The lastest in the patent wars

Lying or honest mistakes? That seems to be the crux of one of the sticking points in the patent reform bill, according to a story in today’s New York Times – Battle Over Patent Law a Boon to Lobbyists:

A fight has erupted in Congress over whether drug makers and other companies should be allowed to keep patents they obtained by misrepresentation or cheating.
The issue has emerged as a contentious point in legislation to overhaul patent laws. In several cases, the courts have voided patents after finding that companies intentionally misled the Patent and Trademark Office.
The legislation, affecting a wide swath of the American economy, has been a boon to lobbyists. In 15 months, two dueling business coalitions have spent $4.3 million lobbying on the legislation, which calls for the biggest changes in United States patent law in more than 50 years. Companies from almost every major industry have joined the battle.
Patents can protect an invention for up to 20 years. But federal judges can void patents after finding that companies engaged in “inequitable conduct,” meaning that they misrepresented or concealed information with an intent to deceive the patent office. In such cases, judges can declare the patents unenforceable.
Robert A. Armitage, a senior vice president and general counsel of Eli Lilly & Company, said, “This is like imposing the death penalty for relatively minor acts of misconduct.”
Brand-name drug companies are urging Congress to eliminate the penalty — or to curtail it as proposed under a bill passed by the House.
Debra S. Barrett, a vice president of the American unit of Teva Pharmaceutical Industries, the world’s largest maker of generic drugs, said the changes sought by brand-name drug companies “would make it easier for them to cheat and get away with it, easier for them to defend their patents and more difficult for us to get generic products onto the market in a timely way.”
Consumer groups like AARP share that concern. They want to speed access to generic medicines, which can cost 30 percent to 80 percent less than the equivalent brand-name drugs.

And the saga continues. In this case, the fight is generics against name brands. Generics want more drug patents invalidated and name brands want to protect their monopoly.
The article has another very interesting quote:

Jon W. Dudas, the under secretary of commerce for intellectual property, said: “We are getting more and more unpatentable ideas, worse and worse quality applications. Historically, in the last 40 years, the allowance rate — the percentage of applications ultimately approved — hovered around 62 percent to 72 percent. It went up to 72 percent in 2000, but dropped to 43 percent in the first quarter of this year.”

That sound very ominous. Let’s see if it is ominous enough to get Congress to act.

The “r” word — and stimulus

Well, the debate will begin as to whether the US economy is in a recession, a slowdown or what. This morning, BEA said its advanced estimate of the 1Q GDP growth was 0.6% (at an annual rate). GDP grew by only 0.6% in the fourth quarter of 2007. The old rule of thumb (which the official arbiters of recessions at the NBER don’t use) is two quarters of negative GDP growth. Now we have two quarters of very slow growth. On previous occasions, we have called this a “growth recession” — not negative, but not strong enough to absorb the growing population. Hence unemployment usually rises.
Not surprising, residential construction was the biggest drag on the economy. But all other investment was down as well. Durable and nondurable goods consumption were down as well. Only consumption of services grew. Most of those “services” however are housing and medical care. Purchases of IT equipment and software increased as well (counted under the category of “fixed investment”).
The news media is already calling this good news. According to Reuters (via the New York Times) U.S. First-Quarter Growth Stronger Than Forecast, the number “handily topping a forecast for 0.2 percent growth in an advance poll of economists by Reuters.” The Wall Street Journal was a little more restrained — Economy Grew 0.6% in 1st Quarter Despite Weak Consumer Spending: “Economists surveyed by Dow Jones Newswires expected 0.6% GDP growth during the first three months of 2008.” It looks like folks are just happy to see a positive number, regardless of how small.
The slow growth may prompt some to call for an additional stimulus package. On the other hand, the Administration is already stated that it prefers to wait and see how the tax refunds work out. Those checks are in the mail now. But since GDP is a quarterly number, their effects will not be known until the 2nd quarter advanced estimate is released in July.
If there is a further stimulus package, it should include some elements that help the I-Cubed Economy. Let me make a suggestion. Add a tax break for worker training — a knowledge creation tax credit. In a time of slower production, rather than send workers to the unemployment office, let’s send them to the classroom. If we can give companies a tax break for a new piece of equipment (as we did in the first stimulus package), surely we can give companies a tax break to upgrade their most valuable asset: their workers.

Future of securitization

Earlier this month, the Wharton School’s online newsletter – Knowledge@Wharton ran an interesting piece entitled Coming Soon … Securitization with a New, Improved (and Perhaps Safer) Face. The article quotes a number of Wharton’s finance and real estate professors on what the reforms are needed in the real estate and securities market. I was specifically interesting in there comments on the securitization process (as opposed to the underlying real estate market). They make the point that the securities market became too complex and complicated which resulted in overly risky investments and a crisis of confidence as those investments collapsed. The article quotes Professor Richard Herring as saying, “there has been a highly rational flight to simplicity.”
Interestingly, Peter Morici at the University of Maryland School of Business made a similar point in a recent piece one overall economic and trade policy — Rethinking Fed Policy – Forbes.com:

In addition to adjusting interest rates and bank reserves, Bernanke needs to sit down with the largest banks and fixed-income investors to define simpler, more transparent loan-backed securities that bond-rating agencies can more reasonably evaluate and that fixed-income investors can purchase with confidence.

These are the same points I have made before as well — and the reason why I believe there may be an opportunity here for intangible asset securitization, as I note in our new Athena Alliance working paper (Intangible Asset Monetization: The Promise and the Reality). Investors need a clear understanding of the asset underlying the security, the risk associated with that asset and the revenue stream generated by that asset. Intangible asset back securities can be crafted with that transparency. And if the nature of the risks involved is acknowledge upfront, specific measures can be taken (and clearly explained) to mitigate that risk. That may be of more comfort to investors than the previous practice of assuming an AAA rated security was risk-less.
Ultimately, the future of an intangible asset backed securities market will depend on the creation of a primary market in intangibles. Certain intangibles — book and music rights — are routinely bought and sold. It is no surprise, therefore, that music rights were among the first to be securitized (the Bowie Bonds). In other areas, such as patent, rights have long been traded but organized markets are just beginning to emerge.
Helping these primary and secondary markets will require a number of actions, including patent reform (to ensure that the patent is really worth something) and maybe the creation of an institution akin to Fannie Mae/Freddie Mac (an Ida Mae). (See earlier posting for a list of the most important policy recommendations).
In any event, securitization is here to stay. As we fix the problems from the previous abuses, let us not only prevent future bad things from happening. Let us also explore ways to make good things happen in the future. Promoting responsible securitization of intangible assets would be one of those good things.

– – –
UPDATE: Another opinion on securitization, from Bob Pozen (How to Revive Securitization Markets – WSJ.com):

Most markets for securitized debt have dried up. The cause is uncertainty: Since no one knows exactly who owns the potential losses from securitized mortgages, many investors stay away. When the Securities and Exchange Commission Advisory Committee on Improving Financial Reporting meets on Friday, it can take a big step toward reviving this critical part of our financial market. It should recommend that the regulators require someone to “own” the securitization process as well as require more disclosures about who will bear the losses from the assets underlying these securities
. . .
The market for securitized assets can revive if trust sponsors make these disclosures and an independent holder of substantial trust equity is given some governance powers. Under these conditions, FASB can safely continue to allow bank sponsors to keep the trusts off their balance sheets – a necessary step lest we go back entirely to banks holding mortgages to maturity and lose the increased funding available for home purchases generated by the securitization process.

I don’t know about the specifics of this proposal, but I wholeheartedly agree that someone has to “own” the securitization process — not just own the financial paper. As I understand most current intangible-asset backed securitizations, there needs to be an active manager of the trust to ensure (and maximize) the revenue stream. Such deals often also come with strict performance measures and backup arrangements. That is another reason why clear rules and a model for intangible asset backed securitization are needed.

Is the future now?

And speaking of service sectors in transition, there is this story in the New York Times — Reluctantly, a Daily Stops Its Presses, Living Online:

With print revenue down and online revenue growing, newspaper executives are anticipating the day when big city dailies and national papers will abandon their print versions.
That day has arrived in Madison, Wis.
On Saturday, The Capital Times, the city’s fabled 90-year-old daily newspaper founded in response to the jingoist fervor of World War I, stopped printing to devote itself to publishing its daily report on the Web.
(The staff will also produce two print products: a free weekly entertainment guide inserted in Madison’s remaining daily newspaper, The Wisconsin State Journal, and a news weekly that will be distributed with the paper.)
. . .
The Web strategy, while seen as a long-term solution, is still a work in progress, [Capital Times editor Paul] Fanlund says. It revolves around a portal, Madison.com, which is owned under the same joint arrangement mandating that both Madison papers share revenues, though they are editorially independent.
The Capital Times will operate a nearly continuous Web newsroom and focus on repurposing online the cultural and entertainment material the staff will begin to produce in the supplement, 77 Square, to be inserted in The State Journal.

And so the experiment really begins.

The decline of financial services

Speaking of the future of the services industry (see earlier posting) , today’s Wall Street Journal is running a Page One story Has the Financial Industry’s Heyday Come and Gone?:

For the past three decades, finance has claimed a growing share of the U.S. stock market, profits and the overall economy.
But the role of finance — the businesses of borrowing, lending, investing and all the middlemen in between — may be ebbing, a shift that would redefine the U.S. economy. “The role of finance in the economy is going to come down significantly in the coming years,” says Carlos Asilis, chief investment officer at Glovista Investments, a New Jersey money manager. “From a societal standpoint, we got carried away with finance.”
The trend already has hurt companies beyond banks and Wall Street firms. General Electric Co.’s first-quarter profits at its financial-services businesses were 21% lower than a year earlier. Retailer Target Corp., which got 13% of its before-tax profit last year from credit cards, last month wrote off $55.5 million in credit-card loans, 8.1% of its total portfolio at an annualized rate.
“I think you’re seeing a clear inflection point,” says Tom Gallagher, an ISI Group analyst. “Whether it’s financials as a share of the stock market or financials as a share of GDP, we’ve peaked.”
. . .
For finance workers, this shift could resemble the 1980s, when manufacturing lost its pole position in the U.S. labor market and thousands found that skills they had honed over the years were less marketable. The Bureau of Labor Statistics already counts 60,000 fewer people working in finance than a year ago. Merrill Lynch & Co. is cutting 4,000 jobs, and Lehman Brothers Holdings Inc. is cutting 1,425. Many of Bear Stearns Cos.’ 14,000 employees are expected to lose their jobs when J.P. Morgan Chase & Co. swallows the firm.
[New York University economist Thomas] Philippon argues that the surge of financial activity that began in 2002 created an employment bubble that is now busting. His model suggests total employment in finance and insurance has to fall to 6.3 million to get back to historical norms, and that means losing an additional 700,000 jobs in the sector.
Finance has seen job cuts before and bounced back. After the 1987 stock-market crash, E.F. Hutton & Co. was taken over by Shearson Lehman Brothers, then a division of American Express Co., and shed 5,000 jobs. Among them was Jeffrey Applegate’s job as a strategist. He spent the subsequent year doing carpentry and thinking he might make a career of it if financial jobs didn’t come back. He got hired by Shearson Lehman, which evolved into the present-day Lehman Brothers.
Now chief investment officer for Citigroup Inc.’s Citi Global Wealth Management, Mr. Applegate thinks the damage to the financial sector this time will be more lasting than 1987. (Citigroup has announced 6,000 job cuts since the credit crisis began.)
But he doubts finance’s role in the economy will ebb much. Globalization’s demand for free-flowing capital will continue. And the process of turning loans into securities is too powerful a tool for risk management and credit creation to abandon. “Is securitization going to go away? I doubt it,” he says. “Is it going to be more transparent? Are ratings going to be more robust? Is there going to be more regulation? Yeah.”

Are financial services going to wither up and die? No. Is the growth in the financial services sector going to slow down or possibly even retreat? Yes. The bloom may be off the rose, put the rose bush remains — thorns and all.
And that should be a lesson on understanding shifts in the economic structure: just because a sector is hot today doesn’t mean that it will be the economic savior of tomorrow.

Services innovation

Today, the University of Cambridge and IBM released a new white paper Succeeding through Service Innovation. The report is based upon the 2007 Cambridge Service Science, Management and Engineering Symposium.
The report is part of an ongoing process to define and develop a new area called “services science.” The report notes that:

Thanks to the application of science, management and engineering to the improvement of agriculture and manufacturing, remarkable products, from disease resistant crops to automobiles and personal computers, can be produced flexibly and efficiently and are widely available. However, as product complexity and diversity increase, it can take more time and consume more resources to search for, obtain, install, maintain, upgrade and dispose of products than production itself. This offers great opportunities for service innovation – including both incremental improvements and radical changes to service systems.
. . .
The need for science, management and engineering in relation to agricultural and manufactured products has not gone away. They are an integral part of service innovation and have a strong impact on the way that products behave and perform in larger service systems. For example, cutting-edge technologies such as biotechnology and nanotechnology can be applied to enhance consumer experience. But as the scope of innovation continues to move beyond products, we must prepare ourselves with skills and knowledge required for service innovation.

The report has a number of recommendations for moving the agenda forward — mostly having to do with fostering interdisciplinary activities and greater research and thinking about “services sciences”:

• Universities should offer courses in the emerging field of Service Science, Management and Engineering (SSME) – teaching graduates to become “adaptive innovators”, capable of working entrepreneurially across traditional boundaries.
• Researchers should embrace an interdisciplinary approach to address business and societal ‘grand challenges’.
• Governments should fund SSME education and research and collaborate with industry and academia to develop service innovation roadmaps.
• Businesses should establish employment policies and career paths that encourage ‘adaptive innovators’ and provide funding and support for service research and education.

I welcome this new trend — especially the extent to which it looks at the broad range of innovation beyond just new technologies. Almost by definition innovation in the services would require organizational and business process changes.
I do worry a little bit about continuing the use of the nomenclature of “services” versus “manufacturing”. I think these lines are blurring. Likewise, not all “services” are the same. As I discussed in an earlier posting, We need to be able to differentiate between the difference between the celebrity chef and the minimum wage fast food workers as well as between the person who designs a bridge and the person who builds it. And what about between composing a symphony and playing a symphony? Engineering a car and building a car?
Services sciences and services innovation may be the opening to explore these deeper issues. But we need to invent a new language to talk about the issues. “Services” and “manufacturing” just don’t suffice any more.

The cost of protecting reputation

Steven Pearlstein’s column in today’s Washington Post is about Cashing In on Corruption. He specifically talks about the rise in internal and external corporate corruption probes. In part, he attributes this to increased enforcement of anti-bribery and other anti-corruption laws in both the US and Europe. But in part it is also defense:

If for no other reason than to protect themselves from legal liability and attacks on their reputations, directors now are quick to order up an outside investigation whenever even the hint of bribery is alleged by customers, employees or competitors.

Protecting both individual and corporate reputations can be costly. Pearlstein estimates the cost of an internal probe to be $1 million to $20 million. And it is providing a lucrative market for Washington law firms (the “cashing in” part of the column’s title).
But not protecting one’s reputation can be even more costly. Pearlstein notes that in the Siemens bribery case, the company has already spent over $500 million on legal and other fees, been fined $300 million by German courts and is looking at fines that “almost sure to reach into the billions.” Siemens stock has also dropped from around $160 per share at the beginning of the year to about $116 today — but it is unclear whether that is directly due to the bribery scandal or other market and business conditions (see earlier Wall Street Journal story).
In any event, companies are taking their reputations and the anti-corruption probes seriously. We will see if they continue to take a largely defense stance (to the boon of the lawyers paid to come in and clean up the mess) or they will modify their management and control systems to prevent problems from happening in the future. The latter would be a wise move to deal with all sort of threats to companies’ reputation and better help them manage their intangibles. But sweeping up the droppings has always been easier than changing management styles.