, China seems happy to have the North Korea “bargaining chip” at their disposal. This allows China to say to any country bordering the Sea of China: “The US may be more powerful than we are, but we share your geographical location and interests. Moreover, we can control North Korea–the US can not.”

The best the US can do is tolerate the situation, at least until there is ample provocation that can both galvanize the US and embarrass China.

The US is stepping up its attack against money laundering in large part to stop funding of terrorist activities, of which North Korea’s actions fit the definition. Along the way, they are picking up many tax cheats. By not allowing North Korea to pass counterfeit money, they are strangling the head rather than the body. The problem is, this approach takes time to be effective. On the plus side, it is hard for anyone to argue in favor of money laundering, so the US will catch no flack from the international community for attacking North Korea on this front.

: So I get your point that KJI looks like the boy who cried wolf—it’s hard to take him seriously now, and he seems to have a finely-tuned sense of where the boundaries of “going too far” lie…so he puts his toes right on the line, but goes no further.

Just to clarify, can you explain exactly how the risks posed by nuclear weapons (in North Korea, Pakistan or wherever) get “priced in” to the market, and by whom? Do analysts actually sit around modeling “chances of nuclear disaster” when making recommendations? Or do traders on the floor do the pricing-in? Or is it really several parties at once involved in the pricing-in process?

: The nuke issue gets priced in several ways. The one way it does not get priced in is through traders, on the floor or otherwise. It gets priced in by “investors”—that is, by money managers, hedge funds, institutions, etc. It also gets priced in by companies, banks, and anyone else whose financial interest in pricing that risk accurately makes it cost-effective to undertake the expense of an Enterprise Risk Management operation (ERM). By and large, ERM divisions tend to be small; I’d guess that in general, they cost firms less than 1% of revenues.

Threats considered by ERM staff typically run the gamut from the mundane (inflation at 1-2%) to the highly unlikely (the French winning a significant military conflict). For the most part, though, ERM staff focus on events likely to have the biggest impact on a particular firm and its industry. If the firm is a manufacturer with a global supply chain, anything that might disrupt that chain receives the lion’s share of attention in ERM: that could range from resource scarcity, to weather, political unrest, and changing social norms. If the firm is strictly trading financial instruments, the focus will be more on economic issues, news events, reaction times (which involve technology like crackberries—remember when that service was disrupted?), and collinearities (i.e., as the US dollar gets stronger, the price of gold rises). The work of ERM is never quite done. There are all sorts of scenarios to think up and action plans to prepare.

So to protect itself and reassure analysts and investors, Nestlé might employ a few analysts who devise all sorts of ways their operations could be disrupted, including what scenarios would likely ensue and how the company could respond to each. For example, a malaria outbreak in Cote d’Ivoire would interrupt cacao shipments from Senegal to Christchurch (New Zealand), thereby limiting supplies to Sydney. Therefore, Nestlé might have in place a plan to buy excess capacity in Manila, for which they pay a monthly premium, almost like insurance. The premium would be paid to whomever was obligated to make the delivery of the cacao: it could be a storage firm holding the commodity on a “just in case” basis, selling it off as their obligation ends; or it could be a plantation owner who normally sells his crop to a local confectioner, but in a pinch will stop selling to the local and sell to Nestlé instead; or it might go to a government holding a monopoly on production of the commodity. You can see how this can get quite complex (and quite politically muddy) very quickly. This is where firms like Morgan Stanley step in to make a buck in return for simplifying matters: they can sell Nestlé a derivative based on malaria outbreaks in Western Africa, creating the same kind of “insurance policy” at lower cost.

As for money managers, especially macro investors like George Soros, they might make financial bets on the likelihood of certain events (the end of the war in Sri Lanka, or a nuclear strike) that threaten markets worldwide, rather than particular companies. So unlike an airplane manufacturer or a Nestlé, a money manager’s ERM strategy focuses on the outcomes of elections, the workings of legislatures, or general economic efficiency in a country or region. Macro investors look for movements on a global scale—like the flow of funds into India and into Central Europe—rather than fluctuations in the prices of individual stocks, This aggregate perspective on risk also means that money managers hedge differently than individual firms do. Instead of taking out “insurance” on the supply of cacao or other production resources, money managers hedge through placements in the currency, commodity, equity or bond markets.

But the really important thing about money managers’ view of risk is how they model it, and how that results in their seemingly blasé responses to disturbing news like nuclear tests by Kim Jong-Il. Money managers’ models treat risk in a much more general way than the ERM of individual firms. So when money managers model market risk to include factors such as “likelihood of a nuclear strike,” location assumptions are irrelevant: the overall likelihood of the strike remains constant no matter whether the threat du jour comes from Iran, Pakistan or North Korea. Furthermore, information about new threats, such as Pakistani nukes falling into Taliban hands, would be treated in the money managers’ risk models as a change only in the overall likelihood of a strike happening somewhere in the world—that is, an incremental change, rather than a cause for reevaluating the model.

These are highly simplified examples, since the real models in use often have thousands of variables, but here’s what it means for our subject, pricing in the risks posed by Kim Jong-Il and his nukes. While it’s widely assumed that he has some sort of nuclear capability, his threats (and tests) are at best loosely related to his actual likelihood of deploying the weapons. That’s why, while each of his threats may make the news, we can say that the actual risk he presents (in terms of deployment ) has already been “priced in” to most financial models.

: What exactly is the US government doing to prevent North Korea from counterfeiting dollars successfully? I know about the changes in the bill design, of course, but do you know whether the US is attacking the problem primarily at the level of technology (i.e., preventing North Korea from obtaining the engraving machines used by the US mint, or just changing the designs so much that it’s hard for counterfeiters to keep up?) or at the level of transactions (that is, once the money has been counterfeited, making it difficult to pass it off as legit)? Is North Korea the worst offender when it comes to counterfeiting, or does it have competition from the other fraud capitals of the world, like Nigeria? (By the way, isn’t it interesting that countries seem to specialize in types of fraud? In Nigeria, it’s the 419 scam; in North Korea, it’s counterfeiting; and god knows what else in other parts of the world…)

: As for the counterfeiting, so far as I can tell, the Treasury wants to keep the fight as quiet as possible. They seem to be attacking the demand and distribution more than the supply. The ability to track money is highly refined. To be able to launder stacks of cash is very difficult. For a willing accomplice, the price is very high and reduces the incentive, unless the incentive is to destroy the dollar and the US. I do not think that is the intent in North Korea. The regime likes their luxuries too much.

The sophisticated nuclear sales group led by Pakistani nuclear scientist and arms dealer Abdul Khadeer Khan is not going to accept counterfeit bills. However, an Iraqi selling a Rocket-Powered Grenade on the street might be an unwitting victim. In any case, laundering that much counterfeit money would be very difficult. Compared to the money supply, which is around US$1.5 trillion, several billions of counterfeit is annoyingly acceptable. So while the US is certainly aware of and working toward stymieing counterfeiting (recall the freeze placed on all Macao bank accounts tied to North Korea in 2005) they are not looking for much publicity.

Of course, I could see an ironic situation where Hugo Chavez accepts North Korean counterfeit cash for payments—whether for Venezuelan oil or for any other transaction in which Venezuela might act as a middle-man—and then uses it to bail out Cuba…and round it goes, with only sworn enemies of the US trading on the assumed faith of a currency that does not exist. But that would be for the limited CSPAN audience.


* To my chagrin, I will not win any originality points for this dreadful pun. I can only say that others have punned worse, and often, on this subject. Google “How Do You Solve a Problem Like Korea” if you dare.

** ERM can range from a curmudgeonly troll in the basement, to a simple software program, to an outsourced quarterly report, to a whole in-house division of PhDs in statistical modeling. How a company approaches ERM depends on the personality and sophistication of the management, including the board of directors. A financial services company can create an ERM strategy quite easily and cheaply by creating a spreadsheet of its positions and hedging the aggregate position of the firm. A simple example: say a firm is long on 10 stocks in the DJIA and short on 20 DJIA stocks; to hedge its risk, it should buy enough futures contracts to balance out its long and short positions, and have a plan in place to unwind the future position once the Dow positions are liquidated.

Here’s a more complex scenario showing why a firm might find it economically valuable to have an ERM in place, both for internal use and as a signal to financial analysts that the firm is stable and reliable, even in times of crisis. Say Boeing or one of the other airplane manufacturers actually studied the impact on the aerospace industry of a terrorist using a plane as a missile. And say their analysis showed major short-term disruption in air travel (a couple of days), followed by a period of greatly reduced traffic (like a 50% reduction in passengers for a few months), culminating in a steady climb back to pre-attack levels. So when a catastrophe like 9-11 happens, the firm can brief the analysts covering their stock, showing that the firm has a response plan in place, such slowing down spending but not cancelling all projects, stretching costs out until growth is expected to resume, etcetera. Having a clear plan in place would impressed analysts and investors, meaning that the firm’s stock dropped less than others in the industry One thing is certain, an effective ERM must have access to all the details of every division in the firm. As a recent example of doing this successfully, consider Goldman Sachs, which just reported its forecast-beating $3.44 billion profit for the second quarter of 2009. ERM was a factor in the firm’s ability to prosper in the midst of chaos and economic dire straits in the rest of the financial services industry. That’s because GS saw its exposure to sub-prime mortgages as a risk and hedged against it. For the first couple of of quarters, the hedging investment looked like wasted money, but eventually it paid off. (BH: Understatement of the year?)