Echoes of the Financial Crisis, in Drug Manufacturing

SMITH BRAIN TRUST – The crisis over tainted heart drugs made in China and sold in the United States had an oddly familiar ring to it for Maryland Smith’s Clifford Rossi.

But it wasn’t a previous medical drug crisis that crept to mind for him. “No,” he says, “my mind immediately went to, ‘Well, it’s not just about banks, this whole risk management thing.’”

Risk management is Rossi’s wheelhouse. It’s not merely what he teaches as a Professor-of-the-Practice and Executive-in-Residence at the University of Maryland’s Robert H. Smith School of Business. Prior to coming to Smith, Rossi was chief risk officer for Citigroup's Consumer Lending Division, overseeing the risk of the bank’s $300-billion secured consumer asset portfolio.

“This crisis is very reminiscent of the loan manufacturing process deficiencies, poor oversight by regulators, short-term financial gain at the expense of shareholders and customers,” he says. The mortgage crisis was serious and had dramatic consequences. The drug manufacturing crisis, he says, has consequences that could be even more dire.

The prescription treatment at the center of this crisis, valsartan, was contaminated with a possible cancer-causing chemical. “This isn’t just a drug that’s used for some rare disease that affects only a few thousand people,” Rossi says of valsartan. “Millions and millions of people are on this drug. The consequences down the road could be pretty significant.”

Again, he harkens back to the mortgage catastrophe, drawing parallels from Crisis A to Crisis B.

“There’s humongous operational risk, enormous fraud risk, legal risks from potential customer class-action lawsuits, reputational risk, supply chain risk, vendor risk, you name it. It’s all there,” he says. “Just like we had in banking.”

As with the earlier crisis, there’s a disconnect between regulatory efforts and public policy. Policymakers were loath to crack down on easy mortgage practices, because homebuilding, buying and renovating had become such an engine in the economy. In the pharmaceutical crisis, meanwhile, policymakers are under pressure to dramatically lower the sky-high and rising costs of prescription drugs in the United States. “And rightly so,” Rossi says.

But don’t miss the warning signs from a risk perspective, he says.

“We are moving increasingly toward generic types of drugs, but at the same time, we have significantly lowered the quality control standards associated with them, allowing a lot of these drug manufacturing companies to identify their own issues,” he says.

According to Bloomberg News, nearly 10 percent of generic drugs approved by the FDA were made by Chinese companies. But the agency that helps safeguard the global supply chain of medicines has been conducting fewer inspections of drug-making plants in China. Only 125 inspections took place there, a nearly 11 percent drop from the year earlier.

The mortgage crisis plunged legions of adjacent industries into trouble, and a drug manufacturing crisis would do the same.

“Many of the drug manufacturers in this country are leveraging overseas plants for manufacturing their generics, and they face a ton of risk if they aren’t doing their utmost due diligence,” Rossi says.

Hospitals and physicians face risk, as well. And companies in the prescription benefits market, such as CVS-owned Caremark, could also face potential liability.

What to do now

“First and foremost,” Rossi says, policymakers should reexamine the role of the FDA and make sure it has ample resources. “Oversight is important. We are talking about life and death with these drugs.”

“The second thing,” Rossi says, “is that the FDA needs to take a look at this more holistically.” That means examining the various market participants, finding a better way to have multiple layers of oversight and creating stronger quality control reporting requirements for manufacturing firms.

The third thing, he says, is heavier penalties from FDA regulators, like the ones that financial regulators impose on banks. “They need to carry that big stick, and make sure the drugs are being manufactured in the proper way.”

And fourth, he says, in those adjacent industries, hospitals and drug benefits companies must take a closer look at what’s being prescribed and do their due diligence into what their sourcing is. “It was the same thing with Fannie Mae and Freddie Mac insuring mortgages,” Rossi says. “They owned the requirement of making sure that the loan manufacturing process of the loans that they were insuring were good as well.” When they weren’t, Fannie and Freddie would be on the hook.

Averting disaster

Banking regulations globally intensified significantly as a result of the financial crisis of 2008-2009. But does it always have to be a crisis that brings about change?

“Unfortunately, usually, yes,” Rossi says. “It’s like with plane crashes. We learn a lot about mechanical problems after a crash. We can’t peer around the corner.”

However, in this case, he says, there is an opportunity to avert a deeper calamity. And that’s where he sees a final parallel between the drug-manufacturing crisis and the financial crisis.

“A lot of the sins of the mortgage crisis could have been averted if there had been proper controls in place. One, to identify this significant increase in the riskiness of those assets, and two, to take immediate action to remediate it, knowing that the consequence on the other side from the regulatory community was that they were going to hit them hard,” Rossi says.

“Unfortunately we all too often find ourselves deep into the crisis and then trying to figure out what to do after it.”