I was walking in Manhattan this week in the midst of an epic journey. The company I lead, M•CAM, is looking to establish a market solution to the current market’s greatest challenge. We are working to create a transparent means of linking human creativity to human enterprise in a way that rewards innovation and aligns capital and enterprise to shared objectives. You see, what has passed for financial innovation over the past three decades has grossly contorted the capital system and has decoupled capital from productivity. Having entered into dialogue with many of the market’s most sophisticated minds stewarding the largest aggregated pools of capital, the daunting realization was that, when confronted with systemic paradigm shifting opportunities, the people you might think are on the frontiers of financial sophistication are truly paralyzed by the reality that the hype about economic recovery is, well, just that – hype.
I’ve written about this before but I’m pretty sure that most people still don’t get what’s wrong at the core of the economic system. And while I’ve tried to highlight a number of components of the disease that still plagues our economic system, I think that I’ve been ineffective at communicating. And in a world where the market “responds to good news” about the slowing of the rate of job loss (because we’re continuing to shed the hopeless – now well over 2 million people – who have not found work from the official count) and sees this as indications of a “recovery”, at some point you must confront the fact that the same media that didn’t see the recession/depression coming are equally incapable of reporting on market recovery.
Let’s revisit some basics. I’ve called your attention to the difference between debt and credit before. Debt focuses on the cost of money and its use. Those with capital – which in their own hands earns nominal interest in, say, Treasury bills – can provide that capital to others as long as their cost to hold the money and their return to lend the money are sufficiently spread. Debt, whether it’s in the form of your mortgage, or bonds to pay for a highway, or pay for an out-of-control government (like the fiscally delusional U.S.) seeks neither productivity nor equilibrium. It seeks its own return and requires perpetual growth. In modern times, debt is resolved (as many of us know) by taking out more debt – politically correctly known as refinancing. If you contemplate debt in its extreme, debt is antithetical to productivity. Three hundred years ago, debtor’s prisons ironically put the debtor in prison extending the usurious reach of obligations to family members and friends while rendering the productivity of the debtor impractical and impossible. In modern times, debtors now find themselves having to take more time away from family with a second or third job, leave children unattended to pay off obligations, etc. In many parts of the world, including the U.S., debtors wind up literally enslaved. Human trafficking, now at an all-time high, is a direct consequence of debt.
There was a time when credit – an entirely different concept – was more commonplace. In its simplest form, credit is best exemplified with a seed. If I have seeds in abundance, I may offer 10 seeds to a farmer and charge him 15 seeds in exchange. This works because I know that each seed I provide will yield 100 seeds – more than enough for him to keep seed for the next year, feed his family, and pay me 15 seeds. While cartoon in its simplicity, this example is quite vital to understand energetically. Unlike debt which seeks its own return divorced from the underlying enterprise, credit takes into account an alignment of all interests. First, as the provider of seeds, my bet is with the farmer and with nature. Second, my return is based on fruitful productivity. Third, my role as seed provider is not necessarily perpetual. In fact, I may work myself out of a job and may need to move on to other forms of credit if a market is fully functional and crops are productive. In short, as the provider of credit, I am betting with future productivity, not a perpetual illusion of capricious returns. And yes, I will lose sometimes. And that’s o.k.
One of the main reasons we are in the economic failure we’re in right now is because we don’t understand credit anymore. And in failing to understand credit, we give no thought to the fruitful ecosystem. Let’s look into this deeper.
In credit, I look to the ecosystem of the seed-farmer-soil-rain-harvest-market dynamic and understand that, to make a functioning system, I need to make sure that my credit works within a closed loop that may or may not have finitude. I need to look at the raw material-production-assembly-distribution-marketing ecosystem and make sure the capital costs fit inside the fruitfulness of the ecosystem. In short, I need to understand the foundations of productivity and then integrate my capital within a viable cost structure therein. In short, my returns – high or low – are directly a consequence of the ecosystem productivity.
Debt, on the other hand, has made capital ignorant and lazy (euphemistically described as “efficient”). I spoke to several people about collateral. Collateral is a form of commitment that says that, if for any reason, an obligor fails to perform on repayment of an obligation, a secondary source of payment in the form of disposable assets, can be monetized to defease the obligation. Collateral has taken on enormous meaning lately as, in its absence, cash-rich banks are unable to lend because their reserves are adjusted based on their creditors’ collateral adequacy. With investment-grade collateral, a bank needs to hold 8 cents in reserve for every dollar lent. Without collateral, the same bank must hold up to 53 cents in reserve for every dollar lent. Most of the American and European public fail to understand that the reason why cash-laden banks are not lending is because they cannot. Technically they cannot because they do not have collateral adequacy in their credit assets. Operationally they cannot because they have no clue how to assess the collateral in today’s market – most of which is intangible. Your home, used as collateral for your mortgage, does not create value and, when real estate markets fail, its loss of value actually puts you in greater debt.
Ironically, during this administration’s rush to stabilize our economy and put it on the road to recovery, it has continued to overlook a comic irony. Intangible assets, intellectual property and innovation are all part of what’s called a “General Intangible Lien” – a collateral instrument holding hostage all corporate innovation from effective deployment. I use the term hostage because, unlike traditional tangible collateral – like real estate – that at least has some form of value, intangible collateral is taken under liens, restricted from use, but assigned NO VALUE. In other words, banks now hold America’s and Europe’s innovation assets, ascribe them NO VALUE, and with real estate and traditional assets loosing value, have no way to unleash their value without worsening their already collateral-insufficient position.
In short, our love affair with debt – mortgage or commercial debt – has enslaved the seeds of future productivity. When I was in Saudi Arabia speaking with people associated with SABIC – the buyers of GE Plastics – they were shocked to learn that many of GE’s patents on critical plastics technology were not expressly conveyed in SABIC’s purchase. Many of them, post the acquisition, were still held in liens taken by banks with whom GE had lending agreements. Companies including electronics, telecommunications, pharmaceutical, and energy enterprises and others, have vast intellectual property holdings which are tied up in senior liens rendering their use limited to non-existent. In the case of one photographic technology company, their patents are expressly prohibited from use in licensing transactions by the bank that holds their debt. And, during my stroll through the banks of New York, I was amazed that nobody seems to realize that we need to fundamentally change. More of the status quo is NOT the solution and will continue to inflame the sores that we've bandaged poorly of late.
I highly recommend deeper exploration of the debt conundrum expounded by my friend and colleague James Quilligan. James writes and speaks about the centrality of debt and capricious interest in the present economic system failings. I will spend more time on this as well. In the meantime, we need to actively decouple our debt dependency and actively work to create fruitfulness-aligned capital systems. This means that when we’re working on building ecologically viable communities in St. Louis, we need to examine every element of our retrofits. The water systems in buildings need to be financed using the future value of potable water and be paid for using water credits. Sanitation systems need to be financed using off-grid commitments where developers can be compensated for reducing or eliminating their reliance on municipal water and sewer systems and where organic waste can be captured, processed and turned into a fuel source. Rather than seeing waste as a cost, we need to see biomass as energy and compost. We need to realize that the private sector – not the government – must lead the way to link capital to future productivity. In a world where our government has reduced its economic empowerment tools to interest rates and tax incentives, little more than the failed status quo can be possible.
And on an unrelated note: Did anyone in Congress EVER run a business? To grow a business, you must invest. To invest, you must use present profits to plow back into enterprise. So, when stimulus bills get passed that provide tax relief (that only is useful if you are creating profits) does ANYONE realize that this only creates loss carry forward positions which make small businesses desirable tax sinks for larger – less employment friendly companies? I’ll write more on this one too.