November 2008 Archives

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).

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!

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!

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!

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.

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 Ideas - Unsafe 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.

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.

It is a brave new world out there.

For a more contemporary discussion of technology and innovation, see the recently released 2008 State New Economy Index. The discussion in the report is especially useful -- even if it is highly IT-centric. The range of indicators is also very impressive. So, if you disagree with the authors aggregate indexes, you can easily look at the indicators you deem to be the most important.

Like many other indicator project, the faults of the report are not in the indicators chosen, but in the data that is not available. For example, we in the US continue to rely on educational attainment and patents as indicators of skill levels and innovation, respectively. This is not because we believe those are the best indicators - it is because that is what we collect information on. As the report states:

One challenge in measuring new-economy structure is that many of the factors that are appropriate to measure cannot currently be measured due to lack of available data. Going forward, the federal government can and should play a much more active role in defining the variables needed at the state level and collecting the data to better measure them.

Let me second that call.

In the meantime, the 2008 State New Economy Index is as good a picture of where we are as there is. Very useful and informative.

Here is an interesting report on the importance of technology adoption -- specifically adoption in the past: Was the Wealth of Nations Determined in 1000 B.C.?

Executive Summary:
To the extent that history is discussed at all in economic development, it is usually either the divergence associated with the Industrial Revolution or the effects of colonial regimes. Is it possible that precolonial, preindustrial history also matters significantly for today's national economic development? The authors find that technology adoption circa 1500 A.D., prior to the era of colonization and extensive European contacts, predicts approximately 50 percent of cross-country differences in both current per capita income and technology in a large cross-section of countries. When exploring the causes of this extreme persistence in technology, they find evidence in favor of the importance of the effect of current adoption on subsequent adoption as the main driver. This leaves a limited role to country-specific factors such as institutions, geography, or genes to explain the persistence of technology. Key concepts include:
* Precolonial, preindustrial differences have striking predictive power for the pattern of both per capita incomes and technology adoption across nations that can be observed today.
* Technology is very persistent both within countries and sectors. Adoption dynamics vis-à-vis country-specific factors such as institutions, geography, or genes appear to be the mechanism behind such persistence.

I'm not sure that I accept the findings of essentially a 500 year technology trajectory lock in. But the data of technology development set is interesting in and of itself.

Third quarter GDP was slightly worse than what was earlier reported. BEA's advanced report had GDP down by 0.3%. Today's more refined BEA preliminary report shows GDP down by 0.5%. The revision was due in part to that fact that exports were not as strong as anticipated.

The Fed announced this morning a new attempt to jump start the asset-backed securities (ABS) market. FRB: Press Release--Federal Reserve announces the creation of the Term Asset-Backed Securities Loan Facility (TALF)--November 25, 2008:

The Federal Reserve Board on Tuesday announced the creation of the Term Asset-Backed Securities Loan Facility (TALF), a facility that will help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).

Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. The FRBNY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS. The U.S. Treasury Department--under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008--will provide $20 billion of credit protection to the FRBNY in connection with the TALF. The attached terms and conditions document describes the basic terms and operational details of the facility. The terms and conditions are subject to change based on discussions with market participants in the coming weeks.

TALF Terms and conditions

It looks like the Fed and the Treasury are trying to go to the root of the issue by supporting old fashioned straight-up ABS deals. As the Fed press release noted, the ABS market came to a complete halt in October.

This is good news for intangible asset monetization. Intangible asset deal have tended to be the straight-up type. Getting the fundamental ABS market restarted opens the door to future intangible-backed deals. In addition, as the terms and conditions description points out:

The set of permissible underlying credit exposures of eligible ABS may be expanded later to include commercial mortgage-backed securities, non-Agency residential mortgage backed securities, or other asset classes.

Here is an interesting quote from a very high ranking government official on the stimulus package (as quoted in today's Financial Times): "Spending must be smart spending." He went on to say, "We must invest in those areas that are critical to our future competitiveness – essential infrastructures, research and innovation, clean technologies to support the transition to the low-carbon economy, energy efficiency, and education and training."

No, it was not Larry Summers. It was José Manuel Barroso, European Commission president at a conference last Friday.

The point is that other nations are going to do the same things we say we are going to do to promote long term competitiveness. If that is the case, then we need to be doubly smart. To stay ahead of the game, we will also need a strategy. Saying we want to take the lead by being green is like every city and region in the country saying they what to take the lead by becoming like Silicon Valley. A much finer tuned strategy is needed.

For that reason, now is the perfect time to create a Commission on the Future of the US Economy. It would be patterned after the 1980’s President’s Commission on the Industrial Competitiveness (the Young Commission), which proved to be a successful mechanism for confronting the issues of its time. But this new Commission would take on the current problems, which are fundamentally different compared with 20 years ago. It would craft new policies and a new long term strategy for economic prosperity. Thus it would be a great compliment to the short term strategy laid out by President-elect Obama.

Speaking of the valuation problem, here is an interesting tidbit. Intangible valuation may have become a factor as a sideline to a brawl between the current management of the European discount airline easyJet and its founder, Sir Stelios Haji-Ioammou. In a dissenting letter at the end of the company's Preliminary Results 2008, Sir Stelios made the following statement:

I believe the methodology by which easyJet ascribed value on its own balance sheet to the Gatwick landing slots that came for free with GB Airways is based on optimistic assumptions about future revenues, particularly in the current economic climate. Given the fact that many airlines have already ceased operating from Gatwick I believe that slots will be freely available and hence it will be more prudent not to create Gatwick slots as an "intangible asset" on our own balance sheet this year.

The preliminary financial statement had this to say about these intangibles:

Goodwill and landing rights at Gatwick have indefinite expected useful lives and are tested for impairment annually or where there is any indication of impairment. They are stated at cost less any accumulated impairment losses.
Landing rights at Gatwick are considered to have an indefinite useful life as they will remain
available for use for the foreseeable future provided minimum utilisation requirements are
observed.

So there is a clear difference in assumptions that drive the different valuations.

All of this may ultimately have nothing to do with intangibles - but a fight over other matters, such as dividends and strategy (see stories in The Guardian and The Economist). Still, it is interesting to see how assumptions as to the valuation of intangibles can become an important bone of contention.

In an earlier posting, I mentioned that the action with regard to toxic assets seems to have shifted from Treasury to the Fed. That shift, however, comes with its won own set of problems on how to handle the collateral and on price discovery.

A story in this morning's Washington Post (Fed Has Giant, and Opaque, Role in Financial Crisis Aid) makes the same point on the role of the Fed:

As of last week, the Fed's loans included $507 billion to banks, $50 billion to investment firms, $70 billion for money market mutual funds, and $266 billion to companies that use a form of short-term debt called commercial paper. It is considering a new program that would make billions more available to prop up consumer lending: auto loans, credit cards and the like.

In lending these vast sums, the Fed is essentially substituting its own unlimited ability to supply cash for that of private markets, which are not functioning normally. The central bank is even fulfilling some of the original goals of the Treasury Department's $700 billion rescue program by allowing financial institutions to use securities that are difficult to sell as collateral for loans.

. . .

The Fed's lending achieves some -- but only some -- of the goals of the Treasury Department's original financial rescue plan. The Troubled Asset Relief Program, which is now focused on investing money in banks, was originally intended to focus on the purchase of mortgage-backed securities.

Although not purchasing such securities, the Fed has agreed to take them on as collateral. That has helped banks get access to cash. But banks are still exposed to further losses if the value of those assets continues to decline. And the lending is not jump-starting the market by serving as a buyer of last resort, which would be the goal of government purchases.

"It's kind of like TARP light," said Michael J. Feroli, an economist at J.P. Morgan Chase.

With virtually unlimited resources, the Fed can act as lender of last resort. The problem here, however, is two fold. First, the toxic assets are not being purchased and taken off the books. They are simply being used as collateral. Banks will still have to write off the bad assets at some point -- with the corresponding hit to the bottom line. And it is unclear whether using the assets as collateral makes it easier or harder to write off the loans. Under a normal commercial transaction, the borrower can't simply dump the collateral. It has to stay on the books to play its role. A write down of the collateral would cause the lender to call in the loan. So following normal procedures, using toxic assets as collateral would be a disincentive to take the write- down. But these are not normal times and we do not know what the terms of the Fed loans are. It could very well be that the Fed will be the one to write off assets, by taking control of the bad assets in exchange for writing off the loans. That would be an interesting mechanism of indirect purchase of the toxic assets.

This brings us to the second problem. The Fed is not required to disclose those loans or describe the collateral used for the loans. Some news organizations, notably Bloomberg, have gone to court to get that information. But others feel it is wise to keep that information confidential, to prevent a run on the borrowing institutions. Be that as it may, the problem here is one of a lack of price discovery. The lack of disclosure means that the Fed does not have to publicly value those assets. This neatly sidesteps the valuation issue -- but also does not provide for any price discovery. And right now, the discovered price for these assets is quickly approaching zero -- which is why the lending market is freezing up again.

We still need a forcing function to get the bad assets priced and written off the books. Maybe the indirect Fed collateral approach will work. We can only hope.

David Herszenhorn's piece in today's New York Times (Congressional Memo - Lame Duck? The Dodo Seems a More Apt Bird) explains exactly what I was saying yesterday as to why nothing will get done this year on solving the economic crisis:

Several Republican lawmakers who are either retiring or were defeated said they would not support aid for the auto industry. And their impending departures gave them little or no incentive to compromise, evidence of why postelection sessions are dicey.

Consider Senator John E. Sununu, Republican of New Hampshire, who lost his bid for a second term, and who on Wednesday objected to a bill offered by Senator Barbara A. Mikulski, Democrat of Maryland, to help the auto industry. Ms. Mikulski snarled, “Boy, am I sorry that is the last act of John Sununu in the Senate.”

Mr. Sununu returned to the floor later. “Well, it won’t be the last thing I do,” he said. “If nothing else, the last thing I will do is explain why her legislation was such a terrible idea.”

The Republican leader, Senator Mitch McConnell of Kentucky, knew that this week offered one of his last moments, ahead of two years of wider Democratic control, to dictate what could or could not get through the Senate.

And Mr. McConnell made clear that he opposed any new money for Detroit and would only support speeding up access to $25 billion in federally subsidized loans already approved. Democratic leaders rejected that idea, leaving the automakers empty-handed.

Not a good start to "bipartisanism." Remember, if a bipartisan solution is to be reach, both sides have to be willing to play. So far, the actions of the GOP in either the House or the Senate are not encouraging. Hopefully, January will bring a different tone to Washington.

In an earlier posting, I mentioned the "not invented here" syndrome. Usually this trait is thought of as applying only to organizations. The concept of "open innovation" is an attempt to overcome the NIH problem.

But the dangers of NIH also applies to nations. A major part of any National Innovation System (to use the fancy title academics have given it) is the ability to absorb and utilize innovation. Two recent studies have highlighted the issue.

First is a report from the UK's NESTA: Innovation by Adoption. NESTA is the National Endowment for Science, Technology and the Arts -- and is Britain's chief innovation agency, something like our NSF but with a much broader mandate on innovation.

As the NESTA report states:

The capacity to absorb external knowledge was identified as early as the 1950s as playing a major role in bridging economic development gaps between places. The new ideas and innovations brought by migration, trade and foreign investment networks cannot be fully captured and exploited if a place lacks the internal ability to absorb external knowledge.

So, the capacity of places to innovate depends on internal and external sources of knowledge, which complement each other. Traditional innovation policy has ignored the importance of external knowledge in developing local innovation capacity. But a place needs both to be able to draw in good ideas from elsewhere – an innovation absorptive capacity (AC) – and to use them to create new products and services – an innovation development capacity (DC). This is what the report describes as the AC/DC model. Absorptive capacity allows a place to identify, value and assimilate new knowledge. The development capacity of a place allows it to exploit that knowledge. The extent to which different places draw on ‘AC’ or ‘DC’ to create new value differs across economic sectors.

Five main components are essential to any innovation system. Three of these elements form the ‘absorptive capacity’ components of the AC/DC model: (1) the capacity to access international networks of knowledge and innovation; (2) the capacity to anchor external knowledge from people, institutions and firms; and (3) the capacity to diffuse new innovation and knowledge in the wider economy. The two components of the ‘development capacities’ element of the AC/DC model are (1) knowledge creation and (2) knowledge exploitation.

The second report is from Harvard Business School: "An Exploration of Technology Diffusion." The authors found that:

• The remarkable development records of Japan between 1870 and 1970 and of the so-called East Asian Tigers in the second half of the 20th century all coincided with a catch-up in the range of technologies used with respect to industrialized countries.
• Adoption lags account for at least 25 percent of cross-country per capita income differences.

Bottom Line:
Technology adoption, the cost of producing capital goods, and per capita income growth may be inextricably linked. As a result, to compete in today’s global economy, countries must learn how to quickly leverage new technologies to ensure that their workforces remain competitive.

But in the United States, we pay little attention to the absorption issue. Why? Well the Harvard study inadvertently highlights the issue: an adoption strategy is for catch-up nations. In other words, "developed" nations don't have as much to learn: NIH

The Booz & Co., analysis of the results understands the broader ramifications. If you are going to stay ahead in this global competitive economy, you have to continue to run fast. That includes utilizing technology from whatever source. As the NESTA report finds, it is a case of AC/DC. Both absorption and development are needed.

So where is the US innovation policy to promote absorption? We have an underfunded MEP (Manufacturing Extension Partnership) program that can't even look in the direction of the largest part of our economy: services.

Time to rethink our policies.

Call it the "do nothing" bear market. As the Wall Street Journal noted:

The market seesawed between gains and losses but began a steep slide around 2 p.m. Eastern as new remarks from senior government officials cast doubt on the likelihood of a new round of federal aid to Detroit's troubled car makers.

By the way, expect that those on the political right will try to blame Obama for all this -- just like everything that has gone wrong in the past eight years has been the fault of Clinton, Johnson, Kennedy or FDR.

Yesterday, the Obama-Biden Transition Team announced its Policy Working Groups. Of specific interest are the "Economic" work group headed by Dan Tarullo and the "Technology, Innovation & Government Reform" group headed by the the trio of Blair Levin, a telecom policy expert, Sonal Shah head of Google.org’s global development efforts and Julius Genachowski, co-founder of Rock Creek Ventures and LaunchBox Digital.

I must say I find the grouping of "Technology, Innovation & Government Reform" a little strange. Innovation is much more than technology. And I've not sure why the government reform part is in there. I also find it interesting that the three heads are IT and telecom folks -- no one from science or other technology areas.

It sounds like the focus will be on technology utilization with in the government and on telecom policy. I hope they can broaden the focus to include a larger focus on innovation (see for example Bruce Nussbaum's piece on innovation policy). At a minimum I hope they are working with both the Economic group and the Energy & Environment group (headed by former EPA Director Carol Browner).

Besides all other other news yesterday (major deflation; stock market below 8000; looming possibility of auto companies' bankruptcy), there are a couple of other disquieting tidings.

First is the state of the credit markets. As the FT report, (in Ugly reaction to Tarp U-turn):

US mortgages and credit markets on both sides of the Atlantic have been severely jolted since the US Treasury turned its back on plans to use some of its $700bn in financial bail-out funds to buy troubled assets from banks.

More than a week has passed since Hank Paulson, the Treasury secretary, changed the parameters of the troubled asset relief programme (Tarp). Yet despite Mr Paulson’s insistence to Congress this week that policy actions were starting to bear fruit, the picture on the ground in the credit markets has turned uglier.

Next is the fact that the Bush Administration has apparently gone into Hoover mode. The Washington Post ran a story this morning (After Wall Street Rescue, Bush Changes Course on Federal Intervention) that:

Bush is likely to spend his last months in office arguing against major new government interventions, according to administration officials and GOP lawmakers. Treasury Secretary Henry M. Paulson Jr. has signaled that he is unlikely to seek congressional approval for more bailout money this year.

In other words, nothing much is going to happen to help the economy until January 20. We may see a limited bridge loan to the automakers. And maybe a very limited increase in unemployment insurance. But for the next two months, the economy is essentially on its own. And on its own is a scary proposition right now.

Looks like a very gray Christmas.

It appears that many tech companies have gotten themselves into a bind. As the New York Times (Convertible Debt Is Hanging Heavy) reports:

Technology companies have issued gobs of convertible debt to raise financing in recent years. These securities, loans that convert to equity, are starting to come due, putting the companies in a bind. Investors who own them probably won’t want to convert them into shares, so the companies will probably have to pay the debt off or refinance it. But the former would drain precious cash, while the latter is absurdly expensive.

For years, the match seemed perfect. Companies ranging from Micron, the memory giant, to Anadigics, a niche chip maker, needed cash upfront to develop products. Because they had few assets to offer as collateral, conventional debt was often too expensive. But tech companies could promise future profit, and their stocks are typically volatile. Those factors make stock options valuable. Convertibles are essentially bonds with these options attached, so the companies could issue them with low interest rates. (emphasis added)

What do you mean "they has few assets to offer as collateral"? It is not that they have few assets. They are asset rich, in terms of intangibles. But those assets are hard to use as collateral.

Let me stress this point -- tech companies financed themselves based on the promise of future growth because they could not raise funds based on their intangible assets.

A perfect example of why we need a financial system that will utilize intangibles as collateral.

The Wall Street Journal has a facinating story on a very simple innovation -- A New Odd Couple: Google, P&G Swap Workers to Spur Innovation. According to the story, the partnership came about as P&G seeks to do a better job marketing to the on-line crowd and Google is seeking more of P&G's advertising money.

The idea of the employee swap between the two companies gained momentum about a year ago, when P&G's then global marketing officer, Jim Stengel, expressed concern that one of the biggest initiatives in the company's laundry-soap history -- a switch to smaller bottles with a more concentrated formula -- didn't include enough of an online search-term marketing campaign, according to two people familiar with the matter.

The issue: Without an online campaign, Tide buyers searching the Internet to figure out why the detergent bottle shrank might not be directed to Tide's Web site. (Mr. Stengel acknowledges raising questions about the campaign but says he was ultimately satisfied.)

Mr. Stengel had recently met with Tim Armstrong, who runs Google's ad sales and operations in the Americas. The two men tossed around the job-swap idea. It started in January.

The learning has been mutual:

As the two companies started working together, the gulf between them quickly became apparent. In April, when actress Salma Hayek unveiled an ambitious promotion for P&G's Pampers brand, the Google team was stunned to learn that Pampers hadn't invited any "motherhood" bloggers -- women who run popular Web sites about child-rearing -- to attend the press conference.

"Where are the bloggers?" asked a Google staffer in disbelief, according one person present.

For their part, P&G employees gasped in surprise during a Tide brand meeting when a Google job-swapper apparently didn't realize that Tide's signature orange-colored packaging is a key part of the brand's image.

Not only does this appear to be a good way to share information between partners, it seem to be a good way of opening up the culture to new ideas in general.

Very interesting.

From the Wall Street Journal's CEO Council Forum: Rahm Emanuel on the Opportunities of Crisis

The five priorities for reform are:
• health care
• energy
• taxes
• education
• financial regulation

Note carefully what he says about education at about the 2 minute mark: there needs to be "fundamental reform to ensure that we are effectively training the workforce."

I agree, and have long called for a real switch to a life-long learning model. We can not ensure our economic competitiveness and property unless fundamentally reform education and train. Of the five areas, however, this may be President Obama's hardest task, since most of the reform has to happen at the state and local level. The President will need all of his leadership skills to get those levels of government to make the necessary changes. On the other hand, this could be a wonderful example of fostering experimentation and learning, as the Federal government provides incentives to state and local government to change the learning system.

You can also listen to the entire

Emanuel comments to the Wall Street Journal CEO Council.

One of the concepts of innovation that Husick doesn't get into (see earlier posting) is where innovation comes from. It seems to be both a top down (science/inventor-driven) and a bottom up (user-driven) approach. A recent article in Forbes -- Patient Power -- describes these two models might interact as patient groups, like the Cystic Fibrosis Foundation (CFF) are changing biomedical research:

Inspired by the CFF's success, patient groups with an entrepreneurial bent have become the drug industry's new power brokers. Medicines for blood and bone cancers have reached the market faster because of their efforts. A hundred more patient-group-backed drugs, one-twentieth of all the medicines in development, are in human clinical trials for Parkinson's, diabetes, muscular dystrophy and a litany of cancers. These patient power brokers will give drug companies $90 million this year, 13 times as much as in 2000, according to Thomson CenterWatch, a research firm that analyzes clinical trials. The Leukemia & Lymphoma Society has 50 drugs in development, including 11 in clinical trials. The Multiple Myeloma Research Foundation is working with 30 drugs, up from none in 2000, and just recruited a cancer-drug executive from Bayer to help run its effort. The Juvenile Diabetes Research Foundation is testing 18 drugs with biotech companies.

Patient power brokers assemble teams of academic scientists to help identify the best medicines to fund. They pay for the invention of new drugs and for clinical trials of medicines making their way to the market. They grease the skids for clinical trials, too, by assembling networks of doctors and patients who want to participate. By becoming a one-stop source for expertise and research about their disease, these patient groups can use as little as a few million dollars in funding to shift the priorities of the drug industry.

The patient groups are filling a void in drug research created by the industry's legitimate fear of failure. Biotech executives dread what they call "the valley of death," the period of time between a drug's conception in a lab and its first clinical trial. For every 10,000 would-be medicines chemists create, only one makes it to market. But if a drug has already been through enough tests in cell cultures and lab animals to justify starting clinical trials, the odds of success have risen to one in nine. Put the substance through early clinical trials with a few dozen patients, and the odds jump to one in six. At some point a drug for even the most uncommon disease becomes every bit as appealing to drug companies as an untested potential heart treatment or impotence pill.

Another version is Michael J. Fox Foundation. As a story in the New York Times (Taking Science Personally) relates:

What makes the story of the Michael J. Fox Foundation different — nay, what makes it important — is that it doesn’t just dole out money to scientists and hope for the best. It has used its money to take control of Parkinson’s research like few other foundations have ever done. In the process of trying to solve the mysteries of Parkinson’s, it has upended the way scientific research is done, and the way academics interact with pharmaceutical and biotech companies, at least in its little corner of the world. It demands accountability and information sharing that is almost unheard of in the broad scientific community. And it has managed to become, in its short seven-year life, the most credible voice on Parkinson’s research in the world.

The story goes on to explain the why the model is different:

What is wrong with N.I.H. funding? To most people, it is a model that makes perfect sense — in part because it is what we are used to. The government accepts grant applications from scientists, and then metes out money to a handful of those with ideas that it deems most promising.

But from the point of view of a disease foundation desperate to find a cure, everything is wrong with it. The government grants tend to go to low-risk projects, so the kind of science that leads to big breakthroughs tends to go underfinanced. The N.I.H. pays for areas of science that are high profile or have a large constituency. It has no connection to industry research, so it is largely through happenstance that government-financed research turns into medicine that helps make us better. And once the money is channeled, that’s pretty much the end of it: there is no follow-up.

In other words, there are two failures here: the failure to think big and outside the box and the failure to think practical. In part, this reminds me of the reason why DARPA was set up -- to handle both types of failures simultaneously.

Interesting models. I think we certainly want to continue the NIH model. That funding provides for the basic research. But we also want alternative approaches. After all, we don't want the initials N.I.H. in this case to stand for "not invented here."

If you want to see the future of car manufacturing, check out this video form the Detroit News about Ford's most advanced assembly plant in rural Brazil. The plant reminds me of the Ford Rouge plant of the early 20th Century -- where raw materials come in one end and cars were spit out the other. In the case of the Brazilian plant, suppliers have co-located their assemply lines in the same plant. A very interested example of collaboration. And a possible view of what the future holds for auto making in the US.

UPDATE:

A recent FT article on the auto industry (Detroit spinners?) describes a similar set up in the US:

The plant that assembles Chrysler’s Jeep Wrangler near Toledo, Ohio sprawls across four buildings, but Chrysler occupies only one of them. The others house three of the troubled carmaker’s suppliers. South Korea’s Hyundai Mobis builds the Wrangler’s chassis, while Kuka, a German maker of robots and welding machines, puts together the body. The facility’s paint shop is operated by Magna International of Canada, with Chrysler responsible only for the vehicle’s final assembly.

Eric Schmidt, CEO of Google, gave an interesting talk on “Technology, Economic Growth and Open Government” sponsored by the New America Foundation. In the talk he touched upon a number of points on innovation. At its base, the idea is that open systems provide a spur for innovation. On energy he referenced the Google Clean Energy 2030 plan.

What struck me was that a number of the ideas he talked about, energy and other, were not necessarily technological – they were policy, social or organizational. For example, the stimulus package should funnel funds to state and local government to do energy efficiency retrofits. Or pay bonus to car companies to beat the CAFÉ standards. These are but a snippet of the types of new innovations he discussed that will help confront the energy problem.

It was refreshing to hear so much discussion of these types of innovative solutions beyond the standard "technology will save us" rhetoric. This was great example the type of innovative thinking about innovation that we need so much.

From the newsletter of the Massachusetts Manufacturing Advancement Center -- Reflections on the Future of Manufacturing in Central Massachusetts by Dr. K. (Subbu) Subramanian, Director - Core Technology (SPT), High Performance Materials Sector, Saint- Gobain Co.:

As the cost of information processing and physical logistics – a large fraction of which are the result of human efforts today – continues to decline, manufacturing new "things" using "new processes", rich with digital technology applications, will soar to new heights around the world.

The drivers of such developments will be the education, knowledge, and skill levels of the local work force.

In other words, the driving forces of manufacturing are intangibles.

As Lawrence Husick reminds us (in From Stone to Silicon: A Brief Survey of Innovation):

“Innovation” is not just inventions; it is a process of making changes by introducing valuable new methods, ideas, or products. “Innovations” are the things themselves—the ideas, methods, and processes. It’s not simply that better mousetrap; it’s different ways of thinking and doing. Innovations may of course be inventions, but they may also be beliefs, organizational methods, and discoveries. An innovation is a value-creation mechanism. It is the way we humans manage to extract more value, generate more economic surplus and therefore more leisure time, and manage to get away from just hunting and gathering.

Thus, it is not surprising to see in his survey that many of his top 25 (actually 26, as he adds an Innovation #0) are organizational and conceptual -- not "technology" in the normal sense that we thing of it as an artifact or object. That is not to say that technology is not important: fire ranks as innovation #2. But most are conceptual.

Here is the list, in his rank order of importance (for background on each, read the report):
Innovation #25: relativity and quantum mechanics
Innovation #24: electromagnetism.
Innovation #23: evolution and natural selection.
Innovation #22: steam power.
Innovation #21: water power.
Innovation #20: the concept of science
Innovation #19: moveable type.
Innovation #18: fossil fuels, including plastics
Innovation #17: specialization of labor, including tribal and clan organization.
Innovation #16: paper,
Innovation #15: the wheel.
Innovation #14: formal law codes.
Innovation #13: the concept of money.
Innovation #12: gods and religions as social institutions
Innovation #11: systems of writing, including numbers
Innovation #10: food preservation
Innovation #9: metallurgy.
Innovation #8: ceramics and pottery.
Innovation #7: farming,
Innovation #6: clothing.
Innovation #5: symbolic communication.
Innovation #4: lever simple machine, including hammers and plows.
Innovation #3: inclined plane simple machine, including blades, wedges, chutes, slides, and screws.
Innovation #2: fire.
Innovation #1: spoken language—true semantic, syntactic, phonetic language.
Innovation #0: intentional pedagogy.

#0 is aptly labeled, as it is the foundation for all others. Accord to Husick

From telling your child that the fire is hot and not to touch it to the internet itself, intentional teaching is the most important innovation of all time.

What a great reminder of the breath and depth of the innovation process.

The Federal Trade Commission is beginning a series of hearings on the IP marketplace. The first hearing is Dec 5 at 601 New Jersey Ave, NW. These hearing are a follow up to the 2003 report on patent reform. According to the FTC announcement:

The hearing on December 5, 2008, will consist of three panels, each designed to examine different aspects of the evolving IP marketplace. The first panel will address developing business models. Panelists will discuss the operation of emerging business models, aspects of the patent system that support those models, and industry responses. The discussion also will explore the implications these developing business models have for patent valuation and licensing. The second panel will examine recent and proposed changes in remedies law, including their impact on innovation and consumers, and their use of economic analysis in determining remedies. In the third panel, participants will examine legal doctrines that affect the value and licensing of patents, such as the recent Supreme Court cases on obviousness, declaratory judgment and exhaustion, and doctrines that make the scope and enforcement of patents unpredictable. The panel will consider whether the notice function of patents operates to support an efficient marketplace. FTC Chairman William Kovacic will offer opening remarks, and the Honorable Paul R. Michel, Chief Judge of the Court of Appeals for the Federal Circuit, will give the keynote address.

The hearing is open to the public - but photo ID is necessary to enter the building. The hearing will also be webcast. The public may also submit comments before or after the hearing. See the website for details.

A new study is out by my friend John Horrigan over at the Pew Research Center’s Internet & American Life Project on the problems of technology - When Technology Fails:

According to a recent survey by the Pew Research Center’s Internet & American Life Project, nearly half (48%) of adults who use the internet or have a cell phone say they usually need someone else to set up a new device up for them or show them how to use it.

Some time ago, I posted a related story about how 50% of products were returned in perfect working order but because the person (buyer or the person receiving it as a gift) couldn't figure how to use it. As I said then:

I have complained earlier that design has been left out of the current discussions about improving our economic competitiveness. As part of the process of using design as a competitive weapon, maybe we need to also change the focus of design and stress the need for usability. Bringing the user into the process seems to me to be a common sense approach. At least any businessperson should be able to quickly understand the business opportunity that is presented by having 50% of your returns due to incomprehensibility of your product (unless of course you have the same boss as Dilbert).

It appears that this business opportunity still exists. And, likewise, an opportunity for innovation policy to bring in design as yet another important component (see earlier posting on broadening innovation).

The incoming Obama Administration has that opportunity. Let's hope they grab it.

When it comes to understanding innovation, the Financial Times get it. Last week, FT and Forum for the Future launched the FT Climate Challenge Competition to "find the most innovative solution to the effects of climate change." The prize for the winner, sponsored by HP, is $75,000. That amount is probably not enough to get any of these innovation scaled up -- but more than enough in publicity to generate venture capital and other financial interest.

The prize idea is point one in how the FT gets it: leverage information via a prize to spur recognition and further work.

Point two is their broad definition of "innovation." As longer piece in the FT last week (FT.com / Climate Challenge Competition / In depth - Call for innovators) notes:

The innovation need not be technological, although such entries are certainly eligible. Creativity could equally come in marketing, financing, analysis or in an entire business model.

Among the ideas that readers uncover – along with contributions from the FT and Forum for the Future experts – we would hope to find proposals that could match up to flourishing initiatives such as Streetcar and Zipcar, SolarCity and Grameen Shakti.

Streetcar and Zipcar are car-sharing clubs that rent pay-as-you-go small cars, typically for short trips. Members pick up and drop off cars parked at designated bays. They have experienced rapid growth: US-based Zipcar had 225,000 members worldwide by last summer, and London-based Streetcar, which started with eight cars in 2004, is trebling in size every year and aims to have 250,000 members by 2012.

Because car clubs give members the freedom of having a vehicle when they need one, they encourage people to give up owning a car; as a result they drive less and their motoring emissions are cut.

SolarCity is an example of innovation in marketing and finance. The California-based provider of solar energy systems has surmounted the problem of consumers’ resistance to making the initial commitment to invest in solar panels by leasing the equipment to home owners.

The result is that consumers can install solar power without a large upfront payment and split the benefit of future savings, including government subsidies, with the company. SolarCity even guarantees the savings that consumers can make.

Grameen Shakti is another innovator in marketing and finance, as well as in economic and social development. Founded by the Nobel prize-winner Muhammad Yunus of the Grameen Bank, the micro-credit pioneer, Grameen Shakti provides solar panels, improved cooking stoves and biogas plants in Bangladesh. It supplies poor communities at affordable prices, and also trains local people as engineers to fit and maintain its products.

So while the US is focused on clean tech (i.e. new gadgets) and green jobs (i.e. construction jobs to retrofit buildings and install solar) (see earlier posting), the FT is looking at more: social innovations, marketing, finance and business models. There is nothing wrong with clean tech and green jobs. They are, as the FT examples point out, just not the complete picture.

Why can't we -- especially the US government -- get it?

A lot has already and will be said about this weekend's G 20 summit. As in most cases, the Statement From G-20 Summit will be parsed and dissected for what it does and does not say. Much will be said about who won and how lost in the battle of ideas. And much will be said about the extent to which it does or does not lock the incoming Obama Administration into any particular position.

There was one particular paragraph in the statement that I focused on:

Strengthening Transparency and Accountability: We will strengthen financial market transparency, including by enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions (emphasis added).

That was amplified later on by the following section:

Strengthening Transparency and Accountability

Immediate Actions by March 31, 2009

The key global accounting standards bodies should work to enhance guidance for valuation of securities, also taking into account the valuation of complex, illiquid products, especially during times of stress.

Accounting standard setters should significantly advance their work to address weaknesses in accounting and disclosure standards for off-balance sheet vehicles.

Regulators and accounting standard setters should enhance the required disclosure of complex financial instruments by firms to market participants.

With a view toward promoting financial stability, the governance of the international accounting standard setting body should be further enhanced, including by undertaking a review of its membership, in particular in order to ensure transparency, accountability, and an appropriate relationship between this independent body and the relevant authorities.

Private sector bodies that have already developed best practices for private pools of capital and/or hedge funds should bring forward proposals for a set of unified best practices. Finance Ministers should assess the adequacy of these proposals, drawing upon the analysis of regulators, the expanded FSF, and other relevant bodies.

Medium-term actions

The key global accounting standards bodies should work intensively toward the objective of creating a single high-quality global standard.

Regulators, supervisors, and accounting standard setters, as appropriate, should work with each other and the private sector on an ongoing basis to ensure consistent application and enforcement of high-quality accounting standards.

Financial institutions should provide enhanced risk disclosures in their reporting and disclose all losses on an ongoing basis, consistent with international best practice, as appropriate.

Regulators should work to ensure that a financial institution’ financial statements include a complete, accurate, and timely picture of the firm’s activities (including off-balance sheet activities) and are reported on a consistent and regular basis.

To me, that sounded like a resounding vote of confidence for the direction that the accounting standards board have been going. Recognition of problems, but no suspension of mark-to-market here.

Let me expand, however, on that very last point: "that a financial institution’ financial statements include a complete, accurate, and timely picture of the firm’s activities." As correct as this is, in is incomplete. All companies need to include a "complete, accurate, and timely picture of the firm’s activities." The only way to do this, however, is to recognize the importance of intangible assets.

Until and unless we include disclosure of intangibles, financial statements will not be complete, accurate or timely.

Yesterday's hearing at the House Committee on Oversight and Government Reform on hedge funds produced an interesting point on the issue of transparency. As the Washington Post story - Fund Chiefs Back Oversight - relates:

Speaking before the panel, the fund managers said they would be willing to provide data to a regulator who could then transfer it to the Federal Reserve, which could use the information to monitor systemic risk to the economy. But the managers said they would vigorously oppose the public release of details about their investment strategies.

"To ask us to disclose our positions to the open market would parallel asking Coca-Cola to disclose their secret formula to the world," Griffin said.

There are some who have made fun of this position (for example Dana Milbank in today's Washington Post). But I am much more sympathetic. That may sound a little strange, coming from some one who favors more mandatory disclosure (see Reporting Intangibles: A Hard Look at Improving Business Information in the US).

The issue is disclosure of information not the disclosure of trade secrets. For a hedge fund, the investment strategy is the trade secret - and its biggest intangible asset. That deserves to be protected. The trick is to disclose enough information to give investors the information they need to make informed decision -- but not enough to make reserve engineering simple. It is probably impossible to completely prevent all reverse engineering. Even the Coke formula has been reportedly been reverse engineered -- but is protected as much by copyright and other forms of intellectual property as by keeping the "secret". The idea it to make it so difficult that it is not worth the effort.

The other way that this can be easily handled is by protecting the information given to regulators. The government collects a great deal of proprietary information. Crafting the same type of protections for the hedge funds should not be a barrier to either mandatory reporting or regulations.

Given these safeguards, I don't think anyone could object to finally bringing these financial institutions into the light of day.

Just a couple of items on the consequences of abandoning TARP. From the Financial Times:

The key benchmark lending rate between banks rose yesterday, ending a 23-day decline as traders reacted to the US government's decision to abandon its plan to buy toxic assets.

. . .

"People are afraid that if the Treasury is not going to buy assets from banks under the Tarp, then banks will need more cash to fund their balance sheets," said Rick Klingman, managing director at BNP Paribas.

"That explains why Libor has stopped falling and it looks as if the Treasury has ruined something that was working."

And this from the Washington Post story Freddie Mac Seeks Government Aid After $25.3B Loss:

Moreover, the decision by Treasury Secretary Henry M. Paulson Jr. to abandon the plan to buy the troubled mortgage-related assets from banks and other financial firms poses a problem for Fannie Mae and Freddie Mac. Not only do the companies lose the chance to sell any of these assets to the government, the announcement Wednesday that the program had been shelved caused the value of the assets to fall.

"You're taking . . . a large buyer out of the market," said Moshe Orenbuch, an analyst at Credit Suisse.

And from the Wall Street Journal:

Along the way, any pretense TARP would actually relieve holders of troubled assets withered. But apparently some investors still clung to the notion; Mr. Paulson's latest TARP flip-flop has hammered asset-backed securities. Markit's ABX index of 2006-vintage, triple-A-rated subprime-mortgage securities has fallen 13% since Wednesday to a record low. The cost of default protection on commercial-mortgage debt has jumped to a record high.

"I'm stunned by the number of people that actually thought TARP was going to do something for them," said Carlos Mendez, senior managing director at ICP Capital, an investment firm specializing in credit. "Prices across the board have just dropped precipitously."

Amazing that people might actually have taken the government at its word.

Let's hope that is all the fall out from Treasury's reversal. But I am not sanguine.

For those of you who missed it, Hank Paulson made a very revealing comment in an interview in the FT -- US eyes fresh capitalisation fund:

"There are two ways of getting at illiquid assets," he said.

"One is to purchase them and have a price discovery that comes with that and the capital flows that come with that.

"The other is making sure banks have plenty of capital and encouraging them to continue the process of recognising losses and selling these assets."

The US ultimately opted for the second approach.

"It is much more powerful," he said.

In other words, let the write-offs begin.

I only hope that all those who have advocated this second approach are ready for the sea of red ink that is about to wash over the financial system - if the process is going to work. I hope that they are also ready for the psychological shock this will cause to the system as bad news is compounded by bad news.

The alternative, of course, is to just let the bad assets sit there and fester. If you recall, Japan tried that. They now call that period "the lost decade."

If securitization of intangible assets is to move forward once the credit freeze is over, it must deal with a little glitch in the process. That glitch -- the power of the pool servicing agent -- has come to the forefront in the mortgage foreclosure problem. The general securitization process works like this: mortgages are bundled into a pool and bonds are sold backed by the pool. The revenue produced by those mortgages is used to pay off the bonds. An agent, called a servicer, handles all the administrative details.

Here is the problem. What happens if adjustments need to be made? For example, what happens if the mortgages start to go into default? That was the topic of yesterday's hearing in the House Financial Services Committee. As the New York Times relates, the answer is not straightforward:

“The servicers are telling me they’re not in power at this time,” Representative Brad Sherman, Democrat of California, said. “You have 10 investors, and any one of them can allege from a purely negligence standpoint that the value of the portfolio has not been maximized.”

At the hearing, panelists disagreed on whether modification was allowed with bundles of mortgages that had been resold. An executive from Bank of America said that the contracts behind some securitizations expressly prohibited changes to the underlying mortgages. The executive, Michael Gross, the bank’s managing director of loan administration loss mitigation, said that banks had more flexibility to modify terms in loans they held.

But an executive with the American Securitization Forum, an industry group, said that contracts did allow bundled mortgages to be modified. The forum is in discussions with a range of investors who bought mortgage bonds to streamline the process of such modification, said Thomas Deutsch, deputy executive director of the group.

“Servicers do have the legal authority, right and responsibility to modify loans in appropriate circumstances, even if those loans are in mortgage-backed security pools,” Mr. Deutsch said.

Mr. Deutsch’s assertion faced skepticism among lawmakers. Barney Frank, Democrat of Massachusetts and chairman of the committee, said he was hearing evidence that servicers were having trouble modifying loans that had been securitized.

“They can’t get this worked out,” Mr. Frank said. “Who am I going to believe? You or my own eyes?”

Some hedge funds, including Greenwich Financial Services and Braddock Financial, told banks in October that they might sue the banks if they changed mortgages that were within mortgage bonds that the hedge funds had purchased. Modifying the terms of mortgages underlying mortgage bonds can change how much those bonds are worth.

One can see the same thing happening in intangible securitization. What happens if the royalty terms on a patent or a brand need to be renegotiated to prevent the collapse of a company? Can the servicer act as post-deal deal maker?

So working out this little detail will be important not only for the mortgage crisis, but also for the future monetization of intangibles. The rules that re developed need to make sure that they don't in some unintended way end up hurting intangibles.

UPDATE:
The Curious Capitalist blog over at TIME makes another interesting point about An unintended consequence of the TARP-and-switch:

once the feds owned the paper, they could have done whatever they wanted, including telling servicers to cut interest rates or reduce principal balances across the board.

BEA announced this morning that the trade deficit once again improved somewhat. The September deficit dropped to $56.5 billion from $59.1 billion in August and $61.3 billion in July. Once again both exports and imports declined as the economy slowed. However, much of the decline in the deficit was due to lower oil prices. As the New York Times notes:

Excluding oil, the deficit actually widened to $35.5 billion in September from $33.7 billion in August as American exports slumped, said James O’Sullivan, United States economist at UBS. American exports fell $9.3 billion from August to September.

Our intangibles surplus increased in September by $400 million to $12.85 billion -- back to the level it was in July. Receipts (exports) of royalties increased while payments (imports) dropped. This drop in September brings the level of royalty payments back in line with other months -- at $2.3 billion -- after an anomalous jump in payment in August. Exports of business services grew slightly faster than imports, leading to an improvement in the surplus in this category.

Overall services exports and imports declined.

Advanced Technology Products trade suffered another anomalous jump in the deficit in September to $7.75 billion, as aerospace exports dropped dramatically. The technology deficit in August was $3.2 billion – similar to previous months. This huge swing in the size of the deficit was similar to what happened in July when aerospace exports were also low. With the resolution of the labor dispute at Boeing, we may have seen the last of these swings. The last monthly surplus in Advanced Technology Products was in June 2002 and the last sustained series of monthly surpluses were in the first half of 2001.

Note: we define trade in intangibles as the sum of "royalties and license fees" and "other private services". The BEA/Census Bureau definitions of those categories are as follows:

Royalties and License Fees - Transactions with foreign residents involving intangible assets and proprietary rights, such as the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises, and manufacturing rights. The term "royalties" generally refers to payments for the utilization of copyrights or trademarks, and the term "license fees" generally refers to payments for the use of patents or industrial processes.

Other Private Services - Transactions with affiliated foreigners, for which no identification by type is available, and of transactions with unaffiliated foreigners. (The term "affiliated" refers to a direct investment relationship, which exists when a U.S. person has ownership or control, directly or indirectly, of 10 percent or more of a foreign business enterprise's voting securities or the equivalent, or when a foreign person has a similar interest in a U.S. enterprise.) Transactions with unaffiliated foreigners consist of education services; financial services (includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks, and excludes investment income); insurance services; telecommunications services (includes transmission services and value-added services); and business, professional, and technical services. Included in the last group are advertising services; computer and data processing services; database and other information services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; industrial engineering services; installation, maintenance, and repair of equipment; and other services, including medical services and film and tape rentals.

And while they are at it, Congress might want to ask the Secretary (new and old) about Robert Shiller's advice on financial reform -- The Real Mandate Is to Bridge the Wealth Gap - NYTimes.com. Shiller point out that the financial system has lost its moorings:

Financial theory is all about incentives for people to work effectively, and diversifying against random shocks by sharing them among many investors. At its essence, finance is really more about helping and sharing than “beating the market.”

His goals is not just "saving" the financial system, but making the system work to reduce inequality:

It may seem paradoxical to try to lessen inequality by relying on the institutions that are most blamed today, but it is only through these institutions that inequality reduction can really work well in a capitalist economy. Enhanced financial institutions could serve the real purpose that financial theory proposes: serving the people.

His plan has four parts:

1) "subsidize financial advice for the common man. The crisis we are in is largely due to investor ignorance."

2) "broaden financial markets to improve risk management. We need sophisticated systems that will act as insurance plans against unexpected risks. The government could lead the way to a historic development of financial infrastructure."

3) "change retail financial institutions, notably those that grant and service mortgages" to create a situation where "workouts could be systematic, automatic and free-market, with costs priced into the original mortgage rate."

4) "index the tax system to income inequality. The system would automatically become more progressive if inequality became more acute."

None of this is likely to be adopted in the next 60 days. However, I hope the Obama Administration and the new Congress is listening.

According to an AP story:

Treasury Secretary Henry Paulson says that the $700 billion government rescue program will not be used to purchase troubled assets as originally planned.

Paulson says the administration will continue to use $250 billion of the program to purchase stock in banks as a way to bolster their balance sheets and encourage them to resume more normal lending.

Talk about a complete 180. And a wrong shift at that. As said earlier, Do everything:

That means government guarantees and unsecured central bank lending to unlock the credit markets, recapilization of the banks with a direct infusion of funds and pulling the bad assets off the books through a TARP mechanism. (emphasis added)

There is still a need to pull those bad assets off the books -- other than by suspending mark-to-market rules which would have the affect of simply hiding the bad assets not removing them.

Remember that Congress only authorized a portion of the TARP funding. I hope Congress will be asking some tough questions on this complete change of course when the Secretary comes back before it to ask for the next installment.

UPDATE: According to a story in the New York Times about the Paulson press conference, the Secretary state that some of the funds would go to prevent foreclosures. I would support that action. However as the story (Paulson Says Treasury Is Shifting Focus of Bailout) notes:

A proposal to have part of the bailout funds used to guarantee mortgages that have been reworked to reduce monthly payments for borrowers is an approach the administration continues to discuss, but Mr. Paulson did not announce that it would be adopted. The chairwoman of the Federal Deposit Insurance Corporation, Sheila Bair, has pushed for that approach.

So it remains to be seen what exactly the Secretary has in mind.

While unclear on that point, the Secretary's announcement does add some clarity for another part of the market. The Financial Times ran a story this morning -- Confusion as Tarp fails to ease clogged markets -- that noted:

Indeed, according to many financial market participants, uncertainty as to whether the government will still implement the original plans of the Tarp to buy distressed assets is making the market worse. They say there has been virtually no trading, as investors wanting to sell are reluctant to do so as long as they think the government may soon step in at a higher price.

“Tarp was supposed to be good for the market, but the lack of clarity and the lack of decision-making has been a problem,” said Thomas Hamilton, head of asset-backed securities at Barclays Capital. He emphasised the Treasury had to decide something, especially as financial institutions near their financial year-end.

Well, Treasury has decided -- and we will see what happens.

UPDATE 2:

Is the reason why Treasury is abandoning the purchase of troubled assets because of the risk of getting the price wrong? As the Wall Street Journal notes in its story Treasury Not Planning to Buy Bad Loans, Assets:

Figuring out how to purchase assets has proved tricky, in large part because it's difficult to determine how to price such assets, many of which are backed by risky mortgages and carry depressed values. Buying them at market prices would further hurt banks, since the firms would have to write down the value of those assets. But paying above-market prices could potentially hurt taxpayers if the assets never recover in price.

But isn't that exactly the point? Doesn't someone needs to play the role of market maker and set the price? I seems to me that the government the only one who can play that role right now -- it is even beyond Warren Buffett (channeling JP Morgan).

Or maybe this part of the action has shift over to the Fed. According to the Journal:

On Monday, Treasury and Federal Reserve officials held a phone briefing with Capitol Hill staffers about the government's revised rescue of AIG. While Treasury will buy $40 billion in preferred AIG stock, the Fed will use $50 billion to purchase distressed assets from the company. On the call, Hill staffers asked why the Fed was buying the assets instead of Treasury. Fed staffers said the structure will help insulate taxpayers, according to someone familiar with the call.

Interesting.

Also, for what the Secretary actually said see Remarks by Secretary Henry M. Paulson, Jr. on Financial Rescue Package and Economic Update.

The big news this morning is the increasing size of the AIG bailout (see AIG's press release: U.S. Treasury, Federal Reserve and AIG Establish Comprehensive Solution for AIG). As the New York Times reports, this new plan highlights the "work-in-progress" nature of the Treasury's approach:

The government’s original emergency line of credit, while saving A.I.G. from bankruptcy for a time, now appears to have accelerated the company’s problems. That short-term loan came with a high interest rate — about 14 percent — which forced the company into a fire sale of its assets and reduced its ability to pay back the loan, putting its future in jeopardy.

The new deal would make the government a long-term investor in A.I.G., something that Treasury Secretary Henry M. Paulson Jr. had said he hoped to avoid. As part of the revamping, the government would lower the loan amount to $60 billion from $85 billion, lengthen the payment schedule to five years from two years, and lower the interest rate.

There seems to be two problems here. The first is what we all assumed was going on: AIG overcommitted its insurance resource. It simply took on too much risk in the form of credit default swaps (CDS). One part of the new arrangement goes directly to that problem.

But the other problem comes from how they thought they could cover that risk -- by speculating. As Wall Street Journal notes:

A second vehicle would be set up to solve the liquidity problems in AIG's securities-lending business. The business involves lending out securities to short sellers or others and investing the collateral for gains.

AIG has labored to unload illiquid assets in order to give back the collateral it accepted. AIG's exposure to the securities-lending market forced it to seek a $37.8 billion loan from the government to cover its commitments.

Under the new plan, the government is expected to inject about $20 billion into the securities lending vehicle, with AIG providing an additional $1 billion. The entity would then buy the illiquid securities the AIG unit holds, known as residential mortgage-backed securities, for about 50 cents on the dollar. AIG would use the proceeds to shut down the $37.8 billion lending facility which it has not yet fully tapped.

A couple of points here. First, it looks like Treasury has set its price for illiquid assets under TARP: 50 cents on the dollar. This also clarifies the risk to the taxpayers. As the Journal states:

Over time, two scenarios could emerge. The assets held by the two vehicles might recover in value, allowing the government to eventually make money on the investment. Conversely, the assets -- many of which are tied to the housing market -- could continue to decline in value, hitting taxpayers with big losses.

Second, maybe it is time to re-look at the whole asset insurance game -- and not just providing a clearing house for CDS. It seems that the insuring of debt has created a wonderland where no one needs to look at the risk. And the risk has dramatically shifted from the risk of the underlying debt to the risk of the creditworthiness of the insurer.

In this new world, it doesn't really matter if the debt is risky or not. All that matters is whether the insurance will cover the loss. Conversely, it doesn't seem to matter if the debt is sound if the insurance is suspect.

This is the case facing transit agencies, including the Washington Metro system. These agencies are facing demands for the immediate repayment of debt simply because the bond rating of the insurance company has fallen below AAA (see story in the Washington Post). Of course, it is more complicated than that, involving tax credit swaps. But the underlying problem still centers on hinging a deal on the bond rating of the insurer, not necessarily the underlying debt.

Such "credit enhancements" can be an important feature of structured finance. They have been key features of deals involving intangible assets (see our report Intangible Asset Monetization: The Promise and the Reality). But it may be past time to take a systematic look at how these enhancements work and their unintended consequences. That may be the first step in rebuilding the system - including expanding the use of intangibles.

Two immediate economic issues have come to the forefront based on President-elect Obama's recent statements. The first is the push for an immediate economic stimulus package. As he stated in his Friday news conference:

I want to see a stimulus package sooner rather than later. If it does not get done in the lame-duck session, it will be the first thing I get done as president of the United States.

The second was immediate aid for the auto industry:

I would like to see the administration do everything it can to accelerate the retooling assistance that Congress has already enacted. In addition, I have made it a high priority for my transition team to work on additional policy options to help the auto industry adjust, weather the financial crisis, and succeed in producing fuel-efficient cars here in the United States of America.

Already the companies are pressing the Congressional leadership, who have responded with a statement urging the Treasury Department to use TARP funds to help the industry (see stories in the Washington Post, New York Times and the Wall Street Journal).

I am concerned that simply opening up the TARP funds for the automakers is not a productive way to go. The industry needs major structural changes. Health care cost are eating the industry alive and they need to show aggressive leadership in moving beyond the internal combustion engine. And, as I noted before, any deal should make sure the taxpayers reap the benefit of any upside - including new technologies and intellectual property.

Health care is especially urgent. Over a decade ago, I served as a member of the Clinton health care task force -- I was working for Senator Riegle of Michigan at the time. My major concern was addressing the health care costs of the auto industry - which were a problem even back then. There was a grand bargain in the making: business would support health care reform as a means of reducing the drag the health care system had on their competitiveness. Unfortunately, that effort failed. But the problems remain.

In 2007, then Senator Obama introduced the Health Care for Hybrids Act, S. 1151, which offered government assistance to pay for retiree health care costs if the companies invested the savings in (to quote the CRS summary) "petroleum fuel reduction technologies, including alternative or flexible fuel vehicles and hybrids, and in the retraining of workers and retooling of manufacturing plants."

President Obama should enforce the same requirements on any new aid.

One of the major factors that has led to the current financial mess has been the lack of transparency in the financial instruments. Investor really didn't know what they were buying and how to model the risk. This last point has been hammered home by a new study by S&P's new independent Market, Credit, and Risk Strategies group: Valuing SF Assets 101. According to the report:

the devil is truly in the details of your assumptions regarding the future path of home prices and mortgage default rates. As we have clearly displayed in our data output and analysis, there is a fine line, or tipping point, between receiving a substantial portion of all anticipated cash flows and the risk of total ruin.

Herein is an important lesson for future monetization of intangibles: KISS - keep it simple stupid. When the underlying product -- mortgages -- was simple, at least people could understand the risk. When it got layered on with levels of financial engineering, that risk disappeared from sight. It didn't disappear -- it was just no longer visible.

To the extent that intangible monetization stays understandable, it has a future once the markets unfreeze. If it come to be seen as yet another complex exercise, then there is no future for this asset class -- period.

BLS is reporting widespread job loss in October of 240,000 and a jump in the unemployment rate to 6.5%. As was the case for other recent economic indicators, the forecasts were for a not-quite-as-bad outcome. As the Wall Street Journal reports, "Wall Street economists had expected a 200,000 decline in payrolls last month and only a 6.3% jobless rate, according to a Dow Jones Newswires survey."

As important, the involuntary underemployed (employed part-time because of economic conditions) jumped to 6.7 million (seasonally adjusted) -- and increase of almost 650,000. Congress is beginning to think about a new stimulus package that includes an extension of unemployment benefits. They need to also think about this silent job crisis.

Few of the proposals in the stimulus package will help the worker whose hours have been reduced. The answer to that problem is a reducing or "holiday" in payroll taxes. With a cut in the amount of withholding for payroll taxes, all workers, including part time, would get an immediate boost.

In addition, any stimulus package should include a knowledge creation tax credit - specifically a tax credit for worker training. That credit should cover not only the cost of direct cost of the training but also the wages paid to the worker while they are undergoing the training. Such a knowledge tax credit helps in a number of ways:
1) it addresses the macro economic stimulus of boosting individual spending;
2) it targets directly the problem of the involuntary underemployed (those who are part time for economic reasons), which is the hidden factor in the current slowdown;
3) it makes companies (and the economy) more competitive; and,
4) it facilitates the transition to the I-Cubed Economy.

The training tax credit would help both the unemployed and the underemployed. If companies are going to either cut back a worker's hours or lay the person off completely, wouldn't it be better to send them to the classroom instead?

UPDATE: for more on the underemployed issue, see Undercounting Under-Employment over at Barry Ritholtz's blog The Big Picture.

Don't be fooled by today's productivity numbers. The Wall Street Journal is running the following story - U.S. Productivity Increases 1.1%, Proving Resilient:

U.S. productivity was surprisingly resilient last quarter despite a steep drop in output, as companies responded quickly to the economic downturn by shedding labor.
. . .
The productivity figures, which included an increase in labor costs, suggests the economy's underlying capacity to grow at healthy rates remains intact, bolstering hopes for a recovery once downturns in housing, financial and labor markets recede.

One of the keystones of President-elect Obama's innovation policy is the green agenda. As I see it, this can be divided into "green collar" and "green tech." Much of the green collar focus is on the massive opportunity for increased energy efficiency through retrofitting existing buildings as well as construction of more eco-friendly new buildings. The retrofit process opens up a large potential for jobs in the construction industry in relatively well paying jobs (see Green for All). Green tech is about creating and utilizing new energy technologies - for both energy efficiency and for new sources of energy.

What has this got to do with Wall Street? Everything. Both green collar and green tech need investment financing. Green tech obviously needs venture capital, research funding and later stage funding for production facilities. For green collar, the fastest way of retrofitting buildings is to finance the work out of the energy savings produced - rather than try to do it all using up front cash. The homeowner gets a loan and pays it back monthly at the same amount as (or slightly less than) the energy bills are reduced.

But, right now, both venture and consumer credit has dried up. I noted earlier that the venture capital industry is bracing for hard times. As today's Wall Street Journal -
Bond Woes Choke Off Some Credit to Consumers - reports, the inability of banks to securitize their consumer loans is hurting lending:

Banks and other finance companies are stuck holding more loans on their balance sheets, which crimps their ability to offer new loans. That, in turn, shrinks available credit for consumers, who need it to finance an education, buy a new car, or pay for household expenses using a credit card. Banks were already reining in lending to customers as they try to reduce exposure to loans that may ultimately go unpaid.

So the innovation agenda is closely tied to the financial agenda. Getting investment flowing again needs to be the first priority. But as we do that, let us also build into that unfreezing a set of tweaks that help push the green agenda along. For example, we should expand loan guarantees for retrofitting buildings. Most importantly, as the financial agenda moves ahead everyone needs to think about how the policies being put in place support the rest of the innovation agenda.

President-elect Obama gets it. He realizes that we face multifaceted problems that require multifaceted solutions. We all need to help him come up with those answers.

The New York Times has a good story on how the latest innovations in financial engineering came apart -- In Modeling Risk, the Human Factor Was Left Out. But, as the story points out, it wasn't necessarily all the fault of the fancy mathematical technology:

The models, according to finance experts and economists, did fail to keep pace with the explosive growth in complex securities, the resulting intricate web of risk and the dimensions of the danger.

But the larger failure, they say, was human — in how the risk models were applied, understood and managed. Some respected quantitative finance analysts, or quants, as financial engineers are known, had begun pointing to warning signs years ago. But while markets were booming, the incentives on Wall Street were to keep chasing profits by trading more and more sophisticated securities, piling on more debt and making larger and larger bets.

“Innovation can be a dangerous game,” said Andrew W. Lo, an economist and professor of finance at the Sloan School of Management of the Massachusetts Institute of Technology. “The technology got ahead of our ability to use it in responsible ways.”

Maybe, as I noted before, we need a return of the field of technology assessment - including for financial technologies.

The other shoe has dropped (see earlier posting on the manufacturing activity index). From the Wall Street Journal - U.S. Service Sector Contracts:

A report from the Institute for Supply Management said Wednesday that the group's overall index for nonmanufacturing activity hit 44.4 last month, from 50.2 in September and 50.6 in August. That compared with the 47.0 economists had been expecting.

Double "oh boy"!

And on Friday the October employment data is released - which may be a triple "oh boy."

Yesterday there was another vote that had significant future ramifications. The Federal Communications Commission voted to open up the unlicensed Television spectrum - known as "white space" - for wide scale use:

The rules adopted today will allow for the use of these new and innovative types of unlicensed devices in the unused spectrum to provide broadband data and other services for consumers and businesses.

A coalition of powerful groups, including broadcasters, Broadway theater producers and sports franchises, hoped to derail or delay the decision. They have argued that their own transmissions — whether from television signals or from wireless microphones used in live music performances — could face interference from new devices that use the white spaces.

The decision opens the way for a major expansion of wireless broadband service and networked devices. According to the Washington Post:

Microsoft Chairman Bill Gates and Google founders Sergey Brin and Larry Page have personally lobbied FCC commissioners on the airwave issue, saying that use of the valuable radio waves -- which can penetrate buildings -- could unleash a wave of innovation in wireless technology. The high-tech firms liken the spectrum to WiFi on steroids and say that the industry will benefit as more people use the spectrum to surf the Web and as they buy smartphones, digital music and video players, laptops and other devices that connect to the networks.

"White spaces are the blank pages on which we write our broadband future," said Democratic Commissioner Jonathan Adelstein during the meeting. "Let's hope this is not just WiFi on steroids but WiFi on amphetamines as well because it will be that fast."

Given that the US seems to be falling behind in the deployment of broadband, this ruling is welcome news as we seek to expand the I-Cubed Economy.

There has been already been a tidal wave of commentary on the Obama victory. I won't rehash everything that has been said but just add my own personal experience. As background note, I have officially supported Senator -- now President-elect -- Obama since his announcement in February 2007 and have worked on his campaign here in the District of Columbia.

Besides the passion and excitement that Barack Obama generated, two things contributed to his victory: the transformation of weaknesses into strengths and the field organization.

Much has been said about the issues of race and experience. Those seemed to be factors that should have weighted down his chances. Obama turned them around to be selling points. By stressing, to use his words, "the improbability me standing here tonight" over and over again, Obama turned the race issue into a story of the American dream: that in America any child can grow up to become President. Senator McCain used his strength as a war-hero to appeal to patriotism in the form of service -- including his slogan "Country First." Obama used his life story to appeal to patriotism in terms of American exceptionalism -- including his slogan "Yes We Can." I know that might strike some as a strange analysis -- but Obama's appeal struck home the way that Reagan's "shining city on the hill" did 28 years ago. The core of the message was that America is a special place. Obama's improbability highlighted that -- and created a very powerful intangible asset.

On the field organization, a lot has also been said about the enthusiasm of the volunteers. But volunteers as only as good as you can put them to work. And the Obama campaign used technology to both put the volunteers to work and to get the message out. The text message of the VP choice was just one example -- which, if you haven't figured it out, was a huge data mining exercise to build a GOTV ("get out the vote" for you non-politicos) database. I was much more impressed about the creation of the do-it-yourself phone bank operation.

Phone banking is one of the basics of GOTV: if you get a personal call from someone, you are much more likely to vote. Election commentators have already noted that the Obama campaign did a phenomenal job in these personal contacts. Part of the reason was the technology.

I spend part of yesterday calling voters in Pennsylvania from my home. Let me stress that last part: from my home. I signed on to the Obama website and got a list of folks to call. The technology was great -- essentially call center software which gave me a screen with the name, phone number and some basic information including polling location (to remind them) and a script. When I was finished I simply clicked on the appropriate responses -- already voted, left message on answering machine, wrong number etc. -- and then the next name came up.

Now, part of the fun of phone banking is the socializing that goes on. But the technology made the process simple and convenient -- and something I could do easily without having to travel to and from the phone bank location. I could make a few calls, do something else, come back to the calls etc. This technology opened up the phone banking process to hundreds of people who might not have otherwise been available. And the phone banking is just one example of how the campaign used technology to change how things are done.

The bottom line for me is that my experience in watching and participating in the campaign has convinced me that America just elected its first President in the era of the I-Cubed Economy.

President-elect Obama has won a historic victory -- one that has the potential to change the direction of the country. We should all celebrate that accomplishment.

But now, the President-elect has two big problems on his hands. The first everyone knows about: he is inheriting a messed up economy and a messed up foreign policy. Add to that the pressures of staffing a new Administration and coming up with a budget. The second problem is a little more subtle: he won't become President for 11 weeks. Yet the public will demand that he fix the twin messes immediately -- or at least start work on them. His problem is not helped by two facts: President Bush and world leaders are meeting at the end of next week to try to come up with a solution and neither the lame-duck Administration nor the lame-duck members of the Congressional minority party have any incentive to be helpful.

On the other side, Congressional Dems are eager for him to take charge. As the Wall Street Journal reports:

Senate Banking Committee Chairman Christopher Dodd (D., Conn.) says the president-elect should start by picking his Treasury secretary and economic team within days. With Congress planning a session this month to push through a second economic-stimulus package and discuss remaking the nation's financial system, lawmakers will look for direction from the future president. Mr. Dodd said he will bring the next White House team into the regulatory talks.

It is quite possible that we may see a "stimulus" package pass the Congress before the inauguration. But there is a good chance that it will not be what an Obama Administration would have proposed. This puts the President-elect in an awkward position.

But, that comes with the territory.

My significant other voted at 7 am this morning. It took her almost an hour and a half. At 11:30 I voted and it took me about 5 minute. Same location. Why? Because the 7 am crowd were people who had to vote before they headed off to work. For them, it would not be practical to leave work in the middle of the day and go back home. Me, I work in the same neighborhood as I live - so it was an easy walk.

Most people are in the same situation as my significant other. They, like her, don't work near where they live. That is why we have huge rush hour crowds at the polling places.

Solution: let people take the day off and stay home. Then they would naturally spread themselves out at the polling places. And, since voting would be easier, participation would probably increase.

Here is something that the proponents of the direct infusion approach probably didn't think of: a chunk of the funds will go to institutions that don't need it. According to the Wall Street Journal -- Rescue Cash Lures Thousands of Banks banks are now lining up for the cash. Why, because they fear the consequences if they don't:

Now institutions across the U.S. worry that if they don't try for the money, the market will judge them as too unhealthy to qualify, or lacking the savvy to deploy cheap government capital on acquisitions and investments.

"There's a perception in the market that the government is actively picking winners and losers...we wanted it well-known in the market that we're on the list of survivors," said Roy Whitehead, chairman, president and CEO of Washington Federal Inc. in Seattle, one of about 20 regional banks approved by Treasury for the program last week.

It is called "signaling" -- and has been a feature of government programs for a very long time, as behavioral economist could have told us.

Factory Activity Slid in October - WSJ.com:

The Institute for Supply Management, a private research group, reported Monday that its index of manufacturing activity failed to grow for a third consecutive month, moving to 38.9 in October, from the contractionary 43.5 in September and the 49.9 seen in August. The October reading was the lowest since September 1982, when it registered 38.8.

Readings above 50 point to expansion in activity. Economists polled in a survey by Dow Jones Newswires had expected the October index to hit 41.5.

Oh boy!

As the economy tanks, we are being inundated with suggestions for what to do. Most are standard macroeconomic stimulus ideas. But a few are in the same vein as my earlier comment that stimulus needs to do more than boost consumer spending. From Rob Atkinson at the ITIF comes this call for a Timely Targeted Temporary Transformative package:

As talk of a possible recession grows, so too does consideration of a second economic fiscal stimulus package. Rather than craft a conventional spending-oriented stimulus package focused solely on tax cuts for individuals and spending increases, Congress should craft a stimulus package of which at least a portion not only gives a quick shot in the arm to the economy but at the same time also boosts investments that spur productivity growth and innovation, especially in information and communication technology, which has been the engine of U.S. economic growth for the past decade.
. . .
1. Allow IT Investments to be Completely Expensed in 2009
2. Provide a Tax Credit for Investments in Health IT Made in 2009
3. Provide $2 Billion to Colleges and Universities That Invest in Needed Research Infrastructure in 2009
4. Provide a Tax Credit of 50 Percent for Investments in Energy Efficient Equipment in 2009
5. Provide $1.6 Billion for Computers and Broadband for Low-Income Families with Children at Home
6. Provide an $8 Billion One-Time Infusion into the Highway Trust Fund to Spur Ready-to-Go Surface Transportation Infrastructure Investments
7. Allow U.S. Companies to Bring Back Foreign Earnings at a Lower Corporate Tax Rate in 2009
8. Provide Forgivable Loans to States to Shore Up Budget Shortfalls, Provided That States Expand “Rainy Day” Funds in Later Years

I generally agree with this list, except for the repatriation of foreign earnings. I'm not sure the evidence is convincing that this worked in the past.

I'm also a little surprised that Rob didn't call for something he has advocated in the past: the knowledge tax credit for worker training. I have long supported this proposal. As I've said before, If we can provide a tax incentive to invest in physical assets such as equipment (including IT), we should also provide tax incentives in the intangible assets of worker skills needed make those physical assets work. Such a training tax credit is especially important in a time of slower production. Rather than send workers to the unemployment office, let's send them to the classroom.

James S. Henry and Jim Manzi writing in The Nation also call for a plan to Invest in Innovation:

In the midst of our deepening recession, the United States faces another economic crisis that is less visible but may be more important than house foreclosures, bank failures, plant closings or stock market avalanches: the systematic under-investment in technology and innovation. Our global economic leadership may be at stake because of it.

Specifically, they want to boost R&D spending and other technology programs

Bernard Schwartz and Sherle Schwenninger at the New America Foundation proposed their Economic Recovery Program for the Post-Bubble Economy earlier this summer - but it is getting renewed attention (see Steve Clemons comments in his blog The Washington Note). According to Schwartz and Schwenninger:

A longer-term economic recovery program must therefore steer the economy onto a new growth path that is less dependent on the debt-financed consumption that has driven economic growth over the past decade. The most promising new sources of growth are America's enormous public infrastructure needs and the increased global demand for American technology created by the drive for greater efficiency in economies around the world. An economic recovery program built around public infrastructure investment and demand for American technology would be more effective in stimulating the economy in the short term, and far better for it in the long run, than would another round of tax rebates for American consumers.

Even David Brooks in the New York Times is writing about a more expanded plan. His is a A National Mobility Project. Brooks argues in favor of infrastructure spending, but not as a short term stimulus measure:

Major highway projects take about 13 years from initiation to completion — too long to counteract any recession. But at least they create a legacy that can improve the economic environment for decades to come.

A major infrastructure initiative would create jobs for the less-educated workers who have been hit hardest by the transition to an information economy. It would allow the U.S. to return to the fundamentals. There is a real danger that the U.S. is going to leap from one over-consuming era to another, from one finance-led bubble to another. Focusing on infrastructure would at least get us thinking about the real economy, asking hard questions about what will increase real productivity, helping people who are expanding companies rather than hedge funds.

Finally, but maybe most importantly, comes this call from Michael Porter Why America Needs an Economic Strategy - BusinessWeek:

The stark truth is that the U.S. has no long-term economic strategy—no coherent set of policies to ensure competitiveness over the long haul. Strategy embodies clear priorities, based on understanding the strengths we need to preserve and the weaknesses that threaten our prosperity the most. Strategy addresses what to do, but also what not to do. In dealing with a crisis, experience teaches us that steps to address the immediate problem must support a long-term strategy. Yet it is far from clear that we are taking the steps most important to America's long-term economic prosperity.

In that article, Porter ends with the following:

We will need some new structures to govern strategically. I served on the last public-private President's Commission on Industrial Competitiveness—in 1983! This time we need one that is less politically motivated. Congress would benefit from a bipartisan joint planning group to coordinate an overall set of priorities.

On the last point about a structure: we had one. It was a bipartisan Congressionally created organization - the Competitiveness Policy Council. It was created in the 1988 Trade and Competitiveness Act and operated from 1991 until 1997, when the GOP-controlled Congress cut off its funding. There was also legislation submitted in 2004 by Senator Lieberman to create a Commission on the Future of the US Economy -- which Athena Alliance consulted on and supported.

Maybe the new Administration and the new Congress will look more favorable on these efforts.

In an earlier posting I mentioned that the economic task of the next Administration will be to deal with the weakness in the economy (going beyond the credit market seizure and financial market meltdown). The new IMF World Economic Outlook notes that:

The major advanced economies are already in or close to recession, and, although a recovery is projected to take hold progressively in 2009, the pickup is likely to be unusually gradual, held back by continued financial market deleveraging.

That is the standard macroeconomic world view: the economy will rebound but financial constraints will limit growth. In this view, we are working off a credit bubble that inflated the economy faster than it should have grown. As the IMF puts it:

lax macroeconomic and regulatory policies may have allowed the global economy to exceed its “speed limit” and may have contributed to a buildup in imbalances across financial, housing, and commodity markets.

While it is undoubtedly true that we are facing the hangover from an easy credit boom, the question of whether the economy exceeded its speed limit is at the core of the discussion as to future remedies. Is the economy doomed to a period of slow growth or are there actions that can be taken to effectively raise the speed limit?

Key to raising the economy’s speed limit involves continued productivity gains via innovation and re-establishing the link between productivity gains and wages. This will require a look at structure issues. A consumer-oriented stimulus package would be fine. But ultimately the economy will grow to the extent that we increase productivity – not by how much we increase consumer spending. As Larry Summers said in a recent piece in the Financial Times, “there is a need to ensure that the pressure to increase spending is directed at areas where it will have the most transformational impact. We need to identify those investments that stimulate demand in the short run and have a positive impact on productivity.”

This is not necessarily the standard view. As Rob Atkinson has pointed out, there are a set of standard views that look at the macroeconomic level without every considering innovation and that “transformation impact” mentioned by Summers. See Rob’s paper “Economic Doctrines and Policy Differences: Why Washington Can’t Agree on Economic Policies” - and his earlier book Supply-side Follies. William Baumol, Robert E. Litan, and Carl Schramm have a slightly different take on the argument. In there book, Good Capitalism, Bad Capitalism and the Economics of Growth and Prosperity, they focus on entrepreneurship as engine of growth.

The ability of the economy to transform itself is key to the discussion of the economic “speed limit” and the debate over “the new economy” in the late 1990’s. The term “new economy” has fallen into disrupt after the collapse of the dot-com bubble. At its best, the term helped describe the economic changes due to technological advances and other factors. At its worse, the term was used to justify an overly rosy outlook that the old economic rules no longer applied. When some of those fundamentals re-applied themselves (like the idea that companies actually needed to have revenues to sustain their stock prices), many were quick to discard the entire concept.

But the underlying question remains valid: to what extent have changes in technology and economic structure increased the productivity level and to what extent can those gains be sustained.

Some fundamentals. The economy’s “speed limit” refers to the potential non-inflationary growth rate of the economy. Conventional economic wisdom holds that economic growth can not exceed a certain rate without increasing inflation. That rate is determined by the rate of growth in the labor force (the number of workers and their hours worked) and the rate of growth of the productivity of those workers.

Proponents of “the new economy” talked about a number of factors that either 1) lowering the possibility of inflation or 2) raising the non-inflationary potential growth rate:
• globalization has increased competition and made it harder for companies to raise prices, therefore keeping down inflation;
• globalization has opened up new sources of supply, thereby reducing any domestic bottlenecks in the production process that could result in inflation due to a lack of capacity to meet demand;
• deregulation has forced companies to become more productive; and,
• new technologies have dramatically increased productivity;
• restructuring has allowed companies to become more productive through increased economies of scale and specialization.

The last two points – technology and structure – go directly to the argument on raising the economy’s non-inflationary growth potential centers through productivity. A decade ago, economist worried about the so-called so-called “productivity paradox.” Data on the overall productivity of the economy did not seem to show any impact from new information technologies. As Noble-laureate Robert Solow once quipped, “You can see the computer age everywhere but in the productivity statistics.” However, over time those productivity numbers final changed. Productivity has grown at an annual rate of 2.6% between 1995 and 2007, compared with a rate of only 1.4% between 1973 and 1995 (data from the Council of Economic Advisors: 2008 Economic Report of the President)

Brynjolfsson and Hitt have argued that the “productivity paradox” was over in large firms by 1991. Their 1996 research shows that “computers contribute significantly to firm-level output, even after accounting for depreciation, measurement error, and some data limitations.” Part of the reason for the delayed impact has to do with complementarities between technologies. Economic historians and theorists have pointed out that new technologies often require a host of other changes -- technological, institutional/organizational, and in worker skills and knowledge -- before they can be fully utilized. As Brynjolfsson and Hitt noted in a 2003 paper “Computing Productivity: Firm-Level Evidence”:

the observed contribution of computerization is accompanied by relatively large and time-consuming investments in complementary inputs, such as organizational capital, that may be omitted in conventional calculations of productivity.

Every once and a while, this emphasis on information technology raises an alarm – such as this comment a few years ago in the Financial Times Federal Reserve may have hit speed limit

Importantly, most of that investment drop has come in computer equipment. So, to the extent that information technology is responsible for the productivity miracle of the 1990s, there is reason for added concern.

According to Dr. Bart van Ark, Director of International Economic Research at The Conference Board: "Over the past decade, information and communication technology has been a key driver of global productivity growth, but with these latest numbers one begins to wonder whether ICT's [Information and Communications Technology] contribution has peaked. The significant fall in U.S. productivity growth is unlikely to be purely cyclical, and the modest European revival of productivity also points to the limited impact of technological change and patchy liberalization of product and labor markets in many countries."

However, according to the report, the "lull" in productivity could also be due to a transition phase to a second wave of ICT-driven productivity growth still to come.

Gail Fosler, Executive Vice President and Chief Economist of The Conference Board, said: "Today's business models have reached a certain level of technology saturation, and incentives for creating a second wave of applications are weak. But there are many industries, in particular in services, in which the potential for more productive technology use seems large. Future productivity gains may be waiting for a new generation of business applications."

But, it is unclear whether we have come to the end of information technology driven productivity increases. A new IT wave may be just beginning, in the form of cloud computing and Virtual Worlds. (Note: Athena Alliance has an on going project on IT and business collaboration - with the first paper to be released in a month or two.)

There are at least three ways in which information technology can increase areas: IT creating industries (such as software); intensive IT using industries (such as banking); and latent IT using industries (such as health care). Each has their own productivity rates. As the consulting firm McKinsey pointed out is a study “Where US productivity is growing”:

After 2000, some of the sectors with the fastest-growing productivity—notably computer equipment—saw their growth slow substantially. Yet productivity growth rates in both retail and wholesale trade have continued their strong growth trajectory. Interestingly, productivity in a much broader set of service industries, including administrative support, scientific and technical services, construction, and restaurants, has also increased. As a result, five of the largest contributors to productivity growth after 2000 were service industries. Over the past decade, the service sector, which today represents 70 percent of US employment, has been a major source of growth in productivity and employment alike.

Services may in fact be the area of biggest productivity increases in the future. (For a more detailed discussion of productivity in the services, see my earlier posting.)

Besides, IT doesn’t work as a productivity enhancer by itself. Organizational change is needed to take advantage of the new technology. Sometime the organizational change itself is enough to cause major productivity increases – think of Adam Smith’s example of the pin factory. As I’ve argued earlier in The Case for Technology in the Knowledge Economy), the issues is not just technology but knowledge.

Finally, there is the whole issue of innovation. Innovation does more than raise the productivity of the existing production process. It creates whole new products and processes.

But that is the subject of another posting.

Suffice it to say that the concept of an economic speed limit is useful. But when economic forecasts start raising the issue of hitting the limit, you need to ask questions about what that limit is, who enforces it and how to change it in order to continue economic growth.

Today's New York Times had this tidbit -- I.B.M. Sues to Block Executive’s Move to Apple:

I.B.M. sued one of its top executives on Thursday in an attempt to prevent him from taking a position at Apple.

The company said that the executive, Mark Papermaster, who until last week had been manager in charge of the company’s blade server business, had signed a noncompete agreement with I.B.M. that would prevent him from accepting a job with a competitor until one year after leaving I.B.M.

The company said that Mr. Papermaster had been one of its top 300 managers and that he had access to a wide range of the company’s intellectual property and trade secrets.

Noncompete agreements are a recognized intangible asset. But you don't hear much about their enforcement in court - I suspect because most are honored. But there may be another reason: noncompete agreements are generally part of state contract law and many states do not recognize noncompete agreements. For example, as I noted in Intangible Asset Monetization, noncompete agreements are considered illegal under California's Business and Professions Code Section 16600.

The IBM lawsuit was filed in the US District Court in Manhattan. The fact that it was filed in New York and in Federal court makes this case worth watching.