Has Quality gone Sub-prime?
Posted by Sten Westgard, MS
As our Congress ponders a $700 billion dollar bail-out of Wall Street, and the rest of us on Main Street ponder our financial futures, it seems like as good a time as any to draw some parallels between the larger US economy and the laboratory economy.
For those of you who aren't watching the news, this Wall Street crisis got its start in Sub-Prime mortgages. (A nifty picture here illustrates how and why this happened and a handy little timeline on the most recent events in the crisis can be found here) Subprime mortgages used to be something that only people with poor credit history could get, perhaps only 15% of the mortgages. They used to be considered a risky proposition that most investors avoided. Yet they become very popular with both borrowers and investors alike, until nearly 25% of all mortgages were subprime.
What happened?
The Start: The Government is here to help
The seeds of this financial disaster were planted, ironically, in the ashes of the last crisis, the Internet bubble. At that time, the Federal Reserve lowered interest rates to just 1% in order to spur the economy. These low rates made it easier to borrow money, making home ownership possible for previously marginal home owners.
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In the aftermath of laboratory scandals, the government passed the CLIA legistation. However, since they were unable to work out the procedure for manufacturer's QC clearance, they delayed that provision. In the interim, they gave some devices and QC methods temporary waivers. |
The New Rules
Eager to attract grow their margins, the mortgage industry created a new raft of "financial instruments" to extend loans to riskier and riskier customers. These loans included the following types:
- Teaser Rates, aka Adjustable Rate Loans. This offered a low interest rate at the beginning of the loan, followed later by a dramatic rise in the rate. Save and buy now, Pay a lot later.
- No Doc or "Liar Loan." This loan allowed the applicant to "state" their income but not provide any proof of this income. It was perhaps first intended for people who work in jobs where the wages are primarily earned in cash, perhaps day laborers and waitresses.
- NINA Loan: No Income. No Asset Verification. For this loan, the applicant did not have to state an income, nor did they have to verify their assets. In theory, these were loans for people who wanted their privacy and were willing to pay through the nose to keep it.
- NINJA Lona: No Income. No Job. No Assets. This was a loan given to people who could fog a mirror. This isn't just tortured logic. This is logic that has been murdered.
At the height of the bubble, when housing prices were rocketing up, these loans seemed to make sense. Why not take out a subprime mortgage, if only a few years from now, the value of the house is going to double. If housing prices rise forever, you can sell the house to the next person for far more than your mortgage, no matter what the terms.
What excerbated this problem even more was the unscrupulous nature of some of the loan officers. Since they were paid commissions up front for getting new subprime loans, some officers would falsify mortgage applications for their unknowing clients.
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After repeated delays, CMS and the FDA cannot find an agreeable way to implement manufacturer QC clearance. So it's back to the drawing boards. CMS writes a new clause in the law - "Equivalent Quality Testing" - and invents a new set of "Equivalent QC Procedures" which are added to the Interpretative Guidelines of the State Operators Manual:
The absurdity of these options have been exhaustively documented and discussed on Westgard Web. Yet despite the near-universal condemnation of the the options, despite the admission from CMS that "We blew it", it appears that these options are here to stay. |
The Collaborators: Pervasive Leadership Failure
It wasn't inevitable that subprime mortgages got out of hand. It wasn't inevitable that Wall Street would become so addicted to these dubious financial instruments. If the heads of these institutions had demonstrated leadership (and ethics), instead of relentless greed, we wouldn't be in this mess.
Part of the problem was the dispersion of risk and responsibility for these subprime loans. Since no single institution owned an entire subprime loan, it didn't feel the need nor the obligation to ensure that it was a good loan. Back in the old world of mortgages, if a single bank made too many subprime loans, it would become obvious that there was too much risk and the market would force the bank to stop its practices. However, banks and mortgage lenders didn't hold onto their own loans anymore. Instead, they packaged them up into "collateralized debt obligations (CDOs)," a type of "mortgage-backed security," which they then sold off to the broader market. Thus, the banks and mortgage brokers got paid up front, outsourced the responsibility to someone else, and had little incentive to be responsible or think for the long term.
Furthermore, competitive pressures meant that choosing to be ethical was a money-losing proposition. "Everyone was doing it." If one bank refused to get into the subprime business, they suffered and another bank got that business.
Worse still, the rating agencies, which could have put a stop to the mortgage-backed securities by giving them bad (risky) ratings, instead felt pressure (and reaped rewards) to give high ratings. Thus, a security made up of many risky subprime mortgages was given a AAA rating by agencies like Moody's and Standard & Poor's. Since mortgage securities were outside federal regulations, the government did not act to rein in the risky practices, either.
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Individual criticism of Equivocal QC wasn't that hard to find. But it was strange to see that most manufacturers, agencies, and professional organizations were silent on the issue, particularly at first. Once the popular verdict on EQC started to come in, more institutions were willing to join them. But quality seems to be a subject like politics in the US; everyone has an opinion on it, but usually they don't want to talk about it in public. Manufacturers face the market pressure to match whatever "cost saving" features their competitors offer. So if EQC means reduced QC costs, it's difficult for a single company to hold fast and insist that their customers need to spend more on QC. Since the professional organizations draw their support from manufacturer sponsorships, advertisements and other support, they have little incentive to discuss a topic that might offend them. The accrediting agencies, like JC, CAP, and COLA, were probably in the best position to halt the downward slide of quality. But they faced competitive pressures, too. If CAP was too strict on POC devices and EQC, labs could and would switch to the laxer standards of JC. Finally, when CMS decided to push EQC through, it simply flexed its deeming authority powers and forced the agencies to adopt some form of EQC or lose its accreditation status. Responsibility for quality has also been spread out until everyone and no one is responsible. Customers talk about quality but make decisions based on cost. Manufacturers struggle to maintain a balance of the two, but cost is the overwhelming driver of their business. The EQC protocols insist that the laboratory director must weigh the "clinical and legal responsibility" against the EQC options, a tacit admission that EQC probably is neither clinically nor legally appropriate. Everyone wishes quality was better, but acts in ways that reduces it. |
The Bubble Pops
It's hard to summarize the factors that brought the end to speculation. But as interest rates rose, it became harder to take out loans. Housing prices began to drop, which meant you could no longer sell your house to pay off the mortgage. As housing values began to drop further, the value of some houses dropped below the mortgages (known as negative equity). People began to miss, even default entirely, on their mortgage payments, as teaser rates reset, as impossibly large payments came due on people who had no means to pay. As defaults rose, more houses came back onto the market, depressing the pricing. It turned into a negative feedback loop - more colorfully put, a death spiral.
Wall Street made it worse. Banks and hedge funds were highly leveraged in mortgage-backed securities (i.e. they had made all these investments using lots of borrowed money). Now their loans were coming due and their investments increasingly looked like they weren't worth the paper they were printed on. As banks and firms "wrote down" the value of these investments (admitted the money they had invested was gone), they began to run out of money. Some went bankrupt, as we've seen. Others have been taken over by the government. As fear gripped the financial community, there wasn't enough money left for the usual, normal and necessary loans - even those that aren't as risky as subprime mortgages. And here we are, looking at hundreds of billions, probably trillions of money, that will be needed to fix the mistakes.
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Will the quality bubble ever pop for the laboratory? If we continue to debase the rules and loosen the regulations, and if our institutions acquiesce in this drift, it's probable that we will fall outside the margins of safety. If we reach the point where testing QC once a month becomes an accepted practice, it's probable we will see bad test results impacting large numbers of patients. The Maryland General scandal, which was the case of an individual laboratory with debased quality practices, is merely an hors d'oeuvre compared to the systemic problems we could face. I believe healthcare is more resilient than Wall Street. We believe more in mission than mere profit. Our professionals have more scruples and commitment to good practices. But all of that means that the errors can grow larger, the bubble can get bigger, before it overwhelms the system. A quality crisis is not inevitable. All we need is leadership. And even then, leadership isn't necessary if enough voices are raised. Your voice. The voices of laboratory professionals. If the chorus is loud enough, the leaders and the market and maybe even the rules will follow. |
Offered in the spirit of a previous essay, Enron and Quality
