Before Michael Burry became famous for betting against subprime mortgages, he was a medical student with an economics brain. And in August 1994, while working as an extern at Northwestern University, he spotted something weird happening in American healthcare.

Burry shared the paper Thursday in his newsletter, noting that it captures a timeless truth about medicine in America: the government creates incentives, and the healthcare industry follows them, sometimes into dangerous territory. The parallels to today's system aren't subtle.

When Payment Rules Create Perverse Outcomes

Here's what caught Burry's attention back then. Rehabilitation hospitals were popping up everywhere during the 1980s and early 1990s, which seemed odd given that everyone was supposedly worried about rising healthcare costs. The explosion wasn't random, though. It was the predictable result of contradictory federal policies.

In 1983, the government put acute-care hospitals on a fixed-payment system. Suddenly, these hospitals bore the financial risk of patient treatment, which meant they had every reason to discharge patients as quickly as possible. But rehabilitation facilities? They stayed on cost-based reimbursement, meaning they got paid back for whatever they spent. The more they invested upfront, the more they could bill.

You can guess what happened next. Rehabilitation hospitals and units "literally erupted," as Burry put it. The numbers tell the story: facilities jumped from 74 to 159, while units skyrocketed from 345 to 848 in less than a decade.

The problem was dependency. Medicare covered more than half of rehabilitation patients, which meant the entire growth story rested on federal policy staying exactly as it was. Burry spotted the fragility immediately.

He pointed to a proposal then circulating within the Health Care Financing Administration, now known as Centers for Medicare & Medicaid Services, that would penalize hospitals for discharging patients to rehabilitation facilities. His assessment was blunt: "This proposal would devastate rehabilitation medicine throughout the nation."

His conclusion reads like a warning label: "Much of it is predictable by following the incentives." Policy-driven bubbles aren't accidents. They're the logical outcome of misaligned rules.

Same Song, Different Verse

Fast forward three decades, and the American healthcare industry is even more intertwined with government policy. Recent developments suggest Burry's framework remains uncomfortably relevant.

Last month, federal officials proposed new payment models called GUARD and GLOBE, designed to lower Medicare drug prices by comparing U.S. costs to international markets. It's another example of the government attempting to redesign incentives to control spending.

Major healthcare stocks have been volatile lately, partly due to uncertainty about whether Affordable Care Act subsidies will be extended. When federal policy shifts, entire sectors hold their breath.

Billionaire investor Mark Cuban has been vocal recently about power imbalances in the current system, repeatedly criticizing insurers and pharmacy benefit managers for what he calls "abusing" independent physicians. Cuban described the ACA, or Obamacare, as "garbage today," though he was quick to clarify that "the fault isn't with the ACA, it's with politicians and administrations that let the abuse of the ACA occur."

Burry's 1994 paper wasn't just about rehabilitation hospitals. It was about what happens when complex systems respond to poorly designed incentives. That dynamic hasn't gone anywhere. If anything, it's become the defining feature of American healthcare economics.