The Greater Fool

In the last four decades, we have witnessed a series of investment "bubbles" that have all collapsed. It seems that there is no end to the number of people with cash who will be intoxicated by a good story line, even when there is little substance to back it up. All of these stories depend on the capital markets to bolster the price of investments, counting on the "greater fool" theory: There is always someone who will take on a bad investment at just the wrong time, providing a good return to those who are lucky enough to escape before the crash.

In the early 1990s, ENRON was entering the market with a new electricity trading division. A business partner of mine was asked by one of the largest government pension funds to evaluate a proposal to invest $250 million in the start-up. He came to me a few weeks later, saying that he was having trouble evaluating the deal. They could not give a substantive answer to the basic questions: How will each transaction make money? What will be your competitive advantage in this business? What do you expect your market share to be? When he would ask the ENRON guys for a business plan, their answer was, "We did it in natural gas. We can do it in electricity. Trust us."

My friend advised the pension fund not to invest. It did so anyway, apparently because of personal relationships between the fund managers and people at ENRON. As we now know, the fiction behind ENRON's financial plan eventually led to its collapse.

A bit later, Bernie Ebbers was building a telecommunications company called WorldCom. His approach was to play on the stock market's desire for growth by acquiring other long distance phone companies. As the market capitalization of the company grew, its stock price rose — notwithstanding a surplus in long distance capacity in the country and declining profit margins. The thing that finally stopped Ebbers was that the government would not let him continue to acquire companies (for antitrust reasons). Then, finally, he had to run the business as a business and make a profit, and he could not. Collapse followed.

More recently, we have all witnessed the subprime debacle, the sale of unsecured insurance products, and the like. As above, these were examples of money chasing money, of stated valuations with no inherent relationship to the actual value of the business enterprise.

What is the next bubble? Might it be private investment in hospitals and hospital systems?

I have discussed above the rationale for and some of the financial techniques involved in private equity acquisitions of hospitals. These acquisitions also tend to have great political support: A financially troubled hospital system will have a more secure pension plan, pay taxes to municipalities and the state, and the like. The private equity firm rescuing the system is seen as a "white knight" and makes commitments that sound very persuasive.

As time goes along, some of those early statements are quietly modified. This Boston Globe article, for example, reports that one private equity firm "also committed to pumping another $400 million in capital improvements into the system over the next four years, although [its CEO] acknowledges that those funds may come from hospital revenues in coming years, rather than from [the private equity firm] itself."

We also learn that strong commitments to local involvement can diminish. At a recent conference, one private equity official derisively talked about the inadequacies of local lay leaders eating their "stale bologna sandwiches" at Board of Trustees meetings, to draw a contrast with the unsentimental businesslike behavior of a board chosen by his firm.

Those seeking to regulate the behavior and financial decisions of for-profit hospitals will find that their post hoc authority will likely be insufficient to protect the public interest from a depletion of plant and equipment and from a plan that is mainly meant to burnish the pre-tax and pre-depreciation short-term earnings of the firm so that it is ready for the initial public offering or resale to another private equity firm.

Who gets hurt if these deals go bust when the next generation of owners takes over and discovers that creating the margin to generate the expected return is very hard in the hospital world? Well, that very last set of investors, the "greater fools." But, as we have seen in the examples above, the hurt goes much further. Hospitals, though, are in a special category. Investors may come and go, but the community depends on its local hospital to provide high quality service. It is the residents of the community who are left holding the bag if the hospital corporation reaches the conclusion that ownership is not financially viable.

Perhaps I am being too pessimistic, but this feels very much like those conversations I had in the 1990s. Let's hope that I am wrong. So in the meantime, enjoy the Super Bowl and root for the good guys to win.

Paul Levy is the former President and CEO of Beth Israel Deconess Medical Center in Boston. For the past five years, he blogged about his experiences in an online journal, Running a Hospital. He now writes as an advocate for patient-centered care, eliminating preventable harm, transparency of clinical outcomes, and front-line driven process improvement at Not Running a Hospital.

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