More on State Street

OceanTomo has sent out the following analysis of the Bilski ruling and its affect on State Street:

Bilski Decision Unlikely to Alter Business Method Patents Value
The Federal Circuit’s en banc decision in In re Bilski, while closely watched, is unlikely to substantially change the scope of subject matter eligible for so-called business method patents or to alter the value of business method portfolios. The Court, relying on a detailed analysis of Supreme Court precedent, articulated a “machine or transformation test” for patentability. Under this test “an applicant may show that a process claim satisfies §101 either by showing that his claim is tied to a particular machine, or by showing that his claim transforms an article.” However, because the claim at issue in Bilski was admitted to be “not limited to operation on a computer,” or to carrying out the process by “any specific machine or apparatus,” the Court expressly declined to consider the contours of the machine implementation alternative. “[I]ssues specific to the machine implementation part of the test are not before us today. We leave to future cases the elaboration of the precise contours of machine implementation, as well as the answers to particular questions, such as whether or when recitation of a computer suffices to tie a process claim to a particular machine.” (Emphasis added).
The Court also made clear that the “transformation” test is broad. For example, it noted that a claim direct to the “transformation” of the depiction of a physical object on a visual display meets that test. Perhaps of greatest significance, the Court overruled the “useful, concrete and tangible result” test established in State Street, holding that it was “insufficient to determine whether a claim is patentable subject matter under §101.” But while this test is no longer the law, the new test will likely not alter the ultimate answer to the question as applied to particular business methods.
“Business method patents” commonly claim implementation by computer. Accordingly, the Court’s refusal to consider “whether or when recitation of a computer” is sufficient to render a process claim patentable means that the practical impact of Bilski should be limited. Absent development of further case law which squarely addresses this point, Bilski does not appear to materially change the business method patent landscape, or alter valuations of these patents.

I’m sure we will see more analysis over the next few days.

More on direct infusion

Steve Pearlstein does an “I told you so” — Hank Paulson’s $125 Billion Mistake:

It was only a few weeks ago that most right-thinking economists and left-leaning bloggers were jumping on Treasury Secretary Hank Paulson for his plan to jump-start the markets in asset-backed securities by having the government buy them up at auction. Much better, they argued, to use the $700 billion to “recapitalize” the banking system, just as Gordon Brown was doing in Britain. Even the Federal Reserve thought that a better idea.
So Paulson changed course, called in the nine biggest banks and “forced” them as a group to accept $125 billon in new capital. The critics patted themselves on the back for having been right all along.
Now, many of the same people are shocked — shocked! — to discover that the banks aren’t using the money to make new loans to households and businesses, as they had assumed, but are using it to maintain dividend payments to shareholders, pay this year’s bonuses to executives and traders, or squirrel it away for future acquisitions.
I hate to say it, but I told you so. Sprinkling money around a highly fragmented banking system when markets were panicked and everyone was scrambling to reduce leverage was always akin to shoveling sand against the tide.

I think it may be a bit premature to call the direct infusion process a mistake. But I continue to believe – along with Pearlstein – that the best course of action is to buy up the assets:

Paulson’s first mistake was in allowing himself to be diverted from his original strategy, which stood a good chance of establishing reasonable and credible market prices for asset-backed securities — a necessary first step in attracting other buyers back into those frozen markets. That would take tremendous pressure off all banks, insurance companies, hedge funds and bond insurers, most of which now can’t raise capital because nobody can even guess what the assets on their books are worth, forcing accountants and auditors to assume the worst. It also would get liquidity to those institutions that most need it.

As I understand it, that program is still being set up. I hope it gets up and running soon.

State Street Bank case overturned limited

From the Wall Street Journal – Court Limits Issuance of Patents on Methods of Doing Business

The U.S. Court of Appeals for the Federal Circuit upheld a ruling made by the Board of Patent Appeals and Interferences, which denied a patent for a method of hedging risks of sudden changes in energy costs. While patent law specifically allows the patenting of processes, the court ruled today that this protection doesn’t extend to all abstract strategies of doing business.
The court, in a 9-3 decision, wrote that in order for a process to receive patent protection, it has to either “transform [an] article to a different state or thing” or be “tied to a particular machine.” The risk-hedging strategy, the court ruled, did not fall into either category. Wrote the court: “transformations or manipulations of…business risks, or other such abstractions cannot meet the test because they are not physical objects or substances…”
The plaintiffs, Bernard Bilski and Rand Warsaw, had developed a hedging strategy used by several utilities to smooth out revenues in a sector where prices often gyrate. Messrs. Bilski and Warsaw argued that the utilities should have to license the right to use the method, citing 1998 court decision which largely allowed so-called “business method patents.” Yet, the patent office denied their request and the plaintiffs appealed.
But in today’s ruling, the court largely disavowed the highly controversial 1998 decision, State Street Bank v. Signature Financial Group. That case had granted protection to a system for managing mutual fund accounts. The State Street decision was widely cheered by the financial-services and software industries, among others. But ever since its issuance, the State Street case has been a lightning rod among patent practitioners, with detractors largely arguing that it led to a glut of weak patents.

This changes a lot.
For more background on the case (not the ruling) see Patent Law Blog (Patently-O): Bilski: Full CAFC to Reexamine the Scope of Subject Matter Patentability, Why In re Bilski will see the US move closer to Europe – Intellectual Asset Management and United States, Intellectual Property, Federal Circuit To Re-Assess Standards For Patent-Eligible Subject Matter – Fenwick & West LLP – 07/04/2008, Patent.

Rebuilding competitiveness

Mike Mandel commenting in Business Week on the global economic meltdown (It’s Not a Crisis of Confidence) blames the problem on three flows: technology and industrial know-how to emerging economies; goods from those nations back to the developed world (read: “US”); and, flow of capital back to the emerging nations to pay for those products.

This tri-flow worked as long as everyone believed that American consumers could finance their debt. But here’s the problem: At the same time Americans were borrowing, their real wages were falling—and not just for the least educated. By BusinessWeek’s calculations, real weekly earnings for college grads without an advanced degree have dropped every year since 2002.
You can’t pay back rising debt with falling wages; something had to give.

And something did give. The house of cards collapsed — or as I have called it, the juggling act (the carry-trade and other arbitrage mechanisms that are now falling apart) on top of a house of cards (the slicing and dicing of risk that simply hid it, rather than reduce it) build on a foundation of quicksand (the teaser/liar subprime mortgage mess).
So, what should we do? According to Mandel:

Policymakers should stop talking about investor confidence as if it exists in a vacuum. Instead, they should focus on the real goal of stimulating the creation of innovative new goods and services that the U.S. can produce and sell on global markets. That would reduce the amount of borrowing the country has to do, and help create a sustainable global economy.

In other words, attack our underlying international competitiveness problem that got us into the financial quagmire.
I agree – to a point. I think the financial collapse came before the effects of the competitiveness/trade deficit problem could be felt. Everyone assumed the economic crisis would start with a drastic drop in the value of the dollar – as other nations stop lending us funds. But in the current situation, the opposite has occurred. The flight to safety has meant a flight to US Treasuries.
So the world has not yet given up on lending to the US. But, at some point, it will. To prevent that next catastrophe from happening we need to follow Mandel’s advice and use this opportunity to rebuild our economic competitiveness. Or the next time will even worse.

Debating the Merits of Mark-to-Market

New York Times’ DealBook has a summary of the SEC hearing on mark-to-market. There was an interesting back and forth between to witnesses. Accounting Professor Ray Ball, University of Chicago Graduate School of Business noted that part of the problem in Japan was that banks “were allowed to keep financial instruments on their balance sheet at historical costs for a very long period of time so that investors in the capital market did not know what were the strong banks and which were the weak banks.”
William Isaac, former chairman of the Federal Deposit Insurance Corporation, argued the opposite:

He said he favors a return to accounting methods that allowed banks to judge for themselves what an asset is worth and not be forced to value it using models marked to current prices.

What is interesting was Ball’s rejoinder about the current mark-to-market rules:

“It probably, of all the accounting standards written in recent decades, brings more judgment into the accounting than any other,” he said. “You can use prices, indexes or you can use basically judgment estimates of future cash flows” to value an asset.

Maybe that it is the real problem — too much judgment. I think Mr. Isaac’s position on letting the banks be the only judge of value is a step in the wrong direction. It would be fine if there was complete transparency, including methodology. But that isn’t the case – as the earlier posting on Fannie Mae illustrates. It would also make accounting statements useless — since the numbers would be based on whatever the bank wanted them to be.
As Alice found out, in Wonderland:

‘When I use a word,’ Humpty Dumpty said, in a rather scornful tone,’ it means just what I choose it to mean, neither more nor less.’
(from Through the Looking Glass)

We need to avoid Wonderland accounting.

GDP down slightly

The BEA advanced estimate of 3rd Quarter GDP shows a decline of 0.3%.
Only 0.3%. That is actually somewhat good news. It is not a big a decline as expected. The Wall Street Journal reports that “Economists surveyed by Dow Jones Newswires had projected a drop of 0.5% during July through September.”
As I said before, the US economy has been in a recession for some time. The coincident indicators have been steady or declining for a year. If we get by with a flat economy, rather than a deep drop, we will be very lucky.
Having said that, today’s data is only the beginning. Based on what has happened so far in October, the 4th quarter looks bleak.

Troubling assets

Here is a reason why we need better transparency in company books. According to a story in the Washington Post, Fannie Mae is writing off almost half of its capital base. Why, because that capital was in the form of deferred tax assets, i.e. credits against taxes on future profits. Fannie has decided that it is unlikely to make a profit in the near future, so the tax credits are essentially worthless. That is a write off of $20 billion of a $47 billion capital base. According to the Post story:

In the months leading up to the companies’ takeover, the firms and their federal regulator cited the capital positions in an effort to allay fears about their financial security. But during a summer probe of the companies’ books, government officials grew concerned about whether the financial cushions were sufficient. In particular, the deferred tax assets drew scrutiny.
Government-appointed Fannie Mae chief executive Herbert M. Allison Jr. and Freddie Mac chief executive David M. Moffett are reviewing a range of accounting policies at the company. At Fannie Mae, Allison decided the company had to be more forthright in how it reports information about the liquidity of certain assets.

Let’s hope that this is the start of a trend toward better disclosure of assets — including intangible assets.