Death Spiral

There’s a thing that can happen to private group health-care plans in the States that’s called an adverse-selection death spiral. Basically, people go to insurance company Foocorp and then get very sick. If Foocorp can’t quite cover the cost of treating their clients, maybe without hurting their stock value, then they raise the rates. Which some people can’t pay, so those people go away, leaving behind the sicker people who need the insurance pretty badly and whose treatement is expensive. And pretty soon Foocorp is in a pretty much irreversible downward spiral, because there’s no way to get out of that cycle.That’s not strictly a health-insurance problem; it’s a special class of risk-management problem. But if you’re looking at the structural of that particular house of cards, swap out illness for insolvency in that model, and you’ll have a pretty good model for the American and world markets, right now.

Except that suddenly, we’re not talking about random private insurance companies, here – we’re talking about all the large financial institutions in the country and, through the magic of networked financial systems and leveraged debt, the rest of the world.

As is typical with these things, once the risk becomes obvious to the professional financiers, the usual two-pronged risk-offloading process gets rolled out – lobbying for government bailouts, and trolling for suckers. The trolling for suckers process has been underway for some time now; that link is just one example of many. The government bailout process is also in play (The Federal Reserve bank cut interest rates this morning down from 4.25% to 3.5% which it’s worth noting is a huge move, and poured a bunch of cheap money into the market a few days ago. Expect more action on that front soon) but it’s really not looking like any of that will be enough.

The first draft of this I wrote a while ago ended with “So don’t expect any of the large institutions that govern these things to actually go out of business, or the people with their hands on the gears might actually suffer anything like unemployment, legal action or even anything as mildly gauche as a lifestyle change. It’s bailouts-a-gogo, no real changes in regulations, and the taxpayer will be the one left holding the bag. Again.” But it’s starting to look worse than I thought and the actual problem, an honest-to-god insolvency problem that a responsible financial apparatus would have strangled in the crib has grown way, way too big to pry apart with the usual levers.

Who would have thought that putting rabid laissez-faire-capitalism ideologues headed up (Jeebus, it’s like some wierd soviet agitprop cartoon) by a bona fide Objectivist at the helm of the American financial apparatus would result in all of this? American markets were closed yesterday, but everywhere else dropped between four and five percent in one day. The knives are apparently out for the people and institutions who’ve made all of this possible, and for the foreseeable future it’s only going to get worse.

Next time somebody tells you how awesome it would be to privatize social security or health care, keep days and weeks like this in mind.

2 Comments

  1. Ken Gerrard
    Posted January 22, 2008 at 12:05 pm | Permalink

    What I love is how I’m seeing proclamations that Canada’s economy is in a good position to benefit from a US recession. Um, good luck with that? It’s all going downhill, I’m thinking.

  2. Rajesh
    Posted January 23, 2008 at 6:30 pm | Permalink

    Even with all the losses last quarter and the write-downs, Citi, JPM, etc still have made billions in profits last year. The yield curve is now steep, and will steepen even more with more FF rate cuts – so these same banks are the best positioned to benefit. Everyone else, buckle up for the ride to the bottom.