AIPIS 260: The Cost of Complexity with Etienne Deffarges

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You know, we live in a complicated world and let's untangle that today a bit. It's my pleasure to welcome Etion Defage to the show. He is the author of Untangling the the Cost of Complex and what Can Be Done About It. Welcome. How are you?

Fine, thank you. Jason, nice to be on your show.

It's great to have you on. Well, I'm sure everybody would agree that we do live in a very complex world. How can we untangle the complexity?

Well, there are many solutions that come both from our own history and from other countries that manage to do things in a less complex way than we do. We have been doing things in an overly complex way for now at least 30 years. When it comes to the solutions, they come not only from other countries that have managed to do things more efficiently and effectively than we do in a number of sectors like health care, but also from our own history. You know, very quickly on history, complexity is not on our DNA. Our constitution, the most acclaimed in the world, is a monument to the elegant effectiveness of simplicity. Throughout history we have taken inventions from others like the automobile from Germany, the railroad from the uk, made them better, cheaper, more at scale. So this is not in the DNA. But over the last 30 years because of three factors, essentially greed, partisanship and also laziness from a lot of decision makers both in politics and in business, we have built something that's intolerably complex. I mean, healthcare is the best example.

Well, you didn't mention the legal system. I think that would be another good one. That would overly complex. Right.

The legal system is by definition has its tentacles on every industry. I'll talk about healthcare finance, they omnipresent and they contribute. Yes. To adding complexity. We spend $10,000 per capita per year. Just to give you a reference, In Germany it's 5300, in France 4400. In Japan 4000. And for subpar outcomes, when it comes to something very basic like how much do we live life expectancy at birth, for us it's 79 years in Japan, it's 84. We've done that because we keep on piling and piling, piling things on top of each other. So we started with health insurance, with your work under Truman. Then of course, our seniors, when they reached an age where they stopped working and they needed health care, basically were in dire financial strain. So under Lyndon Johnson and the Great Society, we added Medicare. And then we also had for good measure, something for the poor called Medicaid, except there were 50 of them, one for each state. We have the VA, which is a gigantic government run organization. And then we have a lot of other. We have not for profit hospitals. About 90% of hospitals are not for profit, but in the private sector they belong to municipal organization, the city to academic center, to religions. 30% of hospitals are Catholic. Insurances are typically private for profit. Although you have some like the blues, which are not for profit. You have a gigantic system where the government at all levels, federal, state, local, is tangling with private sector, some for profit, some not for profit.

Yeah, okay. So nobody will disagree that healthcare is a mess. But I always, and this doesn't excuse bad problems or bad behavior. The question I'm about to ask, but it does give you a bit of a benchmark. I like to always ask the question in everything in life. Compared to what? Compared to what? And I like you, I was born in Europe too. Okay. You know, whenever I go to Europe, I just feel like there's just mountains of bureaucracy. I mean, is the US really that bad? It feels like there's a lot less bureaucracy in the US than there is in Europe. Just as a. Compared to what type of question. What do you think?

It depends. There's some areas where that's true. Like it's much easier to start a business here as an entrepreneur. So we won't argue about that. In healthcare, it's the complete opposite. I don't know what country you come from. If it's uk, you may have. I mean, one thing that happened to me one day on a vacation, UK is I made some stupid mistake with my contact lens and NP treat for an eye. So I show up at a local facility, they treat me quickly and then, you know, I'm very pleased and I've been well treated. I come with my credit card, my passport. Hi, I'm visiting a beautiful country. I want to pay now. The lady at the desk, like she can't even understand what I'm talking about. I think like, oh my God, my French, American accent of English is not resonating. With the natives. Eventually she recovers and she says, sir, this is the National Health Service. We don't need your id, we don't need your money. We treated you, you're happy, now you can go. Goodbye, have a pleasant day.

But critics of that system would say that you die waiting in line. Okay?

And by the way, it's not the one advocates a solution. One of the weaknesses of our political debate here in the US is that there are only two voices. There's some voices say, well, we're going to tweak the existing system and keep going and so forth. And we add complexity, complexity. We had Obamacare, then we had efforts to remove it, and complexity always goes up. On the other hand, you have people are clamoring for single payer pronto. Let's wake up like we're Canada or we're uk. That would never work. Imagine for a second, Jason, what would we do with UnitedHealth, with Aetna? Are we gonna nationalize them like we were Venezuela? That would never work. My solution there is actually much simpler in terms of transition process, is to take what works very well. You know, I'm not there yet because.

We'Ve gotta talk a lot about a lot of other stuff besides healthcare, but go ahead and let's wrap up the healthcare. Go ahead.

Yeah, you have something that works well. Once we reach 65, we have Medicare and then we have the ability to use the private sector for supplementals which call it health advantages plans. And they work very well and everybody's happy. My solution would be take that and bring it to younger tranches of age in a simplified lower cost, lower benefit format. But always keeping the duality of a simple government layer that covers the minimum and big supplements for better treatment, better coverage by the private sector. That way we cover everyone, but we also keep what makes this country great, a thriving private sector. So move on to other sectors. Go ahead.

Okay, good, good. We touched on the legal system, but before we do that, I want to give an outline of some of the stuff you cover in your book. Sports, health care, electricity and utilities, finance, taxation, laws and regulations, a winning history of simple tools, things like that. So there's a bunch of stuff to cover, but let's talk about the legal system if we can.

Yeah, I'll give you one that intersects very well between the legal system and finance. So we all want to make our banks safer, not have a repeat of what happened in 2008 with the financial meltdown. Well, after the Great Depression, Before World War II in 1933, Franklin Roosevelt and Congress was bipartisan, signed something called Glass Steagall, 37 pages.

And then we changed that, didn't we.

Under Bill Clinton and his Secretary of Treasury in 1999. Now that system worked pretty well for basically 60 plus years. What it says is basically, yeah, retail banking, consumer, we're going to give you some protection. Beyond that, it's a great American credo. You do an enterprise that has some risks, you bear the rewards and the consequences of that risk, which is a fundamental covenant that was broken in 2008. The bankers played with all sorts of instruments and when they went bust, we were so afraid we'd lose our economy, we bailed them out. So who took the risk and who paid the consequence were two different sets of society. Unfortunately, to try to prevent that. Then we had Dodd Frank. Now Dodd Frank is at least 2,300 pages long. And that's because some bits were not implemented yet and so forth. And we're not sure it would be as effective as something as simple Glass Steagall was. Now you come to the legal profession. You know, today compliance departments at big banks like it's costing us all a fortune and they're full of lawyers. So of course, things like Dodd, frankly adds complexity to the whole edifice. But they also bonanzas for lawyers of all sizes. The regulators, the people. Compliance and firm people sue each other from time to time for good measure. I mean, so that's how you have basically the legal profession in my book completely entwined with our legislation efforts. In my book, I mentioned, by the way, that the other countries, most of our presidents come from the legal profession. There are some exceptions. Trump is one, obviously before that, Ronald Reagan was one, and then you had John Kennedy, Jimmy Carter. But by and large, or they're lawyers.

The politicians are all lawyers, so they make all the laws in favor of their own profession. It's absolutely disgusting.

Your main competitive rival, China, they're all engineers then, right?

It's an interesting point. Yeah. In China, they're all engineers. In the US they're all lawyers.

Who's going to win?

Yeah, it's unbelievable. It's unbelievable. It really is. And you didn't even touch on, you know, the personal legal issues that people have. You know, getting sued, suing someone else, you know, redress. And it's just a matter of mess. It's a mess. The system is such a mess. I created a startup around that as a passion project. It's called freecourt.com and it's basically an online court system that I hope could make it so that people could just resolve disputes online for free or a very small cost, you know, that could be used globally. It's. We'll see if that takes off. We will see if it.

Congratulations. But yeah, very, very worthy actually invest in a small company that was called Lex Machina that was sold a few years ago. And Lex Machina aimed at least to put online a lot of the processes. It did not purpose to replace a lawyer, but at least a lot of the admin work around them. But you know, that is something that the fact that here before we go out on the street, you got to make sure you have a lawyer.

Oh yeah. It's unbelievable, folks. I'll just tell you and then we'll leave maybe the legal topic because I want to talk about finance a little more and you sort of. These two go together a bit. But we have so many investors listening to the show. But it sure feels like to me, the way my career and life has gone, that I spent the first half of my career creating wealth and then the second half of my career is all about protecting that wealth.

It's amazing the amount of time you have to spend managing and protecting your wealth. It's absolutely mind boggling and it's not productive. You should be doing something to create more wealth, create more jobs and not, you know, worry so much about protecting it. It's just absolutely mind boggling the way the whole system works. But that's the system we have. Let's transition to finance. You know, you talk. I've done shows that talk about, of course, securitization and swaps and dark pools and shadow banking and some of the things you address in your book. Talk to us about that. You did mention Glass Steagall before. We can touch more on that if you like. But the financial system is so complicated, isn't it? It never ceases to amaze me, Etienne, how people can take a simple concept of the old joint stock company, right, the basis of our stock market, and make it insanely complex with all these derivatives. And I just simply call derivatives the thing about the thing, you know, that's my layman definition of a derivative. It's the thing about the thing, you know, what do we do? How does a person act in that world and how can we make it better?

Yeah, you made a great transition. We talked about the fact that we spent half our life building some wealth and then we have to protect it. It's a perfect transition to finance because once you have a little nest egg and so forth, you want to make sure it continues to work so that you don't go in the poor house when you're old. And that means that you're going to involve the stock market because interest rates in recent history have just been too low to allow. Basically. I mean basically the 10 year today t bill barely covers you against inflation. In terms of net income, it's almost nothing.

I'm so glad you mentioned that. That's part of the scam. They've basically made it impossible for older people to simply do the right thing, which would be save money and, you know, invest conservatively. Now they're pushed because of this financial repression into all sorts of speculative investments, aren't they?

Yeah, the minimum you can do. Of course, you may have access to some private equity funds and good hedge funds, although even those have been disappointing in recent years. But you have to deal with the stock market. And if you deal with the stock market, you're going to worry about a repeat of 2008 and before that 1999 and before that 1994, principally when we've had 10 years of growth in the stock market and no accident. And so in my book in finance, even though I have a Harvard mba, I'm not a finance specialist. I rely on the advice of statesmen and people who've had a lot of experience in this area. So for example, we have Neel Kashtari. Neel Kashari helped Treasury Secretary Henry Paulson during the darkest times of the 2008 financial crisis. He had the stint at Goldman Sachs. He is now the president of the Minnesota affairs, even run for governor of California Republican ticket. I mean somebody with a stellar resume. His premise is very simple. If we don't want to have to bail out banks, let's increase their buffers. Their buffers are their equity to debt ratio. Today they're very low, less than 6%. He proposes to boost that two and a half times, at least to 15%, maybe even more. For banks that would be deemed a risk.

So when you do that, that would have a very contracting effect on the economy because as my listeners know through this complicated shell game that is called fractional reserve banking or fractional reserve lending, you know, money is lent into existence and if you curtail lending, a lot of credit based assets will contract in price, right? And less money will be lent into existence. There will be less inflation, which I think would be a more legitimate approach, certainly. But would anybody tolerate this? I mean, you know that the powers that be would hate it because during their term the economy would contract the.

Banks to be would hate it. And I'm going to hide again behind the Neel Kashkari. What he's saying is, no, I'm just going to have them issue more stock. If you think in terms of the equity, I'm just going to have them shoe stock. Now, what is true is a favorite measure of profitability of the banks, the return on equity that will go down. The return on equity will go down for the simpler reason. There's a lot more equity. But I don't believe the impact on lending would be so high. Remember before 1999 when we didn't have all these speculative instruments and so forth, nobody clamored about a lack of credit. Think about it. The expansions of the 80s, the expansion of the 90s, people screaming about lack of credit. No.

Well, because they didn't have the comparison there was on each successive decade there's more credit than before. The cure is always throwing more money on the fire. Right? And so one of the ways you throw more money on it is you expand the credit supply and that becomes sort of a cure. It's not really a cure, but it's like drinking some coffee and having some caffeine. Right. It's a stimulant. But ultimately there's a crash later.

And remember, credit for what? Yeah, Glass Steagall things a good thing. These are the simple proposals in my book. Glass Steagall. Remember that two very successful politicians advocate for them on the campaign trail in 2016, President Trump and also Bernie Sanders. I like increasing the buffers at the back, increase the reserve ratio, equity to capital ratios. Now you talk about credit. What is credit used for today? Of course, for a lot of good things. But also, do you think when a private group borrows at 90% to flip up Burger King an 18th time, do you think that's really very useful? And they do it because for this type of transaction you have tax deductibility of the loans. The way I would adjust with higher equity to debt requirements for the bank is I will also curtail some obviously speculative debt fuel transactions and make them no longer tax deductible because some of these transactions really are not terribly useful to anybody and if anything, they carry risk.

Well, of course, look at. I think everybody listening knows, not everybody in the world, but my listeners know, because we've talked about it a lot, that I mean, the modern finance system is just a complete scam. They're not creating any actual value most of the time. They're simply moving money around, renaming things, putting fancy equations on things these are not value creators, these are just value manipulators.

I quote Paul Volcker the very respect.

Paul Volcker was great. He's the only one that could make the country take the hardness and break.

The back of the basically saying only really truly innovative thing modern finance has done in terms of inventions is the automatic telling machine.

I know, I love jazz.

But he also talks about how he met one of the modern architects of modern finance engineering and he asked the guy put that in the book as well. Well, what does that all do? And Paul Volcker quotes the guy saying he doesn't do move, he shuffles assets around. But it's a lot of fun. And Paul Volcker and yes, that's how finance from 2 1/2% of the economy when it was the Fed became 6 1/2% of the economy. So it's not lost for everybody.

I know, it's absolutely ridiculous. It really is. Okay, we'll wrap up the finance subject and then let's wrap it up with your website and so forth. But what is the thing? I mean we all know there's a problem. Nobody's going to disagree with that. What do we do? What do we do?

What I think we should go back to very simple instruments. I'll give you another individual mention. My book is the Republican chair of the Finance Committee of the House, Jeb Hansarling and his idea was even simpler than Glass. Steagall big financial guard said we still have Dodd Frank. I mean the administration Republicans have nibbled at the edges of it and they exempted some usual but we still have it. And basically saying any bank that can show me they keep at least 15% again of equity capital against debt, I'm going to exempt them from Dodd Frank altogether. So that would tie up some of the ideas have together very neatly. And the idea if you step back a little bit is not to try to micromanage all this, not to try to kill the risk with thousands of page of legislation, but manage the outputs and basically tell the banks well we're concerned about your indebtedness. So we have these complicated laws, put more equity on the books, you get exempt from the constraining these laws.

Very simple. I like that. You know what that's like? That's like the Trump administration approach to housing affordability and discrimination and so forth. It's like a polar opposite of the Obama administration approach where the Obama administration wanted to integrate wealthy communities and do all this crazy social engineering stuff where Ben Carson or HUD secretary, you know, he Just wants to encourage more development. Manage the output. Right, the output of more development and more housing availability. Just let people put it into the marketplace and the marketplace will take care of itself. Now, I have no idea if you agree with that approach. I personally do. I think it's a good approach, you know, rather than trying to make a bunch of overly complex laws that just create new bureaucracies and all sorts of unfairnesses and unintended consequences that they always do. When you said managing the outputs, I thought that was a kind of another example. And since so many of our listeners are into real estate investing, I thought I'd.

Yeah, I don't know about housing and what HUD does very well, but yeah, managing the outputs is very important. In my book I mentioned, you know, people complain about CAFE standards for cars and a lot of back and forth today. Complex regulations, monitoring emissions of pollutants by power plants. Well, if you put a carbon tax, and that's something Joe Schultz, who wrote the foreword for my book, advocates very strongly, you put a simple carbon tax, you price basically the cost of these.

The cost of what's called externalities. That's a term everyone needs to understand. You know, I was talking to my friend about externalities last night. There's so many of them. Not even in that respect. But how about the externalities of leaf blowers and loud motorcycles and loud cars? It's obnoxious. These people should have to pay to disturb the peace.

A simple carbon tax would go a long way to price everything we've done all the way to wars in the Middle East. And then you let the consumer decide. I mean, the people go to Europe and they see a lot of small cars and quite fewer four than 50 pickup trucks. And that's because gasoline is taxed at two and a half times what you pay here.

I hate to actually endorse any kind of new tax because that's another sort of bureaucracy, but maybe.

I don't know.

Yeah, I know, I know they are you.

And by the way, Joe Shultz says that the proceeds of the carbon tax could be returned to the American people in the form of dividends, which would be a very.

Yeah, we'll see, we'll see. I think it'll be spent by another government bureaucracy, but I'm just the best.

Depends on the witch. But remember, you do a carbon tax, you eliminate a ton of regulations, a ton of paperwork.

Yeah, maybe it's possible. Okay, okay, good. Really interesting discussion. Give out your website. And of course the book is available on Amazon. All the usual places, but any anything.

Yeah my website is www my name at and defarge no space no.com so www.e t I e n n e d e f f a R-G-E s.com.

Etion thank you so much for joining us.

Thank you Jason. It's a pleasure to talk to you and to your listeners.

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