Saturday, April 12, 2014
Skin in the Game
Back in the day when I practiced Tai Chi, our teacher informed us that in old China, a family would pay a doctor of Chinese medicine a retainer to keep the family healthy. When a family member became ill, the cost of medicine and treatments came directly out of the doctor’s pocket. Would American medicine (sometimes called sickcare) look any different if we adopted that model? The student loan crisis has been generated, at least in part, because the educational establishment has no skin in the game. There is an almost unlimited source of Government funding and Government guaranteed funding that has allowed our universities to increase the cost of education at 5 times the rate of inflation. The university gets all its money up front—guaranteed—whether or not the student finds a job or even graduates. The lender’s money is guaranteed by the Federal Government by a law that does not allow the student to discharge those loans, even in bankruptcy. If the parent cosigned the loan, it isn’t always discharged with the death of the child. Would American higher education look any different if the university and the bank shared responsibility for the outcome of the loan with the student and parent? What if those loans could be discharged in bankruptcy if the student couldn’t find a job in her field after some reasonable period of time? The Real Estate crash of 2006 and the subsequent market crash of 2008 were generated, at least in part, by banks and mortgage companies that granted loans on the basis of credit scores rather than manual underwriting that examined the entire financial situation of the applicant. The most egregious examples of this nonsense were the so called liar loans. The applicant simply stated they had a job that paid so much a year. The mortgage broker never investigated this claim or if he did it had no bearing on the outcome of the decision making process. The broker had no skin in the game. He got his commission the day of the sale. His employer didn’t have any skin in the game either. The mortgage was sold then bundled into Structured Investment Vehicles and derivatives like Synthetic Credit Default Swaps, guaranteed by Fannie Mae and Freddie Mac by the American taxpayer. These now infamous frauds were sold to the world as AAA investments backed by the full faith and credit of the American people, even though that was not technically the truth. When the truth was discovered it nearly collapsed the world financial system. What if banks were required to maintain ownership of mortgages they granted for the life of the mortgage? What if salesmen were paid on an ongoing basis as long as the mortgage remained in force rather than getting all their commission up front? Would the mortgage process look any different? Just about everyone in the financial markets from hedge fund managers to mutual fund salesmen get most of their money up front, at the point of the sale. Then they typically receive some form of residuals based on the size of the investment rather than the increase in the size of the investment as a result of their investment acumen. There are exceptions to this practice. Vanguard comes to mind. That company charges no sales loads and miniscule ongoing management fees. Still even in that praiseworthy model, the customer is providing all the capital and accepting all the risk associated with the investment. What if the investment manager was paid a percentage of the increase rather than a percentage of the total investment? What if the manager was responsible for making up a predetermined percentage of any losses, effectively sharing the risk with the investor who supplied all the capital? Would this change the current brokerage model, dominated by commission salesmen rather than investment advisors who were willing to sign a fiduciary oath? Is it likely that any system of childcare at any cost could equal the quality of childcare provided by parents? Who cares more about a child than her mother? Who loves a c child more than her mother? Who has more skin in the game than a mother?