An Unsettling Trend

I'm happy to say this post, at least, will be moving away from personal angst and back into the realm of somewhat thoughtful.

To begin with, let me say I adore reading the news (god knows why), so one of my favorite apps is the Times app.  In the morning, I load it up, snag down all the new articles, and then get to read them throughout the day even when I have no net access (and thus cannot check my email, the horror!).  My mom was driving me home as I read one article about GlaxoSmithKline, Avandia (GSK's diabetes drug), and the Food and Drug Administration.  This article explained how GSK, even knowing that Avandia increased probability of heart problems in its patients by 40+%, went to the FDA and waffled around, thereby convincing the FDA that the data was "inconclusive" regarding Avandia's side effects and thus should not be withdrawn from the market.  After explaining the details of that situation, the author then went on to suggest that the FDA has become too easy to trick/game and, the most important part in my opinion, that perhaps the FDA and Pharmaceutical companies are a bit too closely knit.  Apparently about 65% of the FDA's cash comes from "user fees" from the Pharmaceutical companies.

At this point in time, I stopped reading the article.  If so much of the FDA's revenue is coming from the pharmaceutical companies, it's not a far jump to conclude that there might be a conflict of interest.  This idea of a conflict of interest reminded me of another article I'd read a few days ago, this one relating to the gulf oil spill.  Apparently the oil rigs are "officially" supervised by the Coast Guard (I think?), but usually oil rigs can contract private companies to do the inspections.  In other words: oil rigs pay the people that inspect their rigs.  Uh, can anyone else say "conflict of interest"?  The article even highlighted this conflict in that it quoted one inspection company explaining that if one inspection company gives a bad report back to the oil rig, the oil rig may choose to stop using that company in the future and just go to another inspection company for a better prognosis.  In that case, the inspectors that gave the truthful answer are then penalized.  (And even then, the governmental agency that oversees the oil rigs would not see the truthful report as the oil rig wouldn't turn it in!)

Finally, this reasoning brought me to yet another industry that has a similar inspection service: the financial industry.  Oh yes, that financial industry, the one that caused all of these problems in the first place.  Being a business major attending Wharton (the school famous for spitting out Wall Streeters), I got to hear a lot about the financial meltdown, what caused it, etc. etc.  I'm definitely no expert in it, but I think I know a bit more than the normal lay person.  One of the problems in the financial industry is that the US Government leans heavily on the Rating Agencies (such as Moody's or the S&P) to act as a sort of inspection or control agency.  The rating companies look at financial products, analyzes them, then gives them a rating of some sort which both the US Government and the US people tend to accept at face value.

However, there are two blatant problems with using the rating companies as a control agency.  The first is that rating agencies are also notoriously easy to game.  They use statistical models to analyze the probability of default and then assign grades to the items.  For many of the toxic housing derivatives, rating agencies told the banks something along the lines of "well, if you toss in X , it would increase the probability of default for the entire package (including the then-unknown-toxic housing assets) to Y level, at which we can give you Z grade" where Z grade was usually AAA or at least one of the best.  The banks added in X, the rating companies then labeled the entire package Z grade and consumers happily bought Z grade items with no knowledge of what was actually in the package.  To reiterate, the first problem is that the rating companies are terribly easy to game.  The second problem is that, once again, there is a strong conflict of interest in that who pays the rating companies?  The banks of course!  The banks pay the rating companies to rate their financial derivatives; if they don't like the rate, they go somewhere else.

I'm sure by now you, the reader, has also picked up on the unsettling trend that prompted this post: a lot of the USA's inspection services or control agencies have a lot of conflict of interest issues.  First, most of the inspection agencies' cash comes from the companies they are inspecting.  Second, their inspection criteria is easy to manipulate.

Regarding the first, I'd like to say I do not blame the private companies at all.  For Moody's and S&P: they were never meant to be inspection agencies; they're just rating agencies.  The US people have been the ones accepting the grades at face value without doing legwork themselves, and the US Government is the one that didn't put in the proper work to check these financial derivatives themselves.  As for the oil rig inspection companies: they're stuck between a rock and a hard place.  If they do the "morally right" thing (give a truthful but unfavorable report), they screw themselves over and the people don't even get to see what they risked their revenue for.  If they do the "morally wrong" thing and give a false but favorable (to the oil rig) report, they stay in business and make profit.  Businesses are meant to make profits; it's not right but it's understandable.

Regarding the second issue, I think it's an unfortunate side effect of transparency.  Transparency is regaled as a good thing in the USA: there are no gray areas where shady deals (or bribes!) can slip through; people can clearly see what criteria has to be met before a seal of approval of given.  Thus, people are then empowered to know that, for example, if an item is listed as "Organic" then it has met X, Y, and Z criteria.  Of course, the unfortunate side effect of such clear cut rules is that it's easy to game the system.  For example, if you only have to pay taxes if more than 15% of the company is transferred at one time, you may then choose to transfer only 14% at one time and thus avoid paying taxes.  (And lots of people are willing to jump various hoops and hurdles to get these breaks, so it's not just a "big businesses being greedy" when people game the system.)

So as said two paragraphs ago, I don't blame the private companies for the way they've acted.  In fact, this post is not meant to be about assigning blame at all.  This post is meant to bring to your attention an unsettling trend within the USA, that our control/inspection checks are riddled with conflict of interests and until these conflicts are resolved, we're keeping the welcome mat out for disasters like the financial meltdown or the gulf oil spill.

Then, of course, comes the question of "how to resolve this problem?".  How?  I really don't know.  I don't think we can get rid of transparency which means we can't really get rid of gaming the system.  If we allow in greater room for discretion, it creates a greater gray space for questionable activities (either purposefully like bribes or just accidentally such as one person's discretion is not as stringent as someone else's).  One way we can minimize problem 1 would be if the companies that need to be inspected paid the US Government the fee and that fee was then turned over to one of the inspection companies.  The inspection company, plus perhaps a US government official, then conduct the inspection and turn the results into the US Government and the company being inspected.  Then the truthful results always are handed to the US Government and the inspection company is employed by the US Gov, not the company they're inspecting.  The inspected company, in turn, must pay the US Government or else there will be other problems.

Anyways, if I can come up with that idea in just a few minutes, I'm sure researchers and professionals can come up with a better or at least more thought out solution to this problem.  I just wanted to connect the dots, so to speak, for those who haven't seen the trend.

This is Tiffany, finally shutting up. :)