Funding social innovation

David Brooks’s column today in the New York Times has a great idea:

Create a network of social entrepreneurship investment banks. These regionally operated semi-public funds would invest in the best local community organizations, so they could bring their ideas to scale.
These funds, first proposed by the group America Forward, would supplement the safety net and employ college grads entering a miserable job market. They’d have a powerful psychological effect on a country that desperately wants to feel mobilized and united.

America Forward is promoting the idea of “results-oriented, entrepreneurial nonprofit organizations” for solving social problems:

America Forward’s vision is that one day, our leaders and citizens will work together to foster innovation in the social sector, identify what works, and grow the best solutions to wherever they are needed. Our objectives are two-fold: 1) to introduce social entrepreneurship into the national dialogue, helping to fuel a discussion about new, more effective ways to solve domestic problems; and 2) to advance a policy agenda that will create an infrastructure for social entrepreneurs and government to act together to scale the impact of solutions that work.

While this initiative focused on innovation in the social services area, it can foster a broader understanding of innovation in general. Making all parts of the economy more innovative, non-profits included, should be the goal of policy in the I-Cubed Economy.
By the way, the Brooks column also highlights a number of the suggestions from Michael Porter from his Business Week article last month (see my earlier posting on this and other stimulus ideas).

Thanksgiving 2008

As we head into the Thanksgiving holiday, I would like to quote a few stanzas from Edna St. Vincent Millay’s “Thanksgiving 1950”

Hard, hard it is, this anxious autumn,
To lift the heavy mind from its dark forebodings;
To Sit at the bright feast, and with ruddy cheer
Give thanks for the harvest of a troubled year.
The clouds move and shift, withdraw to new positions on the hills;
The sky above us is a thinning haze—a patch of blue appears—
We yearn toward the blue sky as toward the healing of all our ills;
But the storm has not gone over; the clouds come back;
The blue sky turns black;
And the muttering thunder suddenly crashes close, and once again
Flashes of lightning startle the rattling windowpane;
Then once more pours and splashes down the cold, discouraging rain.
Ah, but is it right to feast in a time so solemn?
Should we not, rather, fast-and give the day to prayer?
Prayer, yes; but fasting, no.
. . .
From the apprehensive present, from a future packed
With unknown dangers, monstrous, terrible and new—
Let us turn for comfort to this simple fact:
We have been in trouble before . . and we came through.

Have a wonderful Thanksgiving!

Let TARP be TARP

In an oped in today’s Washington Post, Peter Ackerman and John Vogelstein argue for a large good bank/bad bank approach to toxic assets:

In 1988, we participated in a fundamental restructuring of the Mellon Bank that holds many lessons for today. At the time, the market had no confidence regarding the size of Mellon’s asset problem. Instead of trying to convince investors that Mellon’s assets were valued accurately, chief executive Frank Cahouet asked that an entity be designed to hold all of Mellon’s nonperforming loans.
The Grant Street National Bank (In Liquidation) was formed, capitalized with Mellon’s troubled assets and financed as much as possible through debt secured against those loans. Over the next several years, loans were sold expeditiously to private buyers. Substantially all of the proceeds from the financing and the remaining liquid assets after debt repayment went back to Mellon.
Once Mellon no longer had nonperforming loans on its books, the write-downs taken by the bank from asset transfers into Grant Street could be quickly replenished through equity offerings. Mellon did not go through the trauma that other major American banks (including Citi) experienced in the early 1990s. Despite the dilution from the sale of new equity, its stock went up more than tenfold when it merged with the Bank of New York.
This “bad bank” model has been repeated many times since. The concept was used in the savings and loan bailout and in Korea in the 1990s.

They go on to explain in more detail how this might work — I won’t repeat the whole thing. I would like to highlight their conclusion:

In the early 1990s, the Japanese government encouraged banks to keep nonperforming loans on their balance sheets and value these loans as if they were not impaired. The loss of transparency (as well as the failure to put these loans into the hands of those who would restructure them) contributed to over a decade of slow growth and an underperforming stock market.
The Obama administration should not make the same mistake. If its economic team uses TARP to enhance price and value discovery of mortgages held in the banking system, we will be a lot closer to the end of the financial crisis.

Amen!

President’s Economic Recovery Advisory Board – and the Innovation Council

According to the Wall Street Journal:

President-elect Barack Obama will appoint former Federal Reserve Chairman Paul Volcker on Wednesday to be the chairman of a new White House advisory board tasked with helping to lift the nation from recession and stabilize financial markets, Democratic officials say.
University of Chicago economist Austan Goolsbee, one of Mr. Obama’s longest-serving policy advisers, will serve as the board’s staff director, along with his duties as a member of the White House Council of Economic Advisers. Members of the panel will be drawn from a cross-section of citizens outside the government, chosen for their independence and nonpartisanship.
The board’s mission won’t be to supplant the policy-making role of the Treasury Department and other agencies, but to give Mr. Obama an official forum for getting expert advice outside the normal bureaucratic channels. It will give briefings to the president.
The panel, called the President’s Economic Recovery Advisory Board, is modeled on the Foreign Intelligence Advisory Board established by then-President Dwight Eisenhower in 1956, at the height of the Cold War, when officials worried that that the existing bureaucratic structure was inadequate to help the U.S. keep pace with the Soviet threat. The financial crisis has drawn similar worries that the government isn’t properly organized to monitor and respond to modern financial markets.

There is another group that the President-elect should also appoint in the near future. Section 1006 of the America COMPETES Act creates a President’s Council on Innovation and Competitiveness (PCIC). Made up of the heads of the departments and agencies involved in the innovation and competitiveness agenda, it is chaired by the Secretary of Commerce. The purpose of the Council is to develop a comprehensive strategy and oversee the implementation of that strategy. The law also calls for an advisory board to help the Council in crafting this strategy. This group, which I will call the Innovation and Competitiveness Advisory Board (it is not named in the law), is to be made up of individuals from a variety of background — business, labor, technical/scientific and other.
The two groups would make an excellent compliment: the Economic Recovery Advisory Board would look at the short-term problems while the Innovation and Competitiveness Advisory Board would look at long-term solution.
The America COMPETES Act calls for the National Academy of Sciences, in consultation with the National Academy of Engineering, the Institute of Medicine, and the National Research Council, to recommend individuals to serve on the advisory board. The President-elect should ask the National Academies to immediate begin the compilation of names of individuals to serve on the advisory board, so that it can begin its work on day one.
Creation of these two advisory boards would be quite the one-two punch!

Those government standards – and intangible assets

Yesterday, in addition to the Term Asset-Backed Securities Loan Facility (TALF) programs (see earlier posting), the Fed also announced it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises and mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae.
Why buy securities from these institutions? The Fed is not doing this because it needs Fannie, Freddie and Ginnie’s guarantees. Since the government has already essentially taken over Fannie and Freddie, they are already guaranteeing themselves. No, the reason is the same reason why the Fed is accepting SBA-backed loans as part of the TALF programs: take advantage of the underwriting standards. As the Washington Post notes, Fannie, Freddie and Ginnie “have high standards for credit quality and caps on how large the loan can be.”
The idea behind these two new programs is to unfreeze the high-end of the credit market. And a quick way is to use the existing system. As New York Times notes “the central bank has already lowered the rate to 1 percent, and it cannot reduce it below zero. Instead, policy makers are buying up other kinds of debt securities, which has the effect of driving down the rates in those parts of the market.”
According to the Wall Street Journal, the program has already begun to work:

The Federal Reserve’s attempt to stabilize the housing market set off a chain reaction across the U.S. on Tuesday, dropping interest rates and quickly spurring a burst of refinancing activity by borrowers eager to lower their mortgage costs.

The program also highlights the importance of solid underwriting standards. The Fed doesn’t have to go through the process of evaluating the assets. That has been done according to agreed upon rules. So transaction cost are low and risk is understandable.
Such standards are exactly what is needed to monetization intangibles. As I noted in our report Intangible Asset Monetization: The Promise and the Reality:

The creation of underwriting standards, with or without liquidity guarantees from a GSE or other entity, would be an improvement over the current situation where each deal must be specifically and uniquely structured to meet the requirements of the credit rating agencies. The development of a widely understood template for intangible-backed securities would regularize the market and lower transaction costs.

As we move forward to reform the credit markets, let us take this opportunity to also to modernize them by explicitly creating a place for intangible assets. The place to start is with underwriting standards for the use of intangible assets as collateral for SBA loans. As I noted in the report, SBA’s treatment of intangible is uneven:

Given this spotty record, the SBA should undertake a review of laws and regulations to ensure that SBA loans can be used for the acquisition of intangible assets and that these intangible assets can be used as collateral for such loans.
Such a review would also present an opportunity for a larger look at the role of intangibles in bank lending. Thus, the SBA should also work with their commercial lenders to develop standards for the use of intangible assets as collateral, similar to existing SBA underwriting standards.

Such a review would start the process of unlocking that hidden wealth tied up in intangible assets — and create a new mechanism for financing innovation based on sound underwriting standards. It is past time to take this step.

Vetting financial innovations – part 2

In an earlier posting, I commented upon a notion by Jagdish Bhagwati about the need to vet financial institutions. Most of my comment was on his naive statement that it was not necessary to worry about technological innovations — the assumption that technological change is automatically benign. I disagreed with that view, but supported the idea of vetting innovations.
Turns out that the notion of vetting financial innovations is not an original idea. Over a year ago, Professor Elizabeth Warren of Harvard Law School wrote about the need for a Financial Product Safety Commission in Democracy: A Journal of IdeasUnsafe at Any Rate: “If it’s good enough for microwaves, it’s good enough for mortgages.”
Sounds good to me.
By the way, John Kao, in his book Innovation Nation, has proposed a Congressional Office of Innovation Assessment patterned after the old Congressional Office of Technology Assessment.
Also sounds good to me.

Digital milestone

Just as CD’s replaced vinyl, the New York Times is reporting that Atlantic Records Says Digital Sales Surpass CDs:

Atlantic, a unit of Warner Music Group, says it has reached a milestone that no other major record label has hit: more than half of its music sales in the United States are now from digital products, like downloads on iTunes and ring tones for cellphones.

One might simply pass this off as one technology replacing another. But the shift to digital has a much larger significance for the music business model that the switch to CDs. And it is a business model that the companies are still trying to figure out.
But, Atlantic is optimistic:

“I think we’ve figured it out,” said Julie Greenwald, president of Atlantic Records. “It used to be that you could connect five dots and sell a million records. Now there are 20 dots you can connect to sell a million records.”
In making that transition to a digital business, the music business has become immeasurably more complicated. Replacing compact disc sales are small bits of revenue from many sources: Atlantic Records’ digital sales include ring tones, ringbacks, satellite radio, iTunes sales and subscription services. At the same time, record labels — Atlantic included — are spending less money to market artists.

Not to mention other sources, such a music background in ads and video games.
It is a brave new world out there.