Deregulate!

[stpioc]

The favourite thesis of the tepid recovery in market fundamentalist circles revolves around either an increased regulatory burden causing a slowdown in capital formation directly, or it leads to 'uncertainty' and indirectly affects the economy.

Don't Blame Uncertainty for the Slow Recovery

145 DEC 29, 2015 8:00 AM EST
By [/url]Noah Smith

A few years ago, when the economic recovery had not yet begun, a lot of people were asking why growth wasn’t picking up. One explanation was that the Federal Reserve wasn’t doing enough monetary easing. Another idea was that Congress needed to spend more. But free-marketers and conservatives, who are generally against government intervention, were very reluctant to embrace these explanations.

Many of them turned to an alternative answer: policy uncertainty. This was the hypothesis that businesses were holding back investment for fear of possible government intervention. Chief proponents of this view were economists Scott Baker of Northwestern University’s Kellogg School of Management and Steven Davis of the University of Chicago’s Booth School of Business. In 2011, Baker wrote an op-ed for Bloomberg View laying out the policy uncertainty thesis:

A major factor behind the weak recovery and gloomy outlook is a climate of policy-induced economic uncertainty...[T]he persistence of policy uncertainty wasn’t inevitable. Rather, it reflects deliberate policy decisions, harmful rhetorical attacks on business and “millionaires,” failure to tackle entitlement reforms and fiscal imbalances, and political brinkmanship.

Baker went on to list a number of regulatory interventions, and also cited the debt-ceiling battle and legal challenges to Obamacare as sources of policy uncertainty.

Baker’s claims were based on research he had done with Davis and with Nicholas Bloom of Stanford University. The three economists mined news stories for stories about uncertainty, and found that their measure coincided with major geopolitical and market events. They then showed that increases in this uncertainty index tended to precede declines in investment, growth, employment and stock prices. They even created a website to track similar measures of policy uncertainty in various countries.

But despite these efforts, policy uncertainty has not been embraced by the macroeconomics profession as a major cause of economic fluctuations. The most likely reason is that there is a major weakness in the uncertainty argument -- it is difficult to show causality. Just as roosters don’t cause the sun to rise, policy uncertainty might be a result of deeper underlying uncertainty about the direction of the economy.

It’s easy to see how this would happen. Suppose stock and housing markets crash, threatening the financial system and the real economy. Obviously, policy makers will try to do something about this, but their response could be any number of things. They might decide to increase deficit spending, or regulate the financial industry, bail out banks or engage in quantitative easing. But the government’s reaction might simply be a sideshow to the real forces afflicting the economy. Alternatively, recessions might come from non-government sources such as financial crashes, but the possibility of botched government responses might exacerbate the downturns.

Since Baker, Bloom and Davis came out with their uncertainty hypothesis, there has been a large and sustained drop in the index of uncertainty. But the rate of the U.S. economic recovery has remained slow and steady, leading many to question whether uncertainty is just a sideshow.

A team of empirical macroeconomists recently set out to investigate the uncertainty issue more deeply. Sydney Ludvigson and Sai Ma of New York University and Serena Ng of Columbia University have a new paper in which they investigate whether uncertainty is exogenous or endogenous -- that is, whether it is the cause of economic disruption, or the effect. Their statistical technique requires some bold assumptions, but allows for interpretation of cause and effect.

Ludvigson, Ma and Ng find that financial uncertainty seems to cause every other type of economic uncertainty -- in other words, that financial uncertainty looks exogenous while other types of uncertainty seem to be endogenous. This reinforces what many other macroeconomists have found since the crisis -- finance often seems to drive the real economy.

So what does this result mean for the policy uncertainty hypothesis? On one hand, it reinforces the notion that uncertainty, in the general sense, is very bad for the economy. But it implies that for policy to be the cause of this uncertainty, it would have to do so through its impact on financial markets. Legal challenges to Obamacare or increased regulation of aircraft manufacturing would be unlikely causes of recessions.

So what policies, in 2008, threatened U.S. financial markets? Before the crash, financial regulation was not being emphasized by any credible presidential candidate -- certainly it wasn't a major plank of  Barack Obama's or John McCain's presidential campaigns. Meanwhile, when financial regulation actually did come, in 2010 in the form of Dodd-Frank, it did very little to hurt asset markets.

Therefore there is good reason to be skeptical of the hypothesis of Baker, Bloom, and Davis. It is difficult to lay blame for the Great Recession, or the slow recovery from that recession, at the feet of either the Obama administration or the Republicans in Congress. It looks like the more likely explanation is that the financial industry imploded all on its own, and that the Great Recession was the result.[/b]

[stpioc]

A collection of stories which show why increase complexity of economic life is the main cause behind increasing regulation, it's purpose (if not hijacked by corporate purposes) is to save us from information asymmetries, harmful effects of products and services of which we're blissfully unaware:

"Rogue" beauticians who offer teeth whitening and people who sell illegal kits should face tougher penalties, councils in England and Wales say. Some kits contain 300 times the legal limit of hydrogen peroxide, the Local Government Association said. This would be like "brushing with bleach" and could cause blistering, burns and other damage, the LGA added.

Teeth whitening: Call for action on 'rogue' beauticians - BBC News

In New York state alone, 19 tons of microbeads are washed down the drain each year, according to the Wildlife Conservation Society, where they collect harmful pollutants like DDT. In waterways, fish and other wildlife mistake the tiny scraps of plastic for food. From there, the beads are integrated into the food chain.

Obama bans microbead soaps - Business Insider

A handful of London traders may have rigged the UK government bond market. That's according to reports from Global Capital and The Wall Street Journal.

UK inquiry into bond market manipulation - Business Insider

The UK's Serious Fraud Office started criminal proceedings against 10 former Deutsche Bank and Barclays employees. They're accused of rigging the Euro Interbank Offered Rate (EURIBOR).

UK SFO charges 10 former Barclays and Deutsche Bank employees in European interest rate rigging case - Business Insider

[stpioc]

The 2008 financial crisis was triggered by a run on short term bank debt, illiquidity in the commercial paper market and a sudden lack of confidence in the money market mutual fund industry. All three of these financial products are part and parcel of what is called the “shadow banking system,” which cannot  depend on the safety net of  either a lender of last resort like the Fed or regulatory agencies that can intervene to deal with the volatility of a run.

You Better Read This if You Don't Know Anything About the Shadow Banking System - Forbes

The term “shadow bank” was coined by economist Paul McCulley in a 2007 speech at the annual financial symposium hosted by the Kansas City Federal Reserve Bank in Jackson Hole, Wyoming. In McCulley’s talk, shadow banking had a distinctly U.S. focus and referred mainly to nonbank financial institutions that engaged in what economists call maturity transformation. Commercial banks engage in maturity transformation when they use deposits, which are normally short term, to fund loans that are longer term. Shadow banks do something similar. They raise (that is, mostly borrow) short-term funds in the money markets and use those funds to buy assets with longer-term maturities. But because they are not subject to traditional bank regulation, they cannot—as banks can—borrow in an emergency from the Federal Reserve (the U.S. central bank) and do not have traditional depositors whose funds are covered by insurance; they are in the “shadows.”

What Is Shadow Banking? - Back to Basics - Finance & Development, June 2013

[stpioc]

Acting on a tip, agents of the U.S. Food and Drug Administration paid a surprise visit to a cheese factory in rural Pennsylvania on a cold November day in 2012. They found what they were looking for: evidence that Castle Cheese Inc. was doctoring its 100 percent real parmesan with cut-rate substitutes and such fillers as wood pulp and distributing it to some of the country’s biggest grocery chains.

The Parmesan Cheese You Sprinkle on Your Penne Could Be Wood - Bloomberg Business

[stpioc]

People who reported eating fast food in the last 24 hours had elevated levels of some industrial chemicals in their bodies, according to a new analysis of data from federal nutrition surveys. The study is the first broad look at how fast food may expose the public to certain chemicals, called phthalates, that are used to make plastics more flexible and durable. The chemicals, which don’t occur in nature, are common in cosmetics, soap, food packaging, flooring, window blinds, and other consumer products. The Centers for Disease Control says "phthalate exposure is widespread in the U.S. population." Though the health consequences of encountering these substances aren’t fully known, scientists have increasingly focused on their effects on health and development, particularly for pregnant women and children. Research in rats has shown that they can disrupt the male reproductive system, and there’s evidence for similar effects in humans.

Fast-Food Eaters Have More Industrial Chemicals in Their Bodies - Bloomberg

[stpioc]

The forked tongue is hilarious, at times..

And while corporations often protest loudly against newly proposed regulation, and tend to paint a dark picture on the consequences of new regulation (in so called comment letters), they almost invariably say the opposite to shareholders. For instance:

In July 2015, Dennis Glass, the president and CEO of Lincoln National said in his comment letter that the proposed rule was "immensely burdensome" and "extremely intrusive," and would be "so burdensome and unworkable that financial advisors and firms will not be able to use it"; while two months earlier, Mr. Glass told investors that he didn't "see [the proposed rule] as a significant hurdle for continuing to grow that business." None of those are unconditional quantified falsifiable predictions; they are just adjectives. But the tone is different, sure.

Or: In July 2015, the president of Jackson National Life Insurance Company said in his DOL comment letter that the proposed rule would "be very difficult, if not impossible for financial professional and firms to comply" with; then, in August 2015, the president of Jackson's parent company told investors that a similar rule in the United Kingdom actually led to an increase in retail sales and that the company was positioned to "build whatever product is appropriate under that set and adapt faster and more effectively than competitors."

[stpioc]

ProMarket Interview: Robert J. Shiller on Competition, Deception and Rent-Seeking
Posted on April 26, 2016 by Asher Schechter

Yale economist and Nobel Prize Laureate Robert J. Shiller explains why competition in itself does not always weed out deception and rent-seeking.

“Our free-market system tends to spawn manipulation and deception,” proclaim George Akerlof and Robert Shiller in the beginning of their 2015 book, Phishing for Phools: The Economics of Manipulation and Deception (Princeton University Press). It’s not the kind of pronouncement one expects from two Nobel Laureates and staunch free-market advocates like Shiller and Akerlof, but Phishing for Phools is rife with anecdotes that show how firms—from credit card companies to food companies and pharmaceuticals—manipulate customers by taking advantage of their “psychological or informational weaknesses.”

In Internet parlance, “phishing” means an attempt to extract sensitive personal information by masquerading as a reputable or otherwise trustworthy person, company, or website. But Shiller and Akerlof create a broader definition of phishing, using it as a synonym for the mechanisms of manipulation and trickery that, according to them, are inherent to the free-market system. A “phool,” they explain, is anyone who falls for such tricks—that is, everyone, including themselves.

Akerlof and Shiller define themselves as “admirers of the free-market system.” However, they claim that competitive markets are not only the best conduit of providing consumers with the things they want. “They also create an economic equilibrium that is highly suitable for economic enterprises that manipulate or distort our judgment, using business practices that are analogous to biological cancers that make their home in the normal equilibrium of the human body.”

Akerlof and Shiller call this a “phishing equilibrium.” In such an equilibrium, they explain, companies are incentivized to act in a “less than scrupulous” manner. “If we have some weakness or other—some way in which we can be phished for phools for more than the usual profit—someone will take advantage of it,” they write.

Contrary to standard economic thinking, it seems competition doesn’t eliminate this kind of trickery. On the contrary, says Shiller in a phone conversation with ProMarket, it exacerbates it. “It’s especially onerous in tight markets situations, where profit margins are narrow because there’s a lot of competition,” says Shiller. “You as a business cannot not do these tricks, because your profit margin is too narrow. You don’t have the leeway to experiment with not doing it, you’ll go out of business.”

Shiller, the Sterling Professor of Economics at Yale University, is perhaps best known to the general public as the economist who predicted the dot-com crash in his book Irrational Exuberance (Princeton University Press, 2000) and then predicted the burst of the American housing bubble in the book’s second edition. He is also known as the co-creator of the S&P/Case-Shiller Home Price Indices, the leading index measuring U.S. home prices, which he originally developed in the 1980s with Wellesley College economist Karl E. Case.

In 2013, Shiller shared the Nobel Prize in Economics with University of Chicago economists Eugene Fama and Lars Peter Hansen for his pioneering research into the irrationality of financial markets. In 1981, Shiller published the landmark paper“Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?” in which he compared movements in stock prices with subsequent dividends and found that prices were much more volatile than they should have been had investors and markets operated in a strictly rational manner. The paper, which challenged the then-dominant belief in the efficiency of markets, is considered one of the most influential economic papers of the 20th century, and a milestone in the development of behavioral finance.

In a phone interview with ProMarket, Shiller discussed his recent examination of attitudes toward free markets in Russia and the U.S., explained why competition makes phishing worse, and advocated for a Hippocratic oath for financial advisers.

Q: In a recent paper with Maxim Boycko, you conducted a survey examining public attitudes toward free markets and democracy in Moscow and New York and then compared the results with an identical survey you conducted in 1990. There are a number of differences between the results of the 2015 survey and the one from 1990, but the bottom line remained the same: there were only small differences in attitudes toward free markets in the U.S. and Russia. Given that both countries had very different political and economic trajectories, how do you explain the similarities?

Trajectories are different from personal opinions. I think Vladimir Putin is an example of someone managing a strategy at work, keeping control of the propaganda machine, running an authoritarian government. But I don’t think that the extremes that you appear to see are deeply set.

Q: In the survey, you ask this question: “On a holiday, when there is a great demand for flowers, their prices usually go up. Is it fair for flowers sellers to raise their prices like this?” While in both countries most respondents were opposed to this practice, believing it to be unfair, in New York people were much more tolerant of price hikes than they were in 1990 and more accepting of price hikes than in Moscow. Did the definition of what’s unfair in the market change over the last 25 years?

The Americans changed. It’s disconcerting, what you say. There’s more of a regulatory impulse in the U.S. now. There’s the Bernie Sanders effect, after the financial crisis. We had another question about a factory that produces kitchen tables, and we asked is it fair for them to raise prices if demand goes up, and there was substantial change in the U.S. between 1990 and 2015. The basic similarity between the U.S. and Russia was the most striking thing here. We had another question: “Apart from fairness, should the factory have the right to raise the price in this situation?” And here, the percent of New Yorkers who think they should have the right went down. It’s a little difficult to understand these results.

Q: Is it possible that this increase in tolerance toward price hikes in the U.S. is an Uber effect?

That’s interesting. We didn’t ask directly about that, but I can easily imagine that a lot of people are impressed with Uber. It’s so modern a system, always available, maybe at a higher price. It would be plausible to me that people are more tolerant of peak growth pricing. We didn’t ask about it, but I can imagine. On the other hand, there are many people who are angered by Uber.

Q: You mentioned the Bernie Sanders effect. In this presidential election, there are candidates from both parties that say the system is rigged, that the free market has been distorted by special interests. Americans believe in free markets,but is it possible that they perceive the free-market system in its current state as less than free?

I don’t have questions that directly relate to this, but maybe there’s more perception of monkeying with markets behind the scenes, like bribing lawmakers or influencing lawmakers to support monopolies. It seems plausible to me that people are more aware of that than they were 20 years ago.

Q: There’s extensive literature that shows that when firms seek rents instead of investing in improving services and products, consumers pay higher prices. In Phishing for Phools, you raise a new idea: not only do companies “phish for phools,” but they invest more and more resources in manipulating and “phooling” their customers. For many years, economists thought the solution to rent-seeking was competition, that competition will weed out rent-seeking firms. Many of the industries you survey in the book operate in competitive markets, but the competition seems to be not who can create better products or services, but who can better “phish for phools.”

That’s well put. [In the book] we emphasize a “phishing equilibrium.” It’s especially onerous in tight markets situations, where profit margins are narrow because there’s a lot of competition. You as a business cannot not do these tricks, because your profit margin is too narrow. You don’t have the leeway to experiment with not doing it; you’ll go out of business. So it’s fear that causes business owners to do that, or a sense of responsibility to their investors, or even their employees. It’s just reality that is imposed on them, that they have to engage in state-of-the-art phishes.

Q: The existence of a phishing equilibrium suggests that competition alone is not weeding out the rents, or eliminating phishing?

It’s making it stronger.

Q: Yet regulators today have really just one tool: competition. If competition doesn’t work, if it in fact, as you say, exacerbates the situation, what other tools are there?

It’s both government regulation and business sector organizations like chambers of commerce or better business bureaus, or consumer advice magazines. We’re seeing some progress with the Internet. A lot of retail is done online, and it shows comments by these buyers—that’s a new development. It’s also capable of being manipulated, so there need to be some standards.

Q: We’re used to think that you can only phish, or charge rents, if you have political connections. But in the book you show that firms can do that for many years without being politically connected, which means phishing is not just the result of cronyism, but inherent to the market system. Is it possible to mitigate this phenomena by making people more aware of phishing, through the media, academia, even crowd-sourced review services like Yelp?

The problem is all these people have incentives of their own. You mentioned the media—the media are phishing as well.
Ultimately, part of what preserves it is that normal people don’t think of themselves as crooks. They want their work to make them wealthy but also make them feel good and beneficial. That’s why we have business organizations that advocate for better business standards. Adam Smith wrote The Wealth of Nations, which was an argument for free markets, but he also wrote The Theory of Moral Sentiments, in which he made an observation about human nature that seems inconsistent with his other book. He uses the word “praiseworthiness”: people love praise—it’s part of our human condition, something that evolved in Darwinian evolution to make a better society—but Smith said as people mature, they end up wanting to be praiseworthy. Even if no one is praising them, they still want to think: “I’m a good person, I’m a contributor to society.” This is Adam Smith talking 250 years ago.
I think that’s part of how the free market system works. Even in the 1700s you had an organization called The Guardians, or Society for the Protection of Trade against Swindlers and Sharpers, that accepted consumer complaints and imposed business standards.

Q: In your research and writing, you deal extensively with public trust, and whether the public trusts or doesn’t trust government or markets. What leads to trust, or a lack of trust? Is it outcomes, the service that people get, or is it other players within the idea sphere that influence the public’s perception?

Perception affects the sense of trust. Consider the United States: in the Revolutionary War, the U.S. government issued paper money, the Continental currency, and they ended up inflating it ridiculously until it became worthless. For a long time afterwards, the public wouldn’t trust the government. Until the National Bank Act of 1863, paper money was issued by private banks, local banks. I think this is because this was the perception that you can’t trust the U.S. government, it’ll debase the currency. But I know the local bank in my town, and we know the family, they’re trustworthy.

Then, after that, there were a number of banking crises where these local banks failed and people lost money, and people went back to the government and established the Federal Reserve system, where board members are appointed for 14-year terms and they can’t be removed without impeaching them. So there was still this idea that certain kinds of people are trustworthy. You take a banker, appoint him to the Fed board, you can’t get rid of him for 14 years—and people thought those people can be trusted.
Nobody knows who to trust—that’s the problem. We keep getting let down.

Q: In Phishing for Phools, you emphasize the economic importance of stories—stories we tell ourselves, stories told to us by firms—and tie it to the prevalence of phishing. Is the current story we tell ourselves one in which markets have to be regulated, because they inherently include things like phishing?

It’s hard to summarize a prevailing story, because there are so many stories going on. I came out with the third edition of my book Irrational Exuberance last year, and in it I talked about what I thought was the prevailing new normal story that we have now. The “new normal” story, I think, is one about globalization and a lack of loyalty by people in our country who hire desperate poor people and put them in sweatshops to compete with Americans. There’s also fear about automation and robots eliminating jobs, and much talk of inequality.

Talk about inequality creates a sense of insecurity: people don’t know what they’ll be doing in 20 years, will they even have a job. The free market system was supposed to always create new jobs, now you’re seeing more and more doubts raised about that. There might be a shift away from free markets.
The Bernie Sanders phenomenon and the Donald Trump phenomenon are both responding to the same anxieties. The Sanders phenomenon is saying we have to get some justice for everyone through the government. The Trump phenomenon is saying if you do your thing in a businesslike manner, if you trust Trump to create a business environment to “make America great again,” you’ll be alright.

Q: How does the American healthcare system fit in to the Phishing for Phoolsstory? In the book you write: “the purveyors of medicine phish us for phools.” Is Phishing prevalent in American health care?

Seems that way. We spend a lot of money and don’t have the best outcomes.

Q: How can regulators mitigate phishing in health care, given that Kenneth Arrow already showed 50 years ago that there’s a problem with applying competitive market models to health care?

It’s interesting, because Obamacare is really a system to encourage free-market competition in health care through exchanges, trying to create a more level playing field. The problem is that people find it difficult to make these comparisons.
In the book we talk about the American Medical Association, which over the last century focused on exposing bad practices. The AMA is a nonprofit, and it fostered better intelligence concerning health care. Close to 100 years ago, they had reports about bad practices and products, and that helped alleviate bad medical practices.

Q: Many of the industries that you survey in the book share three characteristics: their services and products are complicated, so there’s information asymmetry. Also, these are services that are ongoing, like credit cards or insurance. Another shared characteristic is that phishing seems to favor mostly for large firms, that have the reputation, the resources and the economies of scale to engage in it. Is phishing also a size issue?

I haven’t done research on this, but it sounds plausible. Especially when it comes to advertising, maybe less so when we have more targeted advertising. It used to be that you couldn’t target your advertising at all. If you’re just dumping your ads out to the whole nation that is more effective to big companies than for local companies.

Q: Is phishing inherently a part of the free-market? Could you have written this book in 1855?

There was phishing, so you could have written the book back then. Some of our book refers to 1855. Maybe it’s gotten more dramatic with the rise of corporations. Big corporations then were limited in scope. There’s also more professionalism. Marketing was primitive in 1855. There’s technological progress in phishing. People learn from watching others. We also have business schools now. Wharton, the first business school in the United States, was established in 1881.

Q: Are you saying business schools teach students to phish?

They have marketing departments. I think business schools also require business ethics. There’s been a movement over the last couple of decades towards more attention to business ethics. Sometimes I admire marketing departments, because they focus on a certain aspect of business reality. It’s better that we have people who are not trying to make money themselves studying that phenomenon in an academic setting.

Q: Should ethics be taught in business schools? In your opinion, should MBA programs contain an ethical component?

I think business schools offer courses in ethics, but they don’t require them. I think they’re trying to encourage it. The problem is it starts to look preachy if it’s mandatory; people don’t want to be there. But maybe it should still be there.

Q: Could we reduce phishing by having business schools teach MBA students that they have other responsibilities besides maximizing shareholder value?

This is what should happen in business education. Typically, an MBA student has been in the business world for some years. When they’re back to a college environment, they’re free from the constraints of not revealing their company’s secrets. Hopefully people will talk these things out and reach more enlightened decisions about how they will handle morally compromising business situations in the future.

Q: Would something like a Hippocratic oath for business students help promote better business ethics?

This is something that I advocated in my book The New Financial Order: Risk in the 21st Century. I advocated that the government should offer a tax subsidy to financial advisers who sign something like the Hippocratic oath for their customers: “The welfare of my clients is my number one concern.” It has to be worded carefully so it has some teeth.

Q: The Department of Labor’s new “fiduciary rule,” which requires brokers who work with retirement accounts to act in clients’ best interests, seems like a step in that direction.

I didn’t read it carefully, but it sounds like a good thing.

Q: A recent study by Amit Seru and Gregor Matvos from the University of Chicago and the University of Minnesota’s Mark Egan, argued that in the financial advisory industry there are firms whose business model consists of manipulating unsophisticated clients, often the elderly or less educated. You mentioned government subsidies for advisers who agree to take a Hippocratic oath—is that a possible way of mitigating this phenomenon?

That’s one of the ways of making it happen. We have this organization called NAPFA, the National Association of Personal Financial Advisors, that makes its members sign a fiduciary oath. They have been hit with scandals of their own lately. With human nature being what it is, there are always going to be lapses.

Q: So there’s always going to be phishing, and we need to figure out how to live with it?
 
I think we can improve. We have already done much to improve the situation. I think we need to constantly be aware of new technologies of phishing. If nothing is done about it, this becomes part of the equilibrium.

[stpioc]

Timing is everything. On Wednesday morning, Wells Fargo analyst David Maris published a report pointing out that Valeant Pharmaceuticals had raised prices on 16 of its products this year. On Wednesday afternoon, Valeant's CEO, a former interim CEO, and billionaire hedge fund manager and board member Bill Ackman were to testify before the US Senate about the company's drug-pricing practices. The company vowed last year to lower prices across the board and change its business model after coming under scrutiny for price hikes.

Wells Fargo says Valeant still raising prices - Business Insider

[stpioc]

Here's another racket:

Bill Ackman and Valeant execs just got through one of the most brutal Senate hearings we've ever seen

• Linette Lopez
  
  
• 5h
  

See Also

The prepared statements from Valeant's Senate hearing are already making us cringe

Elizabeth Warren gets a go at hedge fund billionaire Bill Ackman

Wall Street dropped a bomb on Valeant right before the company's Senate hearing

Valeant Pharmaceuticals' outgoing CEO, Mike Pearson, the company's former interim CEO, Howard Schiller, and board member and hedge fund billionaire Bill Ackman all just testified before the US Senate.

They were answering questions about the company's practice of buying drugs and jacking up their prices.

Not surprisingly, they walked into a very aggressive room.

Ranking member ClaireMcCaskill (D-Missouri) of the Senate Special Committee on Aging was direct from the start. In her opening statement she said:

In case you haven't noticed, that has real ramifications in our political process and could lead to an instability of our government, our economy, and our standing in the world. Pigs get fed, hogs get slaughtered. It's time to slaughter some hogs. I thank the witnesses for being here today, and I look forward to hearing their testimony.

Here are the highlights:

• Pearson was questioned about Valeant's R&D spending, its patient-assistance program, and its drug-pricing policy.
  

• He was also asked about a Wells Fargo note that said Valeant had raised prices on 16 of its products in the past year.
  

• Bill Ackman said that he was focused on saving Valeant from bankruptcy.
  

• He was also questioned about his investments in Herbalife and Fannie and Freddie.
  

• "Can you find me one drug that Valeant didn't raise the price on?" McCaskill asked.
  

• Neither Ackman nor Pearson could find one.
  

Here's how it went down:

Pearson

"I've got a list of 20 drugs that you guys have raised over 200% in a matter of years," said McCaskill.

She had gotten that list from the US House of Representatives, which is also investigating Valeant for the same issue. She considers that matter an issue of national debt because healthcare costs drive the debt so high.

"I don't think you guys understand that you can't do this just because" it's legal, she said.

McCaskill pointed out that Valeant's top 30 drugs increased in price by 70% from this time last year.

"It couldn't have been because of R&D because you don't spend that much," she said.

"We have not raised prices at all this year in terms of the neurology and other products," Pearson said. He also said that it reduced prices for dermatology drugs.

This runs counter to a report from Wells Fargo released on Wednesday morning that showed that the company raised prices for 16 drugs. Pearson said that the report was likely inaccurate, though he hadn't seen it.

Pearson also went back to discussing how much Valeant spends on patient-assistance programs — programs that people in a previous panel said didn't really help anyone. The committee members didn't let him get away with that either, pointing out that these programs allow Valeant to maintain price and that Valeant has a "captive audience."

Sen. Joe Donnelly (D-Indiana) pointed out that even the largest Catholic hospital system in the world couldn't use Valeant's "volume based" assistance program.

"It's a human right not to be treated this way," said Donnelly.

Another senator called Valeant's response to a patient on why it increased the price of a Wilson-disease drug "a red herring."

Valeant responded to the patient with a letter saying that "the investment to develop and distribute novel medicines" would not be worth it unless the company could increase prices for a bigger return on investment.

This letter came up over and over in the hearing.

Valeant bought the drug, the senator pointed out, and spent no money developing it.

He later asked, "Did you just now realize" that this was a life-and-death situation for some patients?

Pearson said that he did not.

Ackman

Hedge fund billionaire Bill Ackman, who has been a big Valeant shareholder for over a year, opened with this gem: "As a shareholder of Valeant, I recognize my investment was an ... endorsement of Valeant's strategy."

Then he went on to talk about the changes he's trying to make to the company since he got on the board and admitted that price increases broke a "social contract" with Valeant's customers.

There was a lot of stuff that was in Ackman's written testimony that wasn't actually said. Like this:

We believe that a drug company can do as much or more for innovation in pharma by acquiring other drug companies and licensing drugs than by developing drugs internally. Much of Valeant's product portfolio has been built through acquisition where Valeant was the high bidder for smaller innovative companies and their products. As a result of these acquisitions, the selling company shareholders earned an attractive and in some cases spectacular return on their investment from the nearly $40 billion that Valeant has invested in acquisitions. We expect that a high percentage of the after-tax capital received by these selling shareholders is likely to have already been reinvested in other early-stage and innovative drug companies so the cycle of drug development can continue.

You can imagine why that would not have gone over well. After one line of questioning, Ackman said that he texted Valeant's board chairman to schedule a call tomorrow to discuss lowering prices for two heart drugs.

McCaskill nailed Ackman for not knowing about Valeant's price increases, naming drugs and hikes and a letter a patient sent to Ackman.

"Yeah, it's horrible. It's wrong," he said.

"One of the things with due diligence in this industry is that it's really hard to find out prices for drugs," Ackman said after stuttering a bit.

We should note that some of these price increases are documented by researcher IMG.

"Can you find me one drug that Valeant didn't raise the price on?" McCaskill asked.

Neither Ackman nor Pearson could find one.

Another senator asked Ackman if he thought that his public and private pension investors want him to invest in this kind of business model.

"Certainly not," he responded.

Then he went on to say that what attracted him to the company were its segments, like consumer brands, that weren't overpriced.

Of course, there had to be an attack on hedge funds, too.

"It's shocking the way hedge funds try to change public policy in order to benefit them," said Sen. Bob Corker (R-Tennessee).

He pointed to a potential Puerto Rico bailout as a policy hedge funds are trying to shape. He also brought up Ackman's aggressive attack against Herbalife, his famous short.

He asked where else Ackman has tried to shape public policy.

"Herbalife is the only one ... I can think of," Ackman said.

"Really?" Corker asked, bringing up Fannie Mae and Freddie Mac. Then they talked about Fannie and Freddie as if the rest of us weren't even there to talk about Valeant.

Sen. Bob Casey (D-Pennsylvania) pointed out that Ackman said that drug pricing was a "serious issue."

Casey continued: "Can you point to anything in your testimony here that points to social responsibility?"

Ackman went back to his written testimony, which lacked the specifics Casey wanted.

"The first thing I've been doing is trying to make sure this company doesn't go bankrupt," said Ackman, adding that the company expected to file its annual report by Friday and was replacing the CEO.

Casey was still not satisfied. "I've heard of no policy ... in regards to pricing that says, 'It shall be the policy of this company to not do this.'"

Ackman said that he would "have that in weeks. Watch what we can do."

Elizabeth Warren

Sen. Elizabeth Warren (D-Massachusetts) is not a fan of Wall Street's financial engineering. So, shocking no one, she came in aggressive.

"You double the price [of a drug] even if you get a waiver to the customer, you make a lot of money," Warren said.

She pointed out that the drug industry spent $7 billion on patient-assistance programs in order to maintain high prices and line their pockets.

"What is the return on investment to Valeant on the money you're currently putting into the patient-assistance programs?" she asked.

Pearson said that he didn't know.

"Don't tell me you've never done the analysis ... By doing this you ... keep the patient on the more expensive drug and then you ... recoup whatever from the insurance company. What I'm saying is that this must be a profitable ... for you ... You're making more money ... You haven't done that analysis?" she said.

Pearson said no.

Warren asked why these programs can't be used on government insurance and answered her own question: It's illegal. She said that government agencies know that the patient-assistance programs are just a way for drug companies to maintain price, and demanded immediate action.

Schiller

Valeant's former interim CEO and CFO, Howard Schiller, kept his opening statement light. He has already been in the hot seat since he filled in for Pearson at a hearing earlier this year. He was barely asked any questions during that hearing.

[stpioc]

At the hearing, McCaskill and her Republican counterpart, Senator Susan Collins of Maine, honed in on four drugs. Isuprel and Nitropress are heart treatments that Valeant acquired and then quickly raised their prices by 525 percent and 212 percent, respectively. Two others, Syprine and Cuprimine, are used to treat a genetic disorder called Wilson’s disease. Valeant raised Cuprimine’s price for 100 capsules to $26,189 from $888, and Syprine’s increased by more than 30-fold, Collins said. Asked if there was any drug that the company sold in the U.S. that Valeant hadn’t raised the price on after acquiring it through a deal, Pearson said he couldn’t name any.

Valeant's `Mistakes' Raised Profit, Destroyed Value, Ackman Says - Bloomberg