Defenestrating Thoughts from the Bivouac

Back during the housing bubble, we didn’t buy a house and lots of people thought I was crazy, since “prices will always go up” so you need to “get in while you can”. Now that the bubble popped, lots of people are confused why we aren’t buying a house. We really want our own place, but I firmly believe that house prices will still continue to drop.

Sure, I could buy now and “ride it out”. But why buy today when I could wait a bit and pay tens of thousands less for the same house?

Saying “house prices will continue to drop” is not a popular opinion, but it’s what I expect will happen based on a simple supply and demand analysis. For the foreseeable future, I expect to see supply increasing and demand dropping. Barring massive economic interference from government policy, the combination of the two should drive down prices further.

#1 – It’s really tough to get a loan (decreased demand)

First, let’s look at the supply of money. During the housing bubble, a lot of demand was driven by “creative lending”. These non-traditional loans included all the usual suspects: zero down, negative amortization, no doc, option-arm, etc. Now, banks are being more careful and lending is trending back towards a tradition model of 20% down and more reasonable debt to income ratios. Since it’s harder to get a loan, fewer people can qualify for loans, so demand for houses is down (source).

On top of this, you have mortgage insurers who need to restructure and launch spin-offs in order to remain viable. As it gets harder to mortgage insurance, people are going to need bigger downpayments, which again reduces demand.

#2 – There are a lot of homes for sale now and tons more in the pipe (increased supply)

During the bubble speculators were snatching up houses and condos. Now most of these speculators are licking their wounds and trying to unload on their holdings. This both increases the supply of properties and decreases the demand for properties.

There is also a large amount of “shadow inventory“. This inventory consists of the following:

• Foreclosures in the pipe – there are lots of homes that are in the process of being foreclosed on, but not on the market yet.
• REOs – bank are sitting on reprocessed homes instead of putting them on the market. For example in Pittsburg’s 94565 ZIP code, banks own 530 homes, but only 15 are on the market (source).
• “Not released” condos – many condo complexes claim “all sold except for two units”. Yet when you drive by these same complexes at night, there are less than 5 units with lights on. What is really happening is that most of the units in the complex haven’t been “released” by the developers for sale. This accounting practice lets the realtor tell the fiction of “there are only two left”.
• Homeowners waiting to sell – there are also many homeowners who want just “want out” and will try to sell as soon as the “market recovers”.

The first three points above increase the supply of homes. The last makes is harder for prices to go up since each time the prices increase, more homes are added to the market.

Foreclosures are still increasing and hitting record numbers. Today, 1 out of every 8 mortgages are in foreclosure or deliquent (source). Additionally, the trends indicate that the rate of prime mortgages in trouble is growing. On top of this, new data suggests that the cure rate for deliquent mortgages is dropping (source).

Foreclosures are double-whammys: not only is the house now on the market which increases supply, but the folks foreclosed on likely don’t have a downpayment saved up, so they aren’t buying a house. This, of course, reduces demand.

Also on the supply side, the pace of new contructions is increasing. Once these homes come on the market, they will add downward pressure on the prices. In addition to this new constructions, there are a lot of stalled projects that will be restarted at the first inkling of a recovery.

#3 – Very few people can actually afford to buy a home or even want to (decreased demand)

Now, let’s consider the buyer side, unemployment is high and will probably continue to climb. It’s tough to find jobs and those with jobs are seeing wage cuts or freezes. This decreases the amount of home that people can afford, which, in turn, reduces demand. The consumer is tapped out as witnessed by record delinquency rates (source).

How many people do you know that have a $60,000 sitting in the bank? Not many right? Well, that’s a 20% downpayment on a $300,000 house. These are indicators that demand will drop more moving forward.

Demographic-wise, we can expect the retiring boomers to be downsizing from McMansions to small homes and even condos. Much of the bubble was driven by the “upgrade” customer. The shift to downsizing will reverse this trend.

Culturally, we’re seeing two important shifts. First, there’s a change in consumer attitude about debt as more people are trying to be more frugal. Second, consumers are starting to remember that the house you live in is not an investment.

What’s in a bottom?

When people say that they see a “housing bottom”, they need to be specific. Generally markets like housing have two bottoms. The first bottom will be for housing sales, starts, and general investment. Now, it might be possible that we’ve hit this first bottom, but we’re still waiting for the next bottom, which will be in price. That’s the one I care about. :-)

Also, remember that hitting a bottom doesn’t mean a quick snap back either. Calculated Risk provides a great analysis of this here.

Where do we go from here?

So from a supply and demand perspective I expect prices to drop. But in a the real short term, I expect to see low-end and mid-range home prices to increase due to the $8000 tax credit. Since this credit expires in November, lots of people are in a rush to get their home purchase settled and get their credit.

People will use this increase of prices to claim that the housing prices have bottomed, but this isn’t the case. The increase in first-time buyers isn’t sustainable. The subsidy just brought demand forward from the pool of people priced out during the bubble and were too scared to buy as the prices were falling.

There’s a limit to how long you can bring demand forward, once it runs out there won’t be any more buyers. This tax credit also won’t help the mid-range to high priced homes, since the first time buyers aren’t in this market. The first time buyers are generally buying homes from people who are not moving up, so there won’t be increased demand in the mid-to-high range.

The other thing to consider is the exact numbers behind a “median price increase”. One way that median price could go up is if there is an increase in distressed sales of mid-range and high-end homes. This would be a bad event, but it would increase median prices. And it turns out this is definitely a factor in the recent median price increases we’ve seen; again Calculated Risk has the story.

Upgrading, interest rates and in conclusion…

I have a few friends who want to upgrade and ask me, “Why does it matter if houses drop? I’m selling one and buying another.” If you’re upgrading it does matter, and it matters more depending on how much you’re upgrading. For example, if you’re selling a $200,000 house and buying a $500,000 house, a 10% drop down the roads means that you sold your house for $20,000 less, but bought the new one for $50,000 less. So the whole upgrade cost $30,000 less!

According to the TV, interest rates are at a “historic low” today. :-P As they start to increase, it will reduce the amount of loan that people can qualify for. This will also reduce the demand for homes and push prices down.

Based on these factors, I expect home prices to drop. But I haven’t yet talked about when prices will bottom. It’s hard to predict and the constant government interference is making it much harder to predict. This makes traditional financial indicators less reliable. So in terms of timing, I’ll be counting more on social indicators. Just like the housing bubble peaked when everyone said “Buy now! Renting is for idiots!”, the housing price bottom will likely be around the time when everyone is saying, “Why would you buy? Renting is the way to go.”

Yup, that’s right. In this case, I guess I’m a contrarian. :-)

My last two posts about the causes of our heathcare problems and how to fix them have been two of my most widely read posts; in fact they are even more popular than the sleeper story of my color-changing pants. :-P

So, given all the continuing ruckus around the issue of health care, I thought it was worth making a few last comments on the topic. :-)

First, we have to remember that the system we have today is not a “free market” system. Why? Well, we already discussed the some of the government policies that cause massive distortions in the market. And there are hundreds of more rules and regulations. For example, in Maryland, employer provided health plans must provide 66 different benefits: everything from hair prostheses to in-vitro fertilization to massage therapy. If they don’t, then they can’t provide any coverage at all. As a result, employer-provided plans in Maryland cost 12% more than the national average (source).

The system we have today is the result of government policies and regulations. Even if you health insurer is screwing you over, you can’t do much. Your only option is to leave your job. This protects the insurers from competition and they lobby heavily to keep things that way. The very last thing they want is to have to compete with other companies to get their customers.

This is something to keep in mind why we discuss how to “fix” the problem. It’s highly unlikely that more of what get us into the problem will get us out.

Second, I think it’s important to point out that there is the goal of “affordable, quality healthcare for everyone” (the “ends”) and then there’s the strategy of achieving that goal (the “means”). “Obamacare” is just one of these means. In these sorts of discussions, people seem to forget that means and ends are separate things. It’s quite reasonable to believe that you can achieve the goal of affordable, healthcare without Obamacare.

Anyone who claims that opposition to Obama’s plan is the same as “not wanting affordable quality healthcare” is being extremely disingenuous. They are either guilty of myopic thinking or worse, just using underhanded propaganda to try to drum up support for their plan.

A good example of this is the “Patriot Act”. Proponents equated the Patriot Act with “protecting Americans”. If you opposed the Patriot Act, they claimed that you were against “protecting Americans”. Which, of course, is just plain wrong.

The same thing is happening with Obama’s plan. I’ve heard many people dismiss criticism of Obama’s plan with, “I don’t understand how anyone can be against reform.” Guess what? You can be against the plan (“the means”) and still be for reform (“the end”). Means and ends are not the same thing!

Here’s another recent example: Whole Food CEO John Mackey wrote an Op-Ed talking about how a few reforms that would improve healthcare and make it more affordable and accessible for everyone. He opposes Obamacare as a solution to the problem. While I don’t agree with everything he wrote, I thought it was a reasonable and thoughtful piece. However, a lot of people are angry with him “because all Americans need health care” and presumably in their minds, Mackey believes otherwise just because he opposes the Obama plan.

There is more than one way to fix healthcare, Obamacare is just one of these ways. Saying no to Obamacare is not the same as saying no to health care reform.

Anyway, it should be fairly obvious that I’m all for reform, but I’m very much opposed to Obama’s plan because it will make things worse.

Obama’s plan will further weaken private options for healthcare. The plan would continue to operate under a model like Medicare. Medicare, on average, pays 60% of what a medical service actually costs. Health providers need to cover this loss, so they pass on the costs to private insurance and other paying customers by inflating our bills.

Since the government plan is legally allowed to pay less for services than other plans and providers are forced to treat these patients, private plans end up paying significantly more for the same services. So essentially, the government plan is heavily subsidized. This subsidy will quickly drive private health plans out of business. And then we’ll all be stuck on a single government run health plan.

And this would be an unmitigated disaster.

Now, I’ve said it before and I’ll say it again: do you really want the same people who run the DMV, airport security, IRS, the Post Office and FEMA to run your hospital?

Heck, even Obama said, “UPS and Fedex are doing just fine; it’s the Post Office that’s having problems.” That’s right, despite massive subsidies and a monopoly advantage, the Post Office is still losing money (and mail), while UPS and Fedex are profitable. That doesn’t leave me very confident about government run hospitals.

First of all, if only the government provides healthcare, it will be rationed. Don’t let anyone tell you otherwise. It’s axiomatically true that there will unlimited demand for free services. That’s just a rule of nature. When you give away something for free, you’ll run out. The only way not to run out is rationing. In every single country with a single payer system, there is rationing. It’ll be the same here.

Second, medical innovation will crawl to a halt. Innovation requires money. A public health plan, like Medicare today, doesn’t even pay enough for current technologies. It definitely won’t pay for doctors who establish new methods of care. Without this incentive and the necessary resources, innovation will suffer and so will we.

Third, new medicines and treatments that are approved for the government plan will not be judged by their merit, but instead who has the best lobbyists. If you don’t believe me, look at how companies win government contracts or how new treatments are approved by Medicare today.

Fourth, due to lack of competition, the quality of care will also be poor. If you don’t believe me, go check out a government-run VA hospital. Would you want to be treated there?

Though, maybe I’m wrong. Perhaps, Obama can deliver on his promise provide affordable, quality medical coverage for all of us.

But tell you what, if the government can provide affordable, quality medical coverage for all Americans, let them prove it first by providing it to our veterans.

Once they do that, let’s talk.

In my last post, I talked about the root causes of our health care problems, so as promised, here’s a post on how to fix it.

First a quick recap: the main cause of the problem is that insurance companies yield disproportionate power over the doctors and the patients. This is caused by government policies:

• Employment based insurance is heavily subsidized by the government, while private insurance is not
• Doctors are not allowed to collectively bargain against insurance companies due to antitrust regulations
• Doctors and medical providers are legally allowed to charge vastly different amounts for the same exact service (though this is illegal for everyone else)

So, as you’d expect, the first step in fixing healthcare is to reverse these three policies and undo their horrible negative consequences.

Now before going through the next steps, it’s necessary to go on a slight tangent about “insurance”. Today, when we talk about “health insurance”, we’re talking about two very different things: (1) a pre-paid plan for routine coverage (e.g. covering your yearly physical and normal prescriptions) and (2) an insurance policy for catastrophic health problems (e.g. coverage for a broken leg).

It’s important to make this distinction. Your car insurance doesn’t pay for your oil changes, but it does pay when you crash your car. Now, on the other hand, when you buy your car, you could buy a “pre-paid” plan that covers oil changes and other routine stuff, but it doesn’t cover for when you crash your car.

The reason they are normally separate products is that they are different businesses with different models. If I were to sell you a package that included all your oil changes and timing belt replacements for the next five years, the business model is just a simple “pre-paid” model. If I were to sell you insurance, that’s an actuarial business.

So, the second step in fixing health care is to stop allowing companies to only sell “bundled” plans while include both “pre-paid plans” and “catastrophic coverage”. They need to allow customers to buy just one or the other. Today, the companies, using their disproportionate power, bundle these services which make it even harder for alternative private plans from existing.

The third step is about prices. We already said that the prices have to be consistent and can’t be different depending on who’s paying. Now, we need to make providers publish their prices. Going into a procedure or appointment, I should know exactly what it is going to cost. It should be the same as when I get my car repaired.

This will do two things. First, it makes sure that all patients are billed the same price. Second, and more importantly, it prevents the common practice of billing private insurance (or uninsured) patients significantly more than Medicare patients.

Today many providers can’t afford to provide services at Medicare’s reimbursement rates, so they charge everyone else extra! If Medicare reimbursement rates are too low, then providers should allowed to simply refuse to provide the service at that price. Furthermore, they shouldn’t be forced by the government to provide those services at prices they don’t want to. And they certainly shouldn’t be allowed to rip off everyone else to make up for the loss.

The fourth step is related to people who can’t pay for emergency health care. People who show up at the emergency room but can’t pay will still be treated by the hospital. But the hospital will no longer be allowed to pass the costs to paying patients (this leads to bloated costs at the hospital). Instead, the bill will be paid by the federal government. The government will treat this as a debt to government and have the IRS collect the bill through their existing mechanisms. And if you’re an illegal alien, we will just bill the patients’ home country. After all, this is what everyone else does: if I needed medical care while in Canada, they would just send the bill to the US government.

The fifth and final step is to hold the health care provider responsible for any clear negative consequences of receiving the care. For example, if I have a surgery and get a nasty inflection (e.g. MRSA), then the hospital is responsible for fixing it. Think of it this way, if I have my car tires rotated and the repair shop drops my car off the lift, they would have to fix the car. Under no circumstances would I have to pay to fix the car.

So what about people on welfare? It’s not actually that complicated; while people are on welfare, the government can simply just buy them a pre-paid plan and catastrophic coverage. Once they are off welfare, they can buy their own.

So, just a few simple steps to fix the mess. By making these changes, we break the tie between employment and insurance, remove the barriers so affordable private insurance options can flourish, and reduce the health care costs across the board.

Once we do this, you will be able to buy affordable private health coverage. And if you don’t like your provider, you can find another or just choose to pay out of pocket for your expenses. And most importantly, the “hidden” costs of Medicare and providing care for those that can’t pay will no longer to hoisted on everyone else.

With all the talk of universal health care, I thought it was interesting that no one was really talking about the real reasons that our health care system is bad. We all know the problems:

• It is near impossible to get affordable private healthcare.
• Insurance companies routinely deny treatment patients need.
• Insurance is tied to employment.
• and so on…

But these are really just symptoms, what we need to identify and fix are the core problems. As always, we need to ask the right questions, otherwise we’ll never really understand the problem.

And the right question is, how on earth did we get to the system we have today? Everyone talks about “the good old days”, when doctors made house calls and we didn’t have to wait 45 minutes after our appointment time passed to see a doctor. In those days, healthcare was affordable and doctors made good money. So let’s try to figure out what changed.

I believe the root cause of the problem is that we have an extremely powerful middleman between the patients and doctors. While, these insurance companies, HMOs, and their ilk may not be completely useless, they wield way too much power. This disproportionate power is the root cause of our health care problem.

The reason that they are so powerful is due to a series of government policies. These are policies which I assume had good intentions, but also had unforeseen, horrible consequences.

#1 – Employment based insurance is heavily subsidized by the government, private insurance is not

Originally, someone thought that “if we help companies provide health insurance, then more people will have it”. This led to a policy where employer provided health care is tax free. This means no federal income tax, no state income tax, and no payroll taxes for either the employer or the employee. This alone is roughly a 50% subsidy!

The unintended consequence here is that the subsidy basically destroyed the chance for affordable private insurance to exist. First of all, due to the subsidy, the price of private insurance is now at least twice as much as employment based plans. Second, since the only potential customers for private plans are the unemployed or people not covered by a government plan, these private plans can never reach the economies of scale to drive down prices.

As a result, we the patients have no power against the insurance companies. If they deny our coverage, we can’t do a thing. Why? We can’t easily “take our business to a better provider”. Since there are no tenable private options, we have to change our jobs to find a better provider!

#2 – Doctors are not allowed to collectively bargain against insurance companies due to antitrust regulations

The insurance companies have the upper hand against the consumer. And it turns out that they have the upper hand against the doctors too. Due to antitrust regulations, doctors are not allowed to collectively bargain with the insurance companies. As much as doctors would like to, as a group, force the insurance company to change, they are not legally allowed to! (Note: this is starting to change in some states, but the damage is already done and will take a long time to undo, if ever.)

This means, if doctors want to play, they have to play by the insurance company’s rules. They have no power against the insurance companies.

As a result, doctors are paid whatever the insurance company decides to pay for a service. Given all the overhead of runing a medical practice, the doctor is forced to see as many patients as possible which lowers the quality of care and increases the wait time to see the doctor since they need to have a full queue of people everyday.

Presumably the antitrust regulations were put in place to prevent doctors from ganging up against the patients, but the unintended, yet predictable, consequence was to put all the power in the hands of the insurance companies.

#3 – Doctors and medical providers are allowed to charge vastly different amounts for the same exact service

Even though the Robinson-Patman Act forbids price discrimination, health care is exempt. So the same exact procedure may cost the insurance company $60, but it often costs a normal person $600 out of pocket! You can see this evidence in the statements your insurance company sends you. You’ll see, for example, that the doctor billed $500 dollars for a service, but the insurance’s negotiated rate is $149.35.

Originally, I suppose this stipulation was in place to allow doctors to charge less for patients that have financial problems. But the unintended consequence is that people without insurance pay more and end up subsidizing those with insurance.

Because of these 3 reasons, the patient is no longer the customer. This is a key observation and goes a long way to explain the distortion in the health care industry. It turns out that the insurance company is the customer; after all they are the ones paying the bills.

Sellers need to adjust and optimize for their customers, so it shouldn’t be a surprise that doctors (the sellers) end up adjusting to the insurance companies (the customers). If the patient was the customer, doctors would optimize for quality of treatment at the best price. Instead, doctors need to optimize for insurance companies and guess what? Insurance companies pay a fixed amount regardless of quality.

Doctors now have little incentive to optimize for quality first. They instead now need to optimize for throughput, they need to see enough patients a day so that they can make enough money to keep their practice running. As a result, we see the doctor for 5 minutes, even though we waited 45 minutes to see him.

The doctor also has an incentive to get whatever money he can from the insurance company, this means sometimes ordering unnecessary labs and procedures.

What are the insurance company’s incentives? Well, first we need to realize that the term “insurance” is a misnomer. We don’t have “health insurance”; we have “pre-paid plan”. After all, it’s not possible to make actuarial estimates for routine coverage; so we just have a monthly premium. So, the insurance company’s incentive is to lower costs. They do this by denying and refusing to cover treatment, medicine, and anything else they can.

Since insurance companies have all the power, doctors and patients don’t decide how they will  be treated, bureaucrats do.

Now that we know what is causing the problem, it turns out that the solution is really simple. But enough for today, I’ll write about that in my next post. :-)