Insurance Makes Things Cost More

When I was a kid, my parents had a friend who ran a car leasing/rental business for the local Ford dealership. This was back in the days when insurance companies were first demanding “used parts” for auto body damage repair. One fine day, a new yellow Thunderbird owned by the agency was in a wreck. A few days later, a new green Thunderbird also owned by the agency was stolen. The used parts which showed up at the body shop to repair the yellow Thunderbird were, of course, green. Nobody will ever be able to prove the second car was stolen and parted out to repair the first car, but neither can anyone prove otherwise. You will certainly never convince this man that it was sheer coincidence. He shrugged and laughed that to save a few dollars, the insurance company had bought him an entire new car.

Insurance companies makes things cost more, and not just with foolish financial decisions. Their very existence costs money. They have offices to rent, light, heat, and furnish. They have employees who deserve to be paid. They have regulations to follow and paperwork to file with the state. They have executives who must be paid enough that they don’t begin to think they should get jobs in banking or securities. They have actuarial tables to compile and interpret. Some of them are for profit, siphoning yet more money out of the system. Although some of the insurance company’s revenues are derived from investments, ultimately all this is paid for by the policy holder.

Insurance also drives up costs for virtually every business. Businesses need insurance too: property insurance; liability insurance; benefits such as health insurance for employees; workman’s compensation insurance; unemployment insurance; insurance for business vehicles. Depending on the industry, there may be over a dozen insurance bills to pay. All these expenses must be accounted for when determining how much to charge for products and services in order to make a profit.

Health insurance in particular drives costs up. It actively short circuits any semblance of the market economy in health care. Not only does the patient not pay the doctor, the patient usually doesn’t even pay the people who do. Most of the time, the patient’s employer pays the insurance company that pays the doctor. On the other side of the transaction, health insurance drives up the cost of doing business for doctors. Now, he needs to pay an employee or service that does nothing but submit insurance claims and process insurance checks. Furthermore, his staff has to spend time figuring out what portion of the final bill should be charged to the patient and what should be sent off to the biller. All of this is before time the doctor himself has to spend figuring out what the insurance company is willing to pay for, and any time he may spend on the phone with the insurance company trying to sort things out. FInally, there is little disincentive for the patient to use unnecessary services. There is a fine art to setting co-payments and deductibles low enough that people will seek help for genuine illness and high enough to discourage frivolous doctor visits, services, tests, and treatments that the patient insists upon despite lack of need.

Insurance has become a necessary fact of life in our modern society. Being without insurance can cost more than having insurance. People who do not carry insurance that they need cost everyone else money by not being part of the risk pool. Uninsured motorists cost money when they are in traffic accidents; if they can’t afford insurance they certainly can’t afford to pay for a wreck. People who do not carry homeowners or renters insurance lose everything should disaster strike. Companies without adequate liability insurance go out of business if they are sued, putting employees out of work and jeopardizing intellectual property. People without health insurance tend to wait until small illnesses become serious before seeking care, both losing productivity and turning a hefty bill into a gargantuan one — and more often than we care to think about, costing taxpayer dollars.

Going without insurance is obviously not a solution. However, something has to be done to bring insurance rates down. Insurance reform needs to be a priority in all 50 states. This is not something that can be fixed by slapping some artificial damage caps on jury awards. Indeed, most of the ways that insurance drives costs
up have nothing to do with the courts, let alone tort reform. The first step in insurance reform is not telling big business exactly how much money they can lose in a courtroom, but rather making sure that more insurance dollars are used to cover legitimate claims. Limit the profit motive: Re-mutualize.

Going Up?

Today the FOMC meets. Even before anyone arrived, even before any of the participants got dressed this morning, everyone pretty much knew what at this writing has not been announced: No change in the interest rates that the Fed controls; something about being vigilant about possible future inflationary risks. Everyone knows that these are the things they “must” say, partly because it is what everyone “expects.”

The days of watching news footage of Alan Greenspan crossing the street to the meeting on CNBC and gauging the possibility of rate changes from the size of his briefcase are long, long gone. In time, that story will be treated as some kind of urban legend. These days there is no need for the “briefcase indicator” because all moves are carefully and clearly telegraphed in advance. The seeds of today’s actions are in the comments from the last meeting, in the various public commentary made in public by members of the Fed, in the statements Greenspan last made to Congress. Just as surely, today’s statement will be the seed of the next meeting’s actions.

The Discount rate — the interest rate banks charge one another for overnight loans, for purposes of having the legally required amount of money on hand — sits at 1%. That is the result of June’s quarter of a percent rate cut, which was the latest in a long series of rate cuts since the beginning of the current economic troubles. As I have previously said, I believe there is a point beyond which rate cuts do not help the economy anymore (I think Japan may know something about that). Some critics even think that this cascade of rate cuts has been a borrowing from the future recovery and allowing companies that should have folded to flounder along. Under this theory, Greenspan should have let things get awful for a quarter or two and create a clear bottom which would theoretically have been over by now.

They can’t raise rates today, because that will make them look like fools for having lowered rates at their last meeting. That briefly summarizes all the esoteric reasons. A rate hike today would cause panic in the stock and bond markets, for no better reason than it’s not what they expect. However, the rate cannot linger here at 1% forever. It has to go up at some point. It has to go up because of certain discrepancies in the bond market and the money supply. It has to go up because we are outside the band where low interest rates make banks money. It has to go up because senior citizens are a powerful lobby in Washington that can influence the people who hired the FOMC members, and many of them live off interest. It has to go up because people have already gotten to the point where they don’t buy a new car without some kind of special deal.

And that brings us to the second thing the Fed will say this afternoon: be on the lookout for inflation. Alternatively, they may indulge in some Greenspeak to the effect of “balanced risks” to the economy. Inflation is the official reason to raise interest rates. Higher interest rates theoretically make it more expensive to borrow money, which reduces the amount of money companies spend on big things — Capital Spending. However, inflation encourages people and companies to buy things that they can afford today, because it may be more expensive tomorrow. People and companies buying things stimulates the economy and results in more jobs. So some limited inflation may turn out to be a good thing.

By the end of the year a rate increase seems likely, particularly if there is the faintest hint of the “second half recovery” actually resulting in people having jobs. But don’t expect low finance rates on new cars to instantly vanish. Don’t expect your bank to start paying you more than a pittance in interest. Consider locking in your variable rate mortgage, just because it’s unlikely for rates to be this low again in 5 years. Paying down the credit cards is frankly a good idea in any economy, no matter what the Fed does. But don’t forget, a rate hike means things are getting better.

You don’t need a crystal ball to know what will happen around 2:15 PM Eastern time today.

Did her skirt give it away?

Don’t tell the folks at Reuters, but it is no longer necessary to point out that a woman is a woman. They seem to have inadvertently discovered that at least in some places, the glass ceiling is semi-permeable.

The headline “Citigroup Taps Woman to Run Consumer Unit” is an insult. Would they have pointed out this promotion had she been a man? Is it not the least bit important to note that her male boss is vacating her new office to become the COO? If they thought the “woman” angle was so important, they could have said “Citigroup Names Marjorie Magner as Global Consumer Group’s Chairman and Chief Executive Officer” as Business Wire chose to do. This approach is subtle and commendable; it conveys the information without sending signal flares of femininity. They furthermore went on to speak glowingly of her accomplishments as an executive, adding the usual sentence or so to point out her son. Perfectly standard treatment for a brief introduction. Dow Jones didn’t consider her gender as issue at all, only using her first name once, no biographical content, dropping the “Ms.” Citigroup’s own press release on the issue was much more informal, calling her “Marge.”

Reuters might be genuinely surprised to know that Ms. Magner is not the only female executive out there. She is blessed with plenty of company on Fortune’s list of the 50 Most Powerful Women in Business. Female CEOs can even be found, and not just at “female oriented” businesses such as Avon. New economy companies like Ebay and even stodgy old Dow components like Hewlett-Packard have female CEOs. Women have offices in high places in a wide variety of industries, including banking, media companies, retail, pharmaceutical companies, airlines, food products, consumer products, electronics, oil companies, and brokerages. They may not be as plentiful as their Y chromosome bearing brethren, but there is no reason to shout “Hey, look, it’s a woman in the corner office!”

Congratulations on the promotion, Ms. Magner. I’m sure you are the right person for the job.

Is the TSA trying to kill air travel?

You’d better allow extra time at the airport.

In this morning’s news, we are told that our TSA screeners will be lavishing extra attention on a long list of items that have nothing in common except batteries. In fact, be prepared to drag everything battery powered out of your carry on bag: not just the laptop computer, but also the camera, the flash for your camera, CD player, cell phone, any radio more complicated than AM/FM, and even the remote key-fob for your car. In short, every single person in the security line will have at least one thing that requires additional scrutiny by your friendly screener. What a fabulous opportunity for thievery! A cornucopia of electronic gadgets, some of them quite pricey, temporarily separated from the direct scrutiny of a traveler who is really more concerned with getting his shoes back on. Lets not forget that although your friendly TSA screener is now a federal employee, he is not required to pass a civil service exam. Indeed, he is not even required to have a high school diploma. Furthermore, “airports wouldn’t put up with waits that last more than 10 minutes, the standard the government has set for its screeners.” So, the screener, who may or may not actually be able to read the manual of any of the devices in question (even if you happened to carry such paperwork), will be rapidly sorting through vast piles of gizmos with the goal of sorting you into the “get out of my way now” line to the terminal and the “wait here for in depth screening by someone who will assume you are a terrorist until you prove otherwise” line. He does not care when your flight takes off. He does not care that you are clearly on your way to an important meeting, or clearly on the way to see your grandchildren. He does not care that the gadget he is mangling or outright confiscating is perfectly normal and perhaps required for your livelihood. Screening silliness has spawned a plethora of anecdotes and websites.

Ask around. You undoubtedly know someone who has an airport screener story.

Business travelers should not put up with this. Indeed, they can’t afford to put up with it. A 3 hour flight already means losing an executive all day. And what if his luggage is lost, or destroyed during the “inspection” process? What if his company issued laptop computer is stolen while in the security line? What if the revolutionary device he was going to demonstrate to his important client is confiscated? What if he is arrested for questioning let alone protesting any of the indignities he suffers at the hands of the TSA? Businesses will be doing a lot more teleconferencing, driving to relatively close locations, and chartering private flights to more remote locations.

That leaves the leisure traveler as effectively the sole market for commercial air travel. They don’t pay full price for flights. They plan months ahead and scan for ultra-cheap flights, bringing down per-seat revenue in the process. Not being frequent fliers, they are more likely to not understand screening rules, to accidentally attempt to bring banned items on flights, and more likely to raise a stink (and get arrested) when such items are confiscated. The leisure traveler may start to think the cross-country road trips of their youth are more appealing than ever. The more wealthy leisure traveler may consider charter flights, just like he takes for work. Some very small very wealthy minority may even decide to learn to fly small airplanes themselves.

Both scenarios bode ill for commercial air travel as we know it. Even the former CEO of American Airlines said the industry is in big trouble “if the system we end up with is so onerous and so difficult that air travel, while obviously more secure, becomes more trouble for the average person than it is worth.” The airlines are already in financial trouble. The “jobless recovery” is not resulting in increased demand for air travel. More smaller planes in the air is not safer than fewer large planes in the air. The only good news is that any effort to create a national air transit carrier will be met with derision.

Bond, 30-Year Bond.

This morning, the nice folks on CNBC’s Squawk Box were discussing the possibility of bringing back the 30-Year Treasury Bond. A Treasury Bond is, in short, your very own piece of the National Debt. Instead of sending the President down to the local Citibank chapter to put a mortgage on Yellowstone, the United States Treasury — the same folks to whom you write that check enclosed with the 1040 — issues bonds. They pay you interest for the term of the bond (2, 5, 10 years) in return for using your money to run the government. But wait, there’s more! These bonds are a liquid investment, meaning you can buy and sell them fairly easily. You don’t have to hold a bond to the bitter end to get your money back. Even if you don’t have one of these in your brokerage account or safe deposit box, you still probably own some of these bonds, because they are often used by banks, brokerages, and mutual funds as an interest-bearing place-holder. Treasury Bonds are considered a very safe investment because they are backed by the United States Government, an entity unlikely to default (or, declare the bonds worthless).

A few years ago, the government stopped issuing the 30-year Treasury Bond. At the time, there was a budget surplus and the national debt was shrinking. It made sense to reduce the number and kinds of bonds out there. It made sense to get rid of what national debt was left in a shorter time frame than 30 years. It made sense not to pay 30 years worth of interest. It was the government equivalent of paying down a credit line and cutting up the credit card. Besides which, the stock market had long since peaked, and I believe there was the unspoken hope that with one less type of bond available, money would make its way to corporate bonds and common stocks. Stock market recovery was vital to the idea of “privatizing Social Security.”

But things have changed since then. The budget surplus is gone. The national debt is rising, buoyed on a rising tide of Homeland Security and War On Terror and tax cuts upon tax cuts. Interest rates are at historic lows, even on a 30-year basis, as proved by America’s collective mailbox full of mortgage and refinance offers. Peter Fisher, the man credited with killing the 30-Year Treasury, is moving on. Bloomberg sees an open door.

The Squawk Box online poll results were 74% in favor of bringing back the 30-Year. Keep in mind, this is not a population of day-trading soccer moms, but predominantly licensed financial industry professionals who happen to have time to respond to an unscientific online poll during the hours when the markets are opening. If this is consistent with the opinions of people with actual authority, consider the return of the 30-year a done deal.

Should it be announced that that new 30-Year Treasury Bonds will be issued, I believe the major stock market indices will go down. This will happen for two main reasons. First, it will mean the Feds are admitting that budget deficits and the national debt will be with us for the foreseeable future. So much for shrinking the government; farewell fiscal responsibility. It will be evident that the government needs 30 years to pay its debts. That bodes ill for the economy, and therefore the stock market. The other reason this will cause market declines is that some investors will take money out of stocks in favor of the new bond. Why? Because it is perceived as safe. After all, if you can’t trust the Federal Government, who can you trust?

Dow Theory Only Slightly Oversimplified

One of the most notable figures in American economic and business news is the DJIA, or Dow Jones Industrial Average. Every newscast in the nation broadcasts this number, if only as a filler screen before a commercial break. Despite this, many Americans do not know what this simple number means.

The Dow is an average of just 30 stocks deemed to be important by the nice folks at Dow Jones, price weighted (stocks with a greater share price — adjusted for past splits — move the index more than those with a lower share price). These are 30 of the largest companies in the United States, 30 of the most influential companies, 30 of the biggest non-government employers. You have very likely heard of these companies or their subsidiaries, and you have almost certainly come in contact with a product or service from one of these companies in the last 24 hours.

As of this writing, here are the components (and their stock ticker symbols):

3M (MMM)
Alcoa (AA)
Altria (Phillip Morris, MO)
American Express (AXP)
AT&T (T)
Boeing (BA)
Caterpillar (CAT)
Citigroup (C)
Coca-Cola (KO)
Dupont (DD)
Eastman Kodak (EK)
Exxon Mobil (XOM)
General Electric (GE)
General Motors (GM)
Hewlett-Packard (HPQ)
Home Depot (HD)
Honeywell (HON)
Intel (INTC)
IBM (IBM)
International Paper (IP)
JP Morgan Chase (JPM)
Johnson and Johnson (JNJ)
McDonalds (MCD)
Merck (MRK)
Microsoft (MSFT)
Procter and Gamble (PG)
SBC Communications (SBC)
United Technologies (UTX)
Wal-Mart (WMT)
Walt Disney (DIS)

Now then, lets look at what happens if the economy is good. I’ll add the ticker symbols of the companies you positively impact. For one thing, you have money in the bank or brokerage account (AXP, C, JPM). So you go and buy things (WMT). Maybe you get Happy Meals for all the kids (MCD, KO). You don’t worry about what you buy at the grocery (KO, MO). Prescription costs don’t bother you either (MRK, JNJ). Go ahead and get a new computer, just like they’re getting at work (MSFT, INTC, IBM, HPQ). Why not a new car (AA, MMM, HON, GM, XOM)? Build a new house with a state of the art kitchen (HD, UTX, GE, CAT)? Go on that Disneyworld vacation, but take plenty of pictures (DIS, EK, BA, UTX, HON, GE). Be sure to keep up with the family (SBC, T, IP). Speaking of work, not only do you have a job, but you’re pretty busy there (MMM, IP, and just about every other component, depending on your profession).

In short, when you have money, it gets funneled through your bank then you spend it. This benefits Dow component companies. They make more money. Their share prices go up, driving the DJIA up. But wait, there’s more. All that stuff the theoretical good-economy you bought had to get to you somehow. So real market geeks look for “confirmation in the Transports.” The nice folks at Dow Jones have two more indices, the Dow Jones Utilities Index and the Dow Jones Transportation Index (strictly speaking, all 3 can be put together to form the Dow Jones Composite Index). So then if the DJIA companies are doing well, they must be shipping products, and therefore the Transports must be doing well.

Now, where did I put that Second Half Recovery?

Do you remember at the beginning of the year, all the analysts and econofolk were talking about how things would get better in the second half of 2003? They were using words like “significant challenges” and “tech replacement cycle” and “effects of tax cuts.” I remember this. I also remember that various members of this tribe have been predicting a recovery 2 quarters out since late 2000.

Thisyear’s big reason was based in the IRS depreciation schedule. A lot of companies bought computer equipment back in 1999 to avoid Y2K issues. You remember Y2K, don’t you? All the computers were supposed to freak out, thinking it was 1900 instead of 2000, causing nuclear disaster and tampon shortages? It didn’t happen. Then the dot-com bubble burst, flooding the used computer market (among other effects). Computers have gotten faster in the last 3 years, and there have been new versions of both Windows and Mac OS, but cash strapped companies have not been upgrading as much equipment as the Hewlett-Packards of the world would like. The IRS lets companies “depreciate,” or spread out the expense of computers. That means there is now a tax incentive to upgrade. Of course it is ludicrous to think the entire economy will magically heal just because a few companies buy some computers.

So then, if the recovery is about to start any minute now, why are the car dealers offering ludicrous incentives? Why is Mercedes offering 2.9% financing? Why are “if you have to ask you can’t afford it” names like Maserati and Rolex taking out print ads? Why does every apartment complex you pass have signs reading “Move In Special” and some ludicrously low number? You can’t blame that entirely on low mortgage rates, because there are lots of reasons to live in an apartment and “can’t afford a house” is the least of them. Why are the retailers with the best performance still the discounters like Target? Why are state and local governments — often dependent on sales taxes for revenue — having budget crises? California and Nevada both have entered the fiscal year without budget, in violation of their respective Constitutions, because of the untenable choice of cutting to the bone or raising taxes (negating federal tax cuts).

Don’t tell me this is a “jobless” recovery. If things are improving, there is more demand for products. The only way to sell more products is to produce them. That means hiring more people or buying equipment that makes your workers more productive. The tech sector which would provide that productivity equipment is still saying “within 2 quarters” and the government is still saying it’s a “jobless” recovery. It sounds more like a lack of recovery to me.

Investing

I’d like to take a minute of your time for a definition. It’s a word you’ve heard before, and you know what it means (to you, anyway), but this way you will know what I mean when I use it.

Investing: Spending money with the reasonable expectation of getting more money back.

So then, bonds are an investment because you get paid interest, and the value of the bond may also go up.

Stocks are usually an investment, assuming you do enough research to decide there is a reasonable expectation of profit, either through dividends or capital gains. You don’t buy a stock expecting it to lose money, do you?

Life insurance is not an investment. You have to die to collect!

The Lottery is not an investment. It is not reasonable to expect to hit the big jackpot.

Real estate might or might not be an investment. It depends on your situation and point of view. I’m sure I’ll have the occasion to discuss that another day.

That business venture your relative goes on about might or might not be an investment. I haven’t seen his prospectus, and I sure don’t know him like you do.

By way of follow-up regarding last week’s FOMC rate cut, subscribers to RealMoney can check out an excellent commentary by Aaron Task. In a much more multifaceted and eloquent way, he sums up why he feels the rate cut was unnecessary, if not outright dangerous to the long term health of the economy.

Cheese it! It’s the FED!

Today, Agent Greenspan and his posse at the FOMC are set to drop interest rates again. Oops, make that yet again. Never mind that interest rates are at historically low levels. Don’t get me wrong, I respect Greenspan and think he has done a generally good job in the past. However, I don’t think one more cut is going to help anyone. I believe there is a point beyond which rate cuts do not stimulate the economy, and that we are there.

Businesses are still not making large capital investments — the official reason why lower interest rates stimulate the economy. Theoretically, businesses expanding on cheap credit build bigger plants and hire more people to work in them (hasn’t happened), and the companies which supply the infrastructure must also expand to meet demand (also not happening).

To make matters worse, the insurance companies are not making money on their investments because of low interest rates, which means premiums must go up. This creates a fake “crisis” in any business which requires heavy insurance coverage.