Month: October 1998

Stock Talk

When the stock market drops, most people wonder: why does the price of a company’s stock really matter? If stock values and prices are dependent merely on the whim of investors and don’t really reflect the value of anything, then why care when the prices dip?

Theoretically, a company’s stock price should reflect the performance of the company. When it makes more profit or increases its market share, the company’s stock price should rise. In the real world, however, that’s not necessarily true. For example, has never made a profit, yet its stock is currently hovering around $100 per share. In contrast, when Boeing added more workers to ramp up production, its stock price fell. Only when Boeing announced that it would lay off workers by the end of the year did its stock price recover. Clearly, stock price reflects what investors think about a company’s potential profits but, more importantly, it also influences the overall health of the company. Here’s how:

First of all, companies are typically valued not just on their annual sales and assets, but also on the price of their stock. When stock prices sink, the overall value of the company decreases, and this effects the credit-worthiness of the company (its ability to borrow money). Companies that need to borrow or issue bonds to finance expansion have a problem when their stock price sinks: they have to pay higher interest rates, because their creditor now views them as a higher risk. For a recent, public-sector example, the government of Brazil’s credit-worthiness suffered when investors began to sell off Brazilian bonds. Moody’s Investors Service downgraded the Brazilian government debt (similar to a sinking stock price), and Brazil’s creditors upped short-term interest rates to as high as 50%. This meant that suddenly Brazil’s interest payments on debt jumped from 1% of the country’s gross national product to an insane high of 7% of GNP. Without interest payments on its debts, the government’s budget would balance; it’s debt service payments that have forced the country to run up ever higher deficits to the point where it’s now begging the IMF for a $30 billion bailout package. The same thing can happen to businesses.

Secondly, in the past two decades, more companies attract upper level management and high-tech or high-skilled employees by offering stock options as part of their compensation package. This causes two major problems for companies. First, major management decisions will be directly linked to the performance of the company’s stock–a good thing for investors who want short-term, stratospheric growth, but not conducive to making long-term, strategic decisions–which often demand investment in new equipment or small wage raises for lower level workers in the near term.

Secondly, in a “tight labor market,” companies compete with one another to attract and retain highly-skilled workers. When a company offers stock options, it suddenly becomes enormously important for the company’s stock to do well. If the price falls, the company risks losing a large number of employees. The company would have to pay for recruitment, training, and replacement of those employees. Lost productivity, training costs, loss of morale, and the loss of experience that occurs when a company has high turnover rate can propel it into a downward spiral. In a sense, this alone proves how inefficient the system really is: companies hobble themselves by overvaluing some employees–thereby creating an “upper class” of employees who can easily afford to move from one company to the next.

Finally, when the stock price decreases, so does the ability of a company to finance mergers. Much of the economic growth of the 1980s and 1990s has been fueled by massive mergers. In the distant past, mergers were financed by heavy borrowing, usually through the issue of corporate bonds or through bank loans. Today, it’s more common for large companies to finance mergers through direct stock swaps. For example, Company A wants to buy their competitor, Company B. Company A offers the shareholders of Company B a chance to trade in 2 share of Company B’s stock for 3 shares of Company A’s. The shareholders vote and, if they approve, the deal is finalized. If, however, Company A’s stock price falls drastically in the interim, Company B’s shareholders may decide to pull out of the deal. In recent months, several large mergers have been put on hold or cancelled for this very reason.

If stock prices really had no impact on companies, large companies wouldn’t spend enormous amounts of cash to buy up their stock when the price falls, yet many do. Boeing, for example, recently spent a chunk of its cash reserves buying up its own stock.

Stock prices reflect an enormous instability in the system; global investors can literally drive a company out of business or force it to sell to competitors, regardless of the overall health of the company. It doesn’t matter if the company makes a necessary product or performs a vital service, or if it employs a lot of people. Waste is endemic to capitalism (as any chronically unemployed or under-employed person can tell you). The fact that companies can be scrapped in the pursuit of profit–just as workers, the elderly, children, and the environment get tossed aside–should surprise nobody.

The Death of Basic Health?

The state’s Basic Health Plan is in serious trouble. Squeezed by rising medical costs on one side and hostile Republican politicians on the other, it may not survive another year…even as the waiting list for new enrollees grows daily.

The state’s health plan was set up in 1992, after the Democratic Party pushed both Bill Clinton and many local candidates to victory on a platform that included health care reform. The plan was meant to provide subsidized medical insurance for low income people who were not making enough to afford to buy health insurance, but who were making a little too much to qualify for Medicaid. In an effort to ensure the plan’s success, the state accepted two types of enrollees: people who needed to have all or a portion of their premiums subsidized by the state, and higher income people who could join and pay the full cost of the premiums out of their own pockets. Today, subsidized members number over 200,000, while unsubsidized members number about 17,000.

Initially the waiting period to join was short and people could sign up at any time; private insurance plans, by comparison, typically designate one month per year as their “open enrollment period,” which is the only time when people can join. In 1996, however, as national “welfare reform” kicked in and poor people were booted off of Medicaid, the uninsured population in Washington State swelled. Local businesses continued to cut benefits to their employees, while most job growth occurred in the low-paying service and retail sectors, which also provide no health care coverage for employees. In 1996 the number of people signing up for the state’s plan more than doubled from 60,000 to around 140,000, placing a serious strain on public coffers. So, the state put a limit on the number of new enrollees for the subsidized plan and instituted a waiting list. By the end of 1997, there were over 60,000 people on the waiting list, while the plan covered over 200,000 people.

Then real trouble struck: during the state’s 1997-98 legislative session, Republicans blocked all efforts to increase funding for the health plan, in spite of rising medical costs and increasing demand. This ensured that most people on the waiting list would have to wait yet another year for a chance to join the plan.

In the meantime, the Basic Health Plan has run into another huge problem: private insurance companies trying to make a profit from the state plan. Initially 18 separate insurance companies contracted with the state to provide benefits to plan members. By 1998 that number dropped to nine, mostly because of mergers, but also because insurance companies dropped out because they couldn’t make enough profit from the state plan. Evidently, low income people tend to get sick a lot or have other chronic health problems; insurance companies call this “severe adverse selection” (i.e., too many sick people have selected the state’s plan–never mind that nobody chooses to get sick in the first place). This cuts into their profit margins, and companies either decide to drop out of the plan or they raise their rates.

Just two weeks ago, two more insurance providers, Providence Health Care and QualMed, announced that they were dropping out of the plan, leaving only seven providers. The remaining companies are raising rates in 1999 by an average of 9% for the subsidized plan and a whopping 62% for the unsubsidized plan. Regence, for example, is upping its rate by more than 130%. To cover the increase, the legislature will have to find an additional $190 million next year.

The legislature, however, may decide to do away with the state health plan altogether; a lot depends on who gets elected or re-elected at the polls this November. If Republicans gain a majority in the state legislature again, we can probably say goodbye to the Basic Health Plan. A Democratic majority, on the other hand, will be open to “fixing” the plan, but this will likely involve paying private health insurers whatever they ask to keep them part of the process.

It’s pretty hard to find a better argument for dumping health insurance companies in favor of a single payer plan. Unfortunately, we’re more likely to see the death of the Basic Health Plan instead.

Hedge Funds and LTCM

Hedge funds are named after the practice of “hedging your bets,” or betting on both sides of a wager. But what happens when the unexpected occurs and the whole wager goes sour? Both sides lose, but the guys who borrowed money to hedge their bets–to bet on both sides of the deal–lose the most. That’s exactly what happened to Long Term Capital Management two weeks ago.

LTCM had nearly $1 trillion in bad investments, but only $2 billion in assets that it could sell to pay off its debts. Its borrowing in the past year alone averaged between 50 and 100 times its asset base, and it borrowed from the biggest of banks and brokerage houses in the world, thereby endangering a banking system already rocked by losses in Russia and the Far East. Last week, more news leaked out about this highly secretive fund and other funds just like it.

Cerulli Associates, a Boston consulting firm which is preparing a report on hedge funds, estimates that there are roughly 4,500 of these funds with an estimated $300 billion in assets. That’s not counting all the money these funds have borrowed to make highly risky investments. About 81 percent of the funds borrow, and most borrow just under 5 times their asset base. Imagine being able to take out a mortgage for 5 times the value of your home; no bank would do it–yet they do it for hedge funds. Why?

In the case of LTCM, the fund was managed by a few “big names” on Wall Street, including three former Salomon Brothers brokers and two Nobel Prize-winning economists, Robert Merton and Myron Scholes. They had the gloss of “expertise” to help them fleece major banks and brokerage firms, and take investment money from not just a few wealthy people, but also a bunch of “institutional investors” that were looking for wildly high returns: pension funds, endowments, and foundations–whose investments now account for about 80 percent of the total assets of all hedge funds today.

How do hedge funds work? In the case of LTCM, it bought mostly derivatives–paper contracts that wager on the movements of markets. Derivatives have no underlying value, are not based on any asset that can be sold to recoup losses, and have no market of their own like stocks or bonds do, so they’re highly “illiquid” (i.e., they can’t be easily traded or sold, like stocks on the New York Stock Exchange). In short, derivatives can be summed up in two words: running numbers. Although the risk is very high, if you bet correctly, derivatives can pay off big-time–if the markets remain stable. But the global markets have deflated, and hedge funds are taking a big hit.

For example, LTCM’s investments consisted of bets in the global bond markets. Not content just to own bonds and collect interest on them, it “hedged its bets” by betting that bonds with credit risk (i.e., emerging market bonds and junk bonds) would gain in price against European government bonds and U.S. Treasuries. It then “hedged its bets” again by buying stocks in emerging markets. Stocks usually rise when bond prices go down–either way, LTCM sought to make a profit. But when the Asian financial crisis hit, emerging market stocks lost much of their value. When Russia defaulted on its domestic debt, emerging market bond prices also fell against U.S. and European bonds, so LTCM lost both ways. And LTCM is not alone: last week, Everest Capital Ltd., based in Bermuda (to avoid paying U.S. taxes), reported that it had lost $1.3 billion–or 52% of its assets. Everest Capital’s main investors include a number of U.S. university endowments.

Hedge funds first appeared in the late 1960s, but have gained in popularity only in the last ten years. They’re considered private investments, so they’re not regulated by the Security Exchange Commission, which regulates banks, brokerage houses, and mutual funds. They avoid public disclosure laws, so they remain highly secretive about their investments and operations. No precise legal definition exists of what a hedge fund is.

Many funds have set up their central offices in Caribbean tax havens to avoid paying U.S. capital gains taxes. Since 1992, when Congress attempted to regulate hedge funds, leading fund managers have poured money into Republican Party coffers to kill regulatory bills. And, since 1987, when banks were given the go-ahead to liberalize credit, hedge funds have found it much easier to borrow vast sums of money to leverage their investments.

Most large banks and brokerage houses now have investments in hedge funds. Merrill Lynch, which was one of the initial investors in LTCM, has $2.08 billion invested in hedge funds. Chase Manhattan has $3.2 billion. Bankers Trust has loaned $875 million to various hedge funds. Europe’s biggest bank, UBS AG (which has already taken an enormous hit from loans made to Russian banks), says it will lose at least $700 million this quarter alone because of LTCM’s problems. Italy’s state bank invested $100 million in LTCM and loaned it another $150 million.

With LTCM’s troubles, investors are beginning to flee hedge funds, but they’re finding it difficult to get their money back. There’s no formal market for derivatives and, when a fund can’t quickly sell its investments to pay back investors, the fund risks collapse. Banks and brokerage firms have stepped in to prop up LTCM, but things will only get worse for hedge funds and for the banks that loaned them money. As Paul Roth of the American Bar Association’s task force on hedge funds said: “Someone was asleep at the switch.”

Well, it’s wake-up time.

What’s Good For You

Local doctors are slugging it out with Regence BlueShield, Washington’s largest health insurer, over changes in the new Regence contract. The doctors say that, in the interest of cost, the insurer wants to limit their ability to prescribe the best care possible for patients; that, in fact, Regence wants to do the prescribing–or give employers the power to do it instead. This is probably true, but then it’s hard for patients to sympathize with doctors or care about this squabble, when doctors and the American Medical Association have been instrumental in limiting patients’ access to various treatments for decades–especially access to alternative medicine.

The standard argument against alternative therapies is that they’re “unproven” or “untested,” as if a laboratory test on rats, rabbits, or pigs, followed by a test on 20-year-old, healthy, male college students is the ideal way to prove the efficacy of anything. People who have been driven to try alternative or “naturopathic” medicine by the outright failure of western or “allopathic” medicine to help them have discovered that massage, acupuncture, herbal remedies, vitamin therapies, and many other alternative treatments have long and distinguished histories–literally centuries, for some treatments. There’s a lot of empirical evidence showing the benefits these therapies can provide to people suffering from chronic pain, fatigue, immune deficiencies, high blood pressure, heart disease, and a whole host of other illnesses that western medicine either finds difficult to treat or treats only with therapies that are difficult for the patient to tolerate and/or survive.

Many doctors use just that argument against alternative therapies: just because many people experience benefits from them isn’t good enough. In other words, until we understand exactly why or how these treatments work, we shouldn’t use them. Yet many treatments prescribed by doctors rely on empiricism (i.e., patient’s experiences, rather than a scientific understanding of exactly how the treatment works in the patient’s body). For example, until very recently, no one understood exactly how anesthesia and pain killers worked to dull pain; there were a lot of theories, but no proof of how these chemicals actually worked in the nervous system. Doctors and the medical community nevertheless relied heavily on both and have done so for over a century. So empirical evidence–the knowledge gained from experience, observation, and patient feedback–was enough to make anesthesia a common treatment, even in light of the known risks; people can and do die under general anesthesia from incorrect dosages or adverse reactions. It happens. But the need obviously outweighs the risks. On the other hand, who dies from receiving a massage?

The other main argument against alternative therapies, especially herbs and dietary supplements, is the danger of poisoning or of adverse reactions. There’s no minimizing this danger; it’s real and nothing to ignore. But we should put it in perspective. Joe and Teresa Graedon, authors of The People’s Guide to Deadly Drug Interactions, estimate that there are over 20,000 adverse drug/drug, drug/food, and drug/vitamin interactions reported in the medical literature. It’s simply impossible for anyone to keep track of them all, nor is anyone even bothering to try–not your doctor, not your pharmacist, not the FDA, not insurance companies, not pharmaceutical companies, and certainly not the government. In the best of all possible worlds, there would be a movement to collect such information in a format that’s easy to read and accessible for both patients and physicians. Yet no coordinated movement exists to provide this basic necessity.

So we have plenty of people every year who unwittingly poison themselves by taking two prescription medicines that interact badly with one another–often ones prescribed by the same doctor. Or, in one of the most common drug/drug interactions, people may accidentally kill themselves by taking MAO inhibitors, such as Nardil or Parnate (anti-depressants), in combination with over-the-counter cold medicines that contain Sudafed or similar decongestants (pseudoephedrine, ephedrine, phenylephrine or phenylpropanolamine). This combination can cause blood pressure to soar and bring on a stroke; although, some lucky folks only suffer nausea, fever, dizziness, and seizures.

Then there are the drugs that cancel each other out. Aspirin may deactivate drugs that lower blood pressure, like Vasotec and Capoten, which are among the 20 most commonly prescribed drugs in the U.S. The most common medicines for migraine headache, Fiorinal and Fioricet, both contain a barbiturate that reduces the effectiveness of birth control pills; ironically, about 70% of migraine sufferers are women. Birth control pills can also be hampered by the commonly-prescribed antibiotics, such as ampicillin, amoxicillin, tetracycline, oxacillin, penicillin V, and doxycycline. Any of these drugs can be prescribed for pelvic inflammations or urinary-tract infections, which are common among sexually-active women. And finally, oral antifungal medicines that doctors prescribe for vaginal yeast infections can also inhibit oral contraceptives; the biggest culprit is griseofulvin.

Numerous over the counter medicines have nasty side-effects or can combine with prescription drugs in dangerous ways. One example is aspirin; it’s in everybody’s home medicine cabinet, and lots of folks take it like it’s candy. They shouldn’t. If taken with anticoagulants (blood thinners), aspirin can cause dangerous, excessive bleeding. It can also reduce the effectiveness of arthritis drugs, like ibuprofen, naproxen, or sulindac. Aspirin may interfere with beta-blockers, another class of drugs that treat high blood pressure. Taken with diabetes drugs, aspirin can trigger sudden, dangerous drops in blood glucose levels. It can also hamper the body’s ability to metabolize certain drugs, thereby increasing those drugs to toxic levels in the body; included in this group are epilepsy drugs, glaucoma drugs, and methotrexate (used to treat rheumatoid arthritis and cancer). Gout medicine can be completely inactivated by just 700 mg of aspirin (2-3 pills). And, of course, aspirin is just plain hard on your stomach; it blocks prostaglandins that work to maintain the coating that protects the lining of your digestive tract. Yet no one has suggested that we give up our aspirin. Doctors even recommend that older people take one aspirin a day to thin the blood and prevent a heart attack.

So, faced with the dangers of commonly used drugs, alternative therapies seem mild in comparison, especially when weighed against the obvious needs of people who can’t be helped by western medicine. The solution is not to exclude alternative therapies from the ever shrinking list of what insurance companies will fund or what doctors will prescribe. Until we have a healthcare system that eliminates the insurance companies and reduces or eliminates the profit motive, doctors will continue to ignore alternative treatments while fighting to preserve the few treatment options they have now. And the way to make both allopathic and naturopathic medicines safer is to start compiling a database of adverse drug reactions and interactions–and include herbs, vitamins, and other supplements, too. No private, for-profit entity will do it; the responsibility lies with us.

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