With the ongoing Oxycontin (a brand name version of oxycodone, a narcotic painkiller) madness continuing in Georgia and nationwide, now seems as good a time as any to write about the DEA's newsmaking efforts this year. Eariler this year (http://www.reuters.com/article/2012/02/06/us-dea-raids-idUSTRE8151NA20120206) two CVS pharmacies were raided for filling an exorbitant number of oxycodone prescriptions, and the article also mentions briefly the Cardinal distribution center the DEA had shut down earlier that week. I don't have a problem with the DEA attempting to rein in pharmacies that are ignoring obvious forgeries and otherwise not making any effort to assure prescriptions are legitimate. However, I do think it is a slippery slope to expect pharmacists to be able to spot whether each and every prescription is somehow justified beyond being a legal prescription drug order.
More than just checking with the physician and documenting these steps to confirm a legitimate prescription, it seems the DEA would like pharmacies to second-guess prescribers and patients as to whether they actually need the medication. Well, actually, the DEA would like pharmacies to simply voluntarily cut the supply of painkillers, particularly Oxy, because then the DEA wouldn't look as foolish for their inability to control Oxy's widespread abuse. So far, the DEA has proven incapable of stopping the flow of Oxy at its source, the physicians running the pain clinics and pill mills. Moving downstream and targeting pharmacies won't have much of an impact if the dam's gates are still open. The Oxy scripts are still out there, so they will just move to a different pharmacy. And who gets left out in the cold in this ambush? Those with actual chronic or acute pain that would be well served by the strong pain control an opiate like oxycodone provides.
A Cardinal distribution center in Florida (Cardinal being one of the major pharmaceutical drug distributors in the US) was raided and, at present, cannot ship controlled substances. Perhaps the DEA viewed this as moving up the supply chain: going from the corner dealer (retail pharmacy, e.g. the raided CVS's) to their supplier. However, the pharmacies that this distribution center supplied will now have to be served by another distributor in order to even fill their elderly patients' sleeping pills. Another distributor will step in to fill the legitimate need for controlled medications, even if they are wary of the DEA with regards to narcotics.
But won't the distributors heed the message and simply drastically cut down deliveries of Oxy to pharmacies? Possibly. Oxycontin/oxycodone does typically get filled initially at retail pharmacies before entering the black market; so you can theoretically cut off the black market by either shrinking the Oxycontin/oxycodone supply to pharmacies. Or, you can reduce the amount of prescriptions written for Oxy by quack prescibers in pill mills. But the first option harms actual patients and drug abusers indiscriminately. The second option, targeting prescribers with harsh actions such as revoking medical licenses for proven abuses, disproportionately affects those attempting to fill prescriptions to resell illegally. Which option do you think the DEA should be focusing on?
Monday, June 25, 2012
Thursday, June 7, 2012
Express Scripts and Walgreens: One Year Later
Around a year ago, the ongoing contract negotiation between Express Scripts (ESRX) and Walgreens (WAGS) promptly ended when Walgreens issued a press release stating that they would not accept Express Scripts prescription coverage after the end of 2011. Walgreens was insisting the reimbursement offered was insufficient. As far as I know, Walgreens never actually said the contract Express Scripts proposed would be unprofitable; I believe they characterized the contract as providing “below market” reimbursement while attempting to imply that Express Scripts was low-balling them. Express Scripts, of course, stated the contract had standard terms. In rejecting the contract and saying they would leave the Express Scripts pharmacy network, Walgreens may have thought other pharmacies would join them in a protest against the ever-declining reimbursement rates in retail pharmacy. That notion obviously did not play out, and, instead, a massive exodus of customers flew out of Walgreen’s doors.
WAGS was alone among major pharmacy chains in declining to fill Express Scripts prescriptions; the campaign to encourage patients to demand Walgreens be in their pharmacy network produced little effect. There has been a widely reported number that come January 1st, Walgreens lost 85% of their Express Scripts covered prescriptions. Walgreens attempted to downplay the loss of these prescriptions throughout the negotiations, stating they expected prescription volume to be only slightly less in 2012 versus 2011. Express Scripts processes about 750 million prescriptions a year; with Walgreens handling about 90 million ESRX prescriptions a year, Walgreens is looking at a lot of lost revenue: over $4B. That’s over 5% of the company’s total revenue right there just in lost prescription reimbursement.
Looking at WAGS first fiscal quarter filings, which cover the quarter ending Feb. 29 thus including the month of December when the Express Scripts contract was still in effect, WAGS has lost over 7% in prescription volume compared to the previous year. Operating income for the quarter was down as well. A recent press released showed comparable store prescription numbers for May were down nearly 8% year over year, and one can assume this was highlighted because it is a brighter outlook than recent months. Taking these numbers into account, it doesn’t seem likely Walgreens can come within a couple percentage points of last year’s total prescription numbers.
For those in retail pharmacy, Walgreens actions during the negotiations with Express Scripts seemed quite peculiar. It is obvious to almost everyone that PBMs hold the bargaining power in today’s pharmacy landscape. How did the stock market react to Walgreens’ bravado? Well, WAGS is down nearly 28% in the past year. After the initial summer drop surrounding the Express Scripts news, WAGS traded in the low $30s for much of the latter half of 2011. Since then, it has slipped to $30.98, dropping over 6% in 2012 alone.
Express Scripts seems to have handled things a bit better. ESRX was also trading lower in the latter half of 2011 versus summer 2011, down from the mid $50s to just under $36. The key point here is that ESRX is currently trading at ~$53. The current price point is slightly below last year’s high, but the stock has been on a mostly steady march upward since the lows of early October. Due to a recent pullback and last summer‘s fall, the year over year return is about -7%, but the stock is up ~12.5% in 2012.
So who gained from those millions of Express Scripts prescriptions that Walgreens used to process? Well, CVS Caremark (CVS) is up 20% in the past year. Rite Aid (RAD) is up nearly 14% in the same period. One man’s loss is another man’s gain.
WAGS was alone among major pharmacy chains in declining to fill Express Scripts prescriptions; the campaign to encourage patients to demand Walgreens be in their pharmacy network produced little effect. There has been a widely reported number that come January 1st, Walgreens lost 85% of their Express Scripts covered prescriptions. Walgreens attempted to downplay the loss of these prescriptions throughout the negotiations, stating they expected prescription volume to be only slightly less in 2012 versus 2011. Express Scripts processes about 750 million prescriptions a year; with Walgreens handling about 90 million ESRX prescriptions a year, Walgreens is looking at a lot of lost revenue: over $4B. That’s over 5% of the company’s total revenue right there just in lost prescription reimbursement.
Looking at WAGS first fiscal quarter filings, which cover the quarter ending Feb. 29 thus including the month of December when the Express Scripts contract was still in effect, WAGS has lost over 7% in prescription volume compared to the previous year. Operating income for the quarter was down as well. A recent press released showed comparable store prescription numbers for May were down nearly 8% year over year, and one can assume this was highlighted because it is a brighter outlook than recent months. Taking these numbers into account, it doesn’t seem likely Walgreens can come within a couple percentage points of last year’s total prescription numbers.
For those in retail pharmacy, Walgreens actions during the negotiations with Express Scripts seemed quite peculiar. It is obvious to almost everyone that PBMs hold the bargaining power in today’s pharmacy landscape. How did the stock market react to Walgreens’ bravado? Well, WAGS is down nearly 28% in the past year. After the initial summer drop surrounding the Express Scripts news, WAGS traded in the low $30s for much of the latter half of 2011. Since then, it has slipped to $30.98, dropping over 6% in 2012 alone.
Express Scripts seems to have handled things a bit better. ESRX was also trading lower in the latter half of 2011 versus summer 2011, down from the mid $50s to just under $36. The key point here is that ESRX is currently trading at ~$53. The current price point is slightly below last year’s high, but the stock has been on a mostly steady march upward since the lows of early October. Due to a recent pullback and last summer‘s fall, the year over year return is about -7%, but the stock is up ~12.5% in 2012.
So who gained from those millions of Express Scripts prescriptions that Walgreens used to process? Well, CVS Caremark (CVS) is up 20% in the past year. Rite Aid (RAD) is up nearly 14% in the same period. One man’s loss is another man’s gain.
Saturday, June 2, 2012
CVS/Caremark Takes Aim at Discount Cards' Hidden Side Effects
Jon
Kamp’s recent WSJ article focused on CVS/Caremark’s attempts to stanch
the flow of pharmacy discount cards and their negative effects on
prescription spending. We aren't talking about the random cards that
people receive in the mail that promise discounts on all medications
(those are a subject for another day); CVS/Caremark is fighting against
the discount cards disbursed by manufacturers. Many people have seen or
used these cards. You get a prescription for a brand name medication
that will be expensive, such as Solodyn. Solodyn is a brand name,
extended release formulation of minocycline, an antibiotic commonly used
to treat acne. Since Solodyn is expensive, your provider gives you a
discount card to reduce your co-pay on the medication to an affordable
level. Now, in a perfect world, these cards would be a major benefit to
patients, helping them afford needed medicines that would otherwise not
be taken due to cost. And there are certainly some cases where that is
what happens.
Often, in my experience, the discount card is for a brand-name medication that provides little benefit over a cheaper alternative in the same class. Generic Solodyn is available, so brand name is typically only filled by patients with coupon cards or other forms of reduced co-pays. Generic Solodyn, extended release minocycline, is ~5-10 bucks a tablet. Brand name Solodyn is ~$20-30 a tablet. So why does anyone pay for Solodyn? Because they have a coupon card that reduces their co-pay down to twenty bucks, not much more than the co-pay for generic minocycline. No harm, no foul though right? Patient is happy and the pharmacy will get reimbursed from the Pharmacy Benefit Manager (PBM) and the manufacturer/card processor.
Not exactly. The pharmacy has the extra fun of dealing with split billing the medication, holding another expensive inventory item on the shelf, as well as an additional accounts receivable to wait on. But that isn't the real story. Why CVS/Caremark is attempting to head off these cards at the pass is because they take advantage of the way benefit plans are commonly designed and change the way the co-pay structure incentivizes patients to use cheaper, effective alternatives where possible. Though benefit structures can be complicated, co-pays are commonly in tier systems.
One basic example would be a first tier with an initial price for preferred generics, a second, higher co-pay tier for non-preferred generics and preferred brands, and a third, still higher co-pay for non-preferred brands or very expensive medications. Some drugs may not be covered by the plan at all, such as over-the-counter items or lifestyle drugs. For drugs that are covered, the pharmacy will electronically send a claim to the PBM, and the PBM will reimburse the pharmacy a contractually agreed amount meant to cover the cost of the medicine and dispensing. Then the pharmacy will charge the patient the copay amount that the PBM returned in the claim (pharmacies also contractually agree to charge the copay).
For our Solodyn example, it may fall in a higher tier, such as Tier 3, since there is a comparable generic minocycline available. A patient's hypothetical co-pay might be $50 for Tier 3 medicines. With a coupon card, the co-pay may come down to, say, $20 with the manufacturer/coupon processor paying $30. This is acceptable to many patients, even if the generic Tier 1 copay is a little lower, say $10. The patient has the Solodyn filled and begins treatment.
But the money for the Solodyn has to come from somewhere; remember a 30 day supply is over $700 just for the pharmacy to order. If the medication is covered, as it was in this hypothetical example where it fell in Tier 3, then the PBM will reimburse the pharmacy something close to that cost. Hundreds of dollars are spent on the drug, but the patient bears very little of the cost burden. PBMs have plenty of money you say? Well, who ultimately pays for the medicine is the plan sponsor, typically an employer or federal agency.
So money that could have been used for raises, hiring additional people, paying dividends, reducing operating deficits, whatever, is instead an additional benefits expense. CVS/Caremark is taking a step in the right direction by not covering many of these coupon card products, thereby placing the cost burden elsewhere. If the manufacturer wants to subsidize the product to a large enough degree that patients will pay for it, or if patients want to pay full price, that is their business.
Of course that won't be the case, and these prescriptions will get changed to a viable, less expensive alternative or go unfilled. Now, CVS/Caremark is also discontinuing coverage for medications that wouldn’t agree to rebates CVS/Caremark asked for, and both of these steps have the main objective of increasing that bottom line profit number. But realigning patient’s economic incentives with the most cost-effective treatments also saves the plan sponsor, patient, pharmacy, and healthcare system as a whole money. In a system that wantonly spends money without evidence-based justification, steps like this by CVS/Caremark are a move in the right direction.
Often, in my experience, the discount card is for a brand-name medication that provides little benefit over a cheaper alternative in the same class. Generic Solodyn is available, so brand name is typically only filled by patients with coupon cards or other forms of reduced co-pays. Generic Solodyn, extended release minocycline, is ~5-10 bucks a tablet. Brand name Solodyn is ~$20-30 a tablet. So why does anyone pay for Solodyn? Because they have a coupon card that reduces their co-pay down to twenty bucks, not much more than the co-pay for generic minocycline. No harm, no foul though right? Patient is happy and the pharmacy will get reimbursed from the Pharmacy Benefit Manager (PBM) and the manufacturer/card processor.
Not exactly. The pharmacy has the extra fun of dealing with split billing the medication, holding another expensive inventory item on the shelf, as well as an additional accounts receivable to wait on. But that isn't the real story. Why CVS/Caremark is attempting to head off these cards at the pass is because they take advantage of the way benefit plans are commonly designed and change the way the co-pay structure incentivizes patients to use cheaper, effective alternatives where possible. Though benefit structures can be complicated, co-pays are commonly in tier systems.
One basic example would be a first tier with an initial price for preferred generics, a second, higher co-pay tier for non-preferred generics and preferred brands, and a third, still higher co-pay for non-preferred brands or very expensive medications. Some drugs may not be covered by the plan at all, such as over-the-counter items or lifestyle drugs. For drugs that are covered, the pharmacy will electronically send a claim to the PBM, and the PBM will reimburse the pharmacy a contractually agreed amount meant to cover the cost of the medicine and dispensing. Then the pharmacy will charge the patient the copay amount that the PBM returned in the claim (pharmacies also contractually agree to charge the copay).
For our Solodyn example, it may fall in a higher tier, such as Tier 3, since there is a comparable generic minocycline available. A patient's hypothetical co-pay might be $50 for Tier 3 medicines. With a coupon card, the co-pay may come down to, say, $20 with the manufacturer/coupon processor paying $30. This is acceptable to many patients, even if the generic Tier 1 copay is a little lower, say $10. The patient has the Solodyn filled and begins treatment.
But the money for the Solodyn has to come from somewhere; remember a 30 day supply is over $700 just for the pharmacy to order. If the medication is covered, as it was in this hypothetical example where it fell in Tier 3, then the PBM will reimburse the pharmacy something close to that cost. Hundreds of dollars are spent on the drug, but the patient bears very little of the cost burden. PBMs have plenty of money you say? Well, who ultimately pays for the medicine is the plan sponsor, typically an employer or federal agency.
So money that could have been used for raises, hiring additional people, paying dividends, reducing operating deficits, whatever, is instead an additional benefits expense. CVS/Caremark is taking a step in the right direction by not covering many of these coupon card products, thereby placing the cost burden elsewhere. If the manufacturer wants to subsidize the product to a large enough degree that patients will pay for it, or if patients want to pay full price, that is their business.
Of course that won't be the case, and these prescriptions will get changed to a viable, less expensive alternative or go unfilled. Now, CVS/Caremark is also discontinuing coverage for medications that wouldn’t agree to rebates CVS/Caremark asked for, and both of these steps have the main objective of increasing that bottom line profit number. But realigning patient’s economic incentives with the most cost-effective treatments also saves the plan sponsor, patient, pharmacy, and healthcare system as a whole money. In a system that wantonly spends money without evidence-based justification, steps like this by CVS/Caremark are a move in the right direction.
Sunday, May 27, 2012
No Surprise Retail Traders Lose on Facebook IPO
Facebook's IPO has been criticized roundly, and the lawsuits are now starting to fly. In the days leading up to the offering, both the amount of shares being sold and the offering price were increased significantly. While this might make sense on the back of some good news about Facebook, the only recent developments in their business were negative: the difficulty in monetizing mobile, slowing growth, and a quarter over quarter revenue decrease. Of course, given the unbridled optimism and enthusiasm some people have for Facebook, the IPO might have succeeded in spite of such warning signs. I assume that is what the underwriters were hoping for.
Not only was demand lacking above, or possibly even at, the IPO price, significant problems with NASDAQ's handling of trades caused delays and unconfirmed trades left and right. The media pointed out that some analysts for underwriters such as Morgan Stanley had communicated misgivings about Facebook's IPO valuation to important clients of the firms. This is an area of legal contention, but it seems that there is likely nothing technically illegal that occurred during the week of the IPO; analysts may have been allowed to share new opinions verbally without running afoul of disclosure rules.
This brings us to my favorite complaint heard throughout the coverage of Facebook: the IPO showed how Wall Street wasn't fair to the little guy because of information sophisticated investors might have been privy to compared to your retail John Doe. The naivete of the assumption that Wall Street should be "fair" in this regard is astounding. Of course a retail trader doesn't have as much information as financial professionals; they never do.
Regardless of whether or not analysts involved in the IPO may have quietly revised price targets down or expressed concerns to clients, retail guys don't have the same knowledge and understanding of Facebook's finances nor analyst research. Even the most well-informed retail traders who can break down accounting statements and dissect a stock's story don't have access to the amount and depth of analyst research that professionals do unless the retail investor is willing to pay large sums for it. Just because an analyst might have disclosed their new opinion on a stock doesn't mean John Doe ever sees this report. It isn't free disclosure.
Retail traders also don't have the market knowledge of professionals who spend every day around the markets and are plugged in. Is the rumor across trading floors that this IPO price will have a hard time being justifiable? What kind of volumes and order flow are coming across the tape right now? What are the derivatives markets telling us, and how will external or global events effect prices today? Most retail guys wouldn't know, as they don't have access to such information flow.
So, your average individual who traded this IPO doesn't understand the business all that well and doesn't have the market knowledge to see warning signs about a lack of price support or interest if such signs did exist. And people are upset and surprised they lost money? I'm more surprised John Doe ever makes money on a trade, but I chalk that up to the laws of probability.
Not only was demand lacking above, or possibly even at, the IPO price, significant problems with NASDAQ's handling of trades caused delays and unconfirmed trades left and right. The media pointed out that some analysts for underwriters such as Morgan Stanley had communicated misgivings about Facebook's IPO valuation to important clients of the firms. This is an area of legal contention, but it seems that there is likely nothing technically illegal that occurred during the week of the IPO; analysts may have been allowed to share new opinions verbally without running afoul of disclosure rules.
This brings us to my favorite complaint heard throughout the coverage of Facebook: the IPO showed how Wall Street wasn't fair to the little guy because of information sophisticated investors might have been privy to compared to your retail John Doe. The naivete of the assumption that Wall Street should be "fair" in this regard is astounding. Of course a retail trader doesn't have as much information as financial professionals; they never do.
Regardless of whether or not analysts involved in the IPO may have quietly revised price targets down or expressed concerns to clients, retail guys don't have the same knowledge and understanding of Facebook's finances nor analyst research. Even the most well-informed retail traders who can break down accounting statements and dissect a stock's story don't have access to the amount and depth of analyst research that professionals do unless the retail investor is willing to pay large sums for it. Just because an analyst might have disclosed their new opinion on a stock doesn't mean John Doe ever sees this report. It isn't free disclosure.
Retail traders also don't have the market knowledge of professionals who spend every day around the markets and are plugged in. Is the rumor across trading floors that this IPO price will have a hard time being justifiable? What kind of volumes and order flow are coming across the tape right now? What are the derivatives markets telling us, and how will external or global events effect prices today? Most retail guys wouldn't know, as they don't have access to such information flow.
So, your average individual who traded this IPO doesn't understand the business all that well and doesn't have the market knowledge to see warning signs about a lack of price support or interest if such signs did exist. And people are upset and surprised they lost money? I'm more surprised John Doe ever makes money on a trade, but I chalk that up to the laws of probability.
Tuesday, May 22, 2012
Mail-Equivalent Reimbursement - A Disruptive Approach for Retail Pharmacies vs PBMs
An injunction to stop the Express Scripts-Medco merger, requested by the NACDS, NCPA, and some other assorted individual pharmacies, was tossed out in April. The lawsuit continues, but the plaintiffs can't be optimistic. Retail pharmacy is worried, as an industry, by the merger. Pharmacy benefit managers, or PBMs, manage the pharmacy benefit for employers or health insurers, processing claims, contracting with pharmacies, and negotiating with manufacturers for rebates. The story goes that, by having a knowledgeable middleman who can squeeze discounts from pharmacies and rebates from pharma, the payer, whether it is an employer or insurer, saves money. The deal between Express Scripts (ESRX) and Medco (MHS) consolidates and increases negotiating power of PBMs over pharmacies even further; together the two will handle a little over a third of all the prescriptions processed in the U.S. In addition, Express Scripts and Medco both operate massive mail-order pharmacy operations, contributing a significant percentage of both firms' revenues. The current trend of PBMs encouraging, or requiring, members to use mail-order for chronic medications further threatens retail pharmacies profitability, and the industry is justifiably worried that the combined ESRX/MHS company will become even more aggressive in pushing their mail-order business.
From a payer perspective, the argument for mail order makes sense; the same prescription can typically be filled at a lower cost to them than at a brick and mortar pharmacy. So, plan sponsors save money when the members receive their meds through the mail. From a PBM perspective, filling the prescription via mail order captures the prescription revenue completely instead of flowing to a retail pharmacy. Of course, from a retail pharmacy perspective, you're simply losing business to a competitor who doesn't have to operate physical stores.
Retail pharmacy has fretted publicly about the loss of the patient relationship with their pharmacist when mail order is required. This tactic won't convince those footing the bill however. For retail pharmacies to attempt to stem or reverse mandatory mail order, the argument must focus on the payer. It is the plan sponsor who is the client of the PBM, and it is the plan sponsor who agreed to the benefit arrangement that allowed or required mandatory mail-order to save money in the first place. Retail pharmacies should offer to accept mail-equivalent reimbursement; the same amount the plan sponsor pays the PBM for a mail order prescription should be offered to the retail pharmacy to accept or decline once a prescription would be required or incentivized to be filled via mail-order.
Under such an arrangement, if the retail pharmacy contracts to accept mail-equivalent reimbursement, the PBM would simply continue its function of processing claims, paying the pharmacy, and billing the plan sponsor client. The plan sponsors still save money, members have more choices in how they receive their prescriptions, and the ancillary benefits of regular contact with the pharmacist are maintained. Pharmacies would have to determine whether the lower reimbursement is worth it, but it certainly would be for some. This appeal has to be to payers, as PBMs have little incentive to surrender mail-order revenue. If retail pharmacy can present this approach to payers as a three pronged argument, helping keep costs in line while increasing access and helping focus on patient care, then PBMs will not have much of a counter-argument. Mail-equivalent reimbursement could be the new paradigm the industry needs to avoid large shifts in prescription volume to mail-order.
From a payer perspective, the argument for mail order makes sense; the same prescription can typically be filled at a lower cost to them than at a brick and mortar pharmacy. So, plan sponsors save money when the members receive their meds through the mail. From a PBM perspective, filling the prescription via mail order captures the prescription revenue completely instead of flowing to a retail pharmacy. Of course, from a retail pharmacy perspective, you're simply losing business to a competitor who doesn't have to operate physical stores.
Retail pharmacy has fretted publicly about the loss of the patient relationship with their pharmacist when mail order is required. This tactic won't convince those footing the bill however. For retail pharmacies to attempt to stem or reverse mandatory mail order, the argument must focus on the payer. It is the plan sponsor who is the client of the PBM, and it is the plan sponsor who agreed to the benefit arrangement that allowed or required mandatory mail-order to save money in the first place. Retail pharmacies should offer to accept mail-equivalent reimbursement; the same amount the plan sponsor pays the PBM for a mail order prescription should be offered to the retail pharmacy to accept or decline once a prescription would be required or incentivized to be filled via mail-order.
Under such an arrangement, if the retail pharmacy contracts to accept mail-equivalent reimbursement, the PBM would simply continue its function of processing claims, paying the pharmacy, and billing the plan sponsor client. The plan sponsors still save money, members have more choices in how they receive their prescriptions, and the ancillary benefits of regular contact with the pharmacist are maintained. Pharmacies would have to determine whether the lower reimbursement is worth it, but it certainly would be for some. This appeal has to be to payers, as PBMs have little incentive to surrender mail-order revenue. If retail pharmacy can present this approach to payers as a three pronged argument, helping keep costs in line while increasing access and helping focus on patient care, then PBMs will not have much of a counter-argument. Mail-equivalent reimbursement could be the new paradigm the industry needs to avoid large shifts in prescription volume to mail-order.
Sunday, May 13, 2012
5 Points on the Regulatory Fallout from JPMorgan's Trading Losses
As the news of JP Morgan’s trading losses continues to reverberate
around the web, (check out http://www.usnews.com/news/articles/2012/05/11/in-jp-morgan-loss-bank-regulation-advocates-see-opportunity
for an overview of why there is continued debate) here are five key takeaways that
I think are mostly missing from the coverage:
- Many people are speculating that the hedge was a “bet,” which I guess is critical parlance for subversive gambling of some kind. However, there doesn’t seem to be any reason to not believe JPMorgan CEO Jamie Dimon’s statement that the position was a hedge. It sounds like the trade was meant to hedge some macro exposure the bank’s risk officers felt they had, and the trade went awry.
- Any business involved in the financial markets can have individual risk exposures from a single trade, asset, or business dealing, but the risk of the firm can also be looked at as the net exposures of the collective transactions. Even if you try to completely hedge every individual transaction, that won’t typically be feasible; thus you have net exposures from the sum of all of your individual risks.
- If you don’t allow banks to look at their portfolio, assess the risk from it and their other business lines, and subsequently choose whether or not to attempt to hedge to reduce that risk, you actually increase the likelihood of the bank failing (the opposite intended effect of Dodd-Frank and the Volcker rule) as you have taken away a risk management tool.
- Though I certainly have not read the ~850 odd pages of Dodd-Frank, I am under the impression that the rules currently proposed would allow for macro hedging, such as hedging of business risks not associated with single assets. Thus, it would seem that JPMorgan’s trade wouldn’t be illegal. Even if the regulations end up attempting to tie hedges to specific holdings, I would think any enterprising bank could still argue for trades that act as macro hedges by pointing at assets in their vast investment portfolio. Of course, taken further, practically any trade a bank desires could be justified. And that’s what you get when you try to regulate something so complex.
- It may be nigh impossible, and will almost certainly be a waste of time and money, for regulators to concoct a definition for hedging that would be as effective or constraining as they would like. Even in a single, simple transaction, such as a derivative sold by a bank such as JPMorgan to an investment fund, the bank will likely have resulting exposure to the underlying assets, volatility, interest rates, time, and the other variables derivatives depend on. Will regulators be able to tell banks how, how much, and how often they should hedge each of these risks in their quest to eliminate prop trading? How will a regulator, who almost certainly will understand the assets less than the bank, determine whether a transaction is over or under-hedged and thus has exposure that might be considered “prop?” Congressman Frank and Senator Levin would have people believe that Dodd-Frank, and the Volcker rule in particular, are going to help the country by reducing risk and avoiding any more bank meltdowns. Looks to me like the winners right now are financial services lawyers and lobbyists.
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