Wednesday, August 26, 2009

What a Difference a Quarter Makes

As promised, I wanted to make sure that we didn’t lose the forest for the trees. With today’s meeting of the FDIC (and the wonderful liquidity conundrum that they face in dealing with the 81st bank closure of the year), we now know that private equity firms seeking to buy troubled banks will need to commit to holding assets for at least 3 years and maintain reserve ratios that are greater than the industry wanted. Ironically, the FDIC is in a Catch-22. On the one hand, they desperately need the market to do their job – namely back the Federal guarantee to banks while maintaining their illusion of control. On the other hand, they realize that traditional capital sources know too many of the dirty secrets about credit quality to pay for catching falling bank stars. However, all this FDIC nonsense is a bit of “deck chairs on the Titanic” for a more significant reason. To race to the punch line, the FDIC failed to consider that the reserve capital they want for market evidence of commitment isn't in the market in a staggering number! Read on.

As promised, I wanted to make sure that you all are tracking the upcoming September release of the Federal Reserve’s Flow of Funds Accounts data (slated for release on September 17, 2009). The reasons are myriad but one of the big reasons is buried on Table B.100, lines 24-30 on page 102. If you’d like to, you can turn there with me. If not, you can trust me – like you’ve trusted the Federal Reserve for so many years…

In one reporting quarter – from the 4th Q of 2008 to the 1st Q of 2009, life insurance reserves lost $10 billion. During the same period, pension fund reserves lost $500 billion. If you look back just five quarters, you realize that the losses are even more consequential (comparing year end 2007 with 1st Q 2009 where the losses are $31.7 billion and $3.47 trillion, respectively). Now some of you still don’t get why these numbers matter but let me connect some dots for you.

Life insurers remain one of the major contributors to credit enhancement leveraging their reserves for credit guarantees at 15-20 times their face value. So, when you lose $31.7 billion in life insurance reserves, you are really losing enhancement value of $475 billion in credit guarantees which in turn erodes the investment grade of credits totaling up to $5.7 trillion in extended credit. Add to that the real loss from pensions of $3.47 trillion and you realize that patient capital in the amount of $9.17 trillion in investment grade (and reserve qualified) money has vanished from the system. Taken together, and concerning ourselves not one iota about other losses in the system, we have an interesting test of true “market recovery” looming on the horizon – namely, will we have investment grade assets for reserves to support debt markets in growing or shrinking numbers on September 17. In short, the FDIC is counting on a theoretical asset reserve that has ceased to exist and is evaporating at a record rate.

Now, please remember, trained propaganda artists still want you to put your money in the NYSE casino so that they can take it before the next “correction” – which is a euphemism for money that you mistakenly thought was “yours” which was really “theirs”. However, if you look at the fundamentals of what it would take to get a healthy system – using the Federal Reserve’s definition of healthy (which you should know I question on many levels) – we would need to see this vector change. For the record, I am making the audacious prediction that the green shoots are poison ivy and we’re going to develop a serious itch on or around the 17th of September when we find out that we’ve been weaving garlands of green with a seriously flawed botanical awareness. Let’s see.


Wednesday, August 19, 2009

When Will We Ever Learn?

Yesterday, the markets shook off Monday’s 2% drop and confirmed that the recession is really, basically over and we should all be back to the heady days of 2007 all over again really soon. Thanks to the surgical intervention by those who “didn’t see the crisis coming”, the market has vindicated these activities and we’re really out of the woods now… really…trust me…

Now I know that there are those of us who look at economic data and see vortices of wailing and gnashing of teeth while we are told to see the resilient hubris of the dons of Gold Men, but let me introduce you to a theme that we’ll be examining here in the next few entries.

Based on the best available data in the U.S., publicly traded companies (approximately 0.01% of all corporations in the U.S.) account for less than 1% of the employment and value creation in the U.S. however, according to the Federal Reserve’s Flow of Funds data, get credit for close to 90% of the reported value of corporate equity in the U.S. Pronouncements about the health of the market – derived from the statistically irrelevant sample of Dow Jones Industrial Average or S&P 500 constituents – are alleged to be indicators of market health and economic failure or success. And, the good news is that the Federal Reserve – as it has no way to measure the value in the vast majority of the engine of our GDP – simply ignores those companies that don’t generate trading income for investment banks. Ironic, isn’t it that our financial mavens come from investment banks that live on the illusion that the pitiful minority of firms who trade stock publicly are all that matter? Friends, if you sat through any statistics course in high school or college, you understand that we have a profound failure of sampling in our diagnostic data.

If we examine the Flow of Funds data, which I am going to report on for the next few entries (assuming I don’t find another distraction) leading up to the much anticipated September reporting, we can see the seeds of the ignorance that led us into the maelstrom and the reason why we’re no closer to escaping it than we were on the glorious day when Merrill’s bull escaped the rodeo only to wind up facing the Matador (trust me, this is going to be a great metaphor in due course).

Let me entice you to read subsequent postings with the following. You know that I’ve been trying to illuminate the colossal risk our domestic industries (to say nothing of Europe and Asia which may actually be worse) have on pension illiquidity and miscalculated leverage on actuarial funds. By using the Fed’s own data I will show you that if they used their own data, they would be sounding alarm bells too but, that, my friends, wouldn’t support the popular message that we’re on the mend. This willful ignorance arises from the convergence of an over-sampling of public company data; an under-sampling of private company leverage; and a failure to understand the dynamics of the actuarial requirements of pensions and their associated risk transfer market components. I’ll do my best to weave these threads into a tapestry that you can explain to your kids. We’re not and our addiction to exuberance and greed is merely prolonging the agony that’s inevitable for those who are unable or unwilling to interrupt the dance of the market madness. More to follow.


Thursday, August 13, 2009

Business Creation in a Global Recession: Opportunities to Explore New Horizons in Entrepreneurship

4th Asia Pacific Conference on Business Incubation
August 6-7, 2009
Coimbatore, India

Keynote Address by: Dr. David E. Martin
Executive Chairman, M•CAM Inc.

Batten Fellow, Darden Graduate School of Business Administration,
University of Virginia

Honorable Delegates and Friends,
Few occasions could be imagined that would serve as greater evidence of the unquenchable spark of the human spirit than holding an event organized around the genesis of value creating business against the backdrop of systemic global economic volatility. It is appropriate, at this juncture in the story of modern social evolution to take an honest stock of where we’ve been, where we are, and where wisdom invites us to craft a more ethical and suitable future. Regrettably, when words like “economic crisis” are invoked, we respond with rather unsophisticated reflexes. Reflexes, by their very nature necessitate rapid, unconsidered, hyperactive responses short on the consideration of consequence or collateral damage. Reflexes do not seek, nor do they function with, considered consequence. So it is, that when we hear talk of “recovery” or “market resilience”, we fail to ask whether the pathologic condition that precipitated the current instability is a condition to which we should aspire. Do we want to return to a nostalgic view of a few years ago?

Who among us wish for a return to the optimistic days of 2007? Which one of us long for days when financial innovation involved placing bets – in the form of derivatives and credit default swaps – at 5 times the face value of the global GDP hoping for the failure of our fellow man and the taking of monies from the gullible public? Which one of us longs for the “wealth” that was created by hedge funds generating in excess of 10 times greater returns by betting against the performance of industry rather than investing for a more fruitful future? Who among us would like to see the public and private sector continue to abuse pension funds by leveraging them for short-term usury, failing to consider the social and political upheaval which now looms when the illiquidity of entitlement programs and pensions are evidenced? While we pursued ever faster bit rates to transmit data across the globe, we saw a record number of humanity enter severe malnutrition without a bite to eat. While we obsessed about speculative market returns, we saw a record number of humanity fall deeper into poverty. While we gained efficiency with unconsidered labor outsourcing, we saw a rise of human trafficking. While we spoke of global stewardship and the environment, we saw unchecked expansion in devastating mining and the growth of metals markets which supported paramilitary violence. We celebrated the iPod but turned the seed pod from food into ethanol to charge the batteries for our energy consumption addiction. I, for one, don’t want a return or a recovery. Rather it’s time for reconsideration, reconciliation, and renaissance.

We did not arrive at this point in our economic history by accident. This was not an unanticipated shock that “no one saw coming”. To the contrary, the present conditions were wired into the system from its birth and came to full bloom almost two decades before the spoiled fruit was plucked. While many economists debate the mechanics of the failures – which are many and rather simply discerned – I would like to address three issues which don’t enjoy frequent consideration.

First, we saw unchecked capital disequilibrium where ignorance arbitrage was the rule of the day. For the past two decades, capital migrated from receivables financing and dividend returns from profitable operations to speculative equity with returns from a carnivorous market food-chain where most died and the moderately successful were cannibalized by the few. This condition worsened when the few at the top of the food-chain, lured by “cheap” capital decided to leverage their insatiable desire to consume ever more. Public accountability and its surrogates turned a blind eye to untold abuses in every sector.

Second, under the politically correct construct called “Free Trade”, those framing the schemes removed the very utilities that they used to arrive at their powerful positions insuring that poverty could serve as the outsourcing energy of last resort at all costs. We will revisit this item a bit later.

Finally, greed simply eclipsed rational consideration both for self-preservation and for ecosystem survival. Returns of 30-50% were justified because the knowledge economy was full of risk, we were told. However, what we were not told was that “risk” was a mask used to cover careless due diligence, value chain assessment failure, and opaque dealing.

We now have an opportunity to pursue an alternative path – one that is not foreign to humanity but rather draws on some of the greatest models from the distant and proximal past. This new path involves the perpetual interaction between three macro dynamics which serve as both organizing principles and metrics of performance. They include Innovation Literacy – rightly understanding the core of innovation and its deployment; Gross Innovative Output – linking innovation to commercial consequence using all requisite economic tools and with the customer consumer precedent over the capital source; and, Innovation Recycling – using the fossils of the excesses of the past thirty years as catalysts of new growth.

Some of you are familiar with the epistemology of innovation but it’s worth reminding ourselves that we live with an ever more confused sense of what innovation is and what it is not. There are three distinct dynamics that are too often blended in conversations about innovation. They are:
• Invention: The creation of something entirely new, without precedent or anticipation;
• Innovation: The assembly or contextualization of components and knowledge for a new purpose; and,
• Incrementalism: The nuanced modification of a thing or utility for a specific market purpose.

Most of what we see called invention and innovation isn’t. Most of it is incrementalism and serves only finite, unsustainable purposes. By building civil society structures and proprietary frameworks around it, we afford it consequence that it neither deserves nor does it stimulate “sciences and the useful arts” to use the phrase on intellectual property from the U.S. Constitution.

Innovation is not synonymous with intellectual property. In point of fact, while its purveyors would love to find some shred of data to suggest otherwise, IPR is seldom the core or even the catalyst for successful venture formation and sustainability. In fact, the majority of innovation lives a rather unremarkable life. It is found in internally funded and contracted research, academic pursuits, commercial responses to market demands, and internal enterprise optimizations. Those who wish to say that IP is core to attracting capital need to admit that to date, no effective collateral position exists for IP to be counted as an investment grade asset and in the global market, no jurisdiction on the planet has a reliable treatment of IP in bankruptcy. More dramatically, while subject to general intangible liens, only a fraction of all intangibles are even correctly transferred when enterprises are sold or liquidated.

Innovation illiteracy is prevalent largely to serve as a protectionist utility for multi-national corporations to manipulate and control markets. Therefore, when we consider venture creation, we must address Innovation Literacy. In most of the world, the notion of turning ingenuity into profit is antithetical to local or regional values. The growth of the “Commons” model in the free and open source software movement and the expanding use of the general purpose license or GPL are wonderful examples of the growth of commons stewardship even in markets like the U.S. and Europe. When one focuses on innovation arising from a network – the nature of most endeavors now – one understands that it is the fusion of contributors to that network linked to markets which is the core of enterprise creation – not the access to restrictive, usurious capital seeking its rapid return. Programs like the Heritable Innovation Trust and the Peace Trade initiative have been established to formalize market accountability for programs that engage communities and networks – focusing on the dynamics of value in clusters of entrepreneurial endeavors rather than seeking the isolated lottery winnings for the few. In these and other programs, engagement of the full supply chain in every element of the commercial pursuit not only enhances the opportunity for more ethical treatment of people and their environments but also raises the value of production to include social benefit premiums.

Innovation literacy, put simply, is fundamental to engaging actors within communities around business and market models based on genuine conditions and market dynamics rather than holding out wistful models that are neither true in their telling nor reproducible in their promotion.

This cannot be more clearly critiqued than in the telling of the story of the last 60 years of entrepreneurial activity in the U.S. What the world has never been told is that we didn’t start our economy with angel funds and venture capital. We didn’t have a Constitutional right to an IPO. Rather, the U.S. and Europe deployed protectionist government procurement, aided by expropriated knowledge from enemies and allies, to create pockets of excessive capital that, when fully satiated in their own market hegemony, started capturing other pieces of industry in an ever expanding reach first in our own borders and then around the world. Holding out the false aspiration that others could follow suit, the U.S. promoted the fallacy of its model for others to replicate and without fail, countless nations have followed blindly into models which have left their populace disillusioned and more impoverished. It was government purchasing and preferential purchasing of everything from cars to chemicals to silicon chips that built American wealth – not fair trade. In fact, in the early 1980’s it was our fear of Japanese technology that reinforced our modification of patent laws and investment policy to artificially enhance our innovative position in the world.

In India alone, hundreds of U.S. Patents from thousands of labs have been filed with virtually no commercialization in any fashion. Meanwhile these pieces of property have served to inspire thousands of commercial projects for which no benefit has returned to India. Thousands of plants, heritable knowledge elements and know how has been taken from India with no concerted program to repatriate it or the profits derived therefrom. And all the while, India’s government and those throughout the world, are forced to accept fraudulent patents on medicines and technologies which have been granted in error without any access to equitable relief. In both IPR and trade, the U.S. and Europe utilized their market influence to generate wealth and, having arrived, then created rules forced on the rest of the world to deny the rest of the world the utilities they used in their own ascent.

I am reminded of the image carved into one of New York’s landmark buildings depicting the Auschwitz concentration camp with the inscription “Indifference to Injustice is the Gate to Hell”. Aligning with those who, having used protectionism to gain power, prohibit others from favorable purchasing and consumer dynamic enablement, is participating in an injustice that has cost millions their lives and livelihoods and cannot be tolerated. It is, in the final analysis, the case that any endeavor in business incubation must benefit from market and public policy that is willing to invest in enterprise by being its first customer, not creditor. Gross Innovative Output must be a condition adopted by, and assessed within all levels of tender and procurement and is essential for any nation to integrate if it is to create a dynamic and healthy domestic enterprise environment. The purchasing of locally supplied products and labor, at a premium, has been shown to be the fuel for the U.S., Japanese, Korean, Chinese, and European economies and it must be promoted for the benefit of all nations.

Now we come to my favorite topic – Innovation Recycling. To know me is to know that I have advocated my whole life for accountability in innovation. With over 50 million patents issued around the world covering all manner of technology, good, or service, the world is awash with disclosures of creativity and corruption, transformative enablements and imposters. However, in the past 10 years, this chaos has provided the compost – or recycling – for a new opportunity. During the expansion of the leveraged merger and acquisition markets over the past 15 years, it became quite common for larger integrated companies to acquire smaller innovative companies for one or two core products or capabilities. All in-process and non-core technologies held by the acquired company were abandoned as “non-core”. If a technology didn’t generate over $100 million in annual revenue, it was discarded outright by several major corporations. In short, the majority of acquired innovation was put in the rubbish heap for the short term exploitation of the select few. In every key environmental technology sector, for example, more patents were abandoned and expired into the public domain than all currently enforced commercial platforms. In short, the solutions for everything from distributed power, to fuel cells, to intelligent batteries, to wind, solar, water energy and purification, hydrogen fuel, and much more is available in the Open Source commons as expired and abandoned. This was not because it was useless. Rather it is because it had not yet achieved a level of commercial output to displace the incumbent – often inferior – technology. Every incubator and innovation lab should immediately put in place an active profile of this recyclable asset pool for research, development, repurposing and commercialization. In addition, the innovators, whose work was abandoned and discarded, can be re-enlisted to help bring new life to their discarded and overlooked creativity enabling new models of value creation and social network exchanges.

This type innovation network re-engagement facilitates what I refer to as “Fusion Networks” where we catalyze industrial and gross innovation output with the same restrictive properties – now in the public domain – that had precluded earlier use and adoption. By seeing what has been done and learning from barriers to commercialization, the emerging entrepreneur can pre-qualify countless resources that were once thought to preclude engagement and now repurpose these into value components. This open source innovation stewardship views innovation in the appropriate light of what it is – namely, a utility of enterprise, not the enterprise in and of itself. By right-sizing awareness of interdependency, the common impediment to incubation emanating from the innovator seeing him or herself as the exclusive enabler is mitigated with evidence sourced from numerous inputs provided by innovation recycling.

The journey towards a future integrating innovation literacy, gross innovative output and innovation recycling can begin here today. In point of fact, it has begun whether we like it or not. There will be no Silicon Valley or Bavarian economic miracle in India because it wasn’t a miracle where the legends started. Exploitative capital will not build the next economy or the next nation. By educating ourselves to see that value – and all the dimensions of wealth – manifest when we focus on humanity rather than the artifacts created thereby we can create models of providential wealth which create lasting industry with purpose rather than short term punctuated equilibriums of extractive excess. Rather than teaching our entrepreneurs how to win exclusively, we can support efforts to expand the use of and contribution to the commons. As David Bollier points out in his book Viral Spiral, the rise of social network utilities on the internet has already catalyzed the emergence of economic innovation not considered just 5 or 10 years ago. This dynamic can spread to other domains.

Specifically, we recommend that discussions of capital access be replaced with discussions of customer facilitation and value recognition. Realizing that investment is constrained to achieve a neutral effect – a dollar invested is a dollar spent – where as market validation is value accretive and capable of supporting ethical financial services, our efforts should be to map and then facilitate market access. At a public policy and NGO level, this means purchasing from local SMEs and, when larger tenders are constructed for national procurements, governments should insist on the use of innovation recycling, open source innovation and facilitate the same through the use of Global Innovation Credits. This scheme allows a government to purchase from suppliers who are ethically using open source and charging premiums only where genuine new effort and innovation is required.

Today, as we kick off the 4th Asia Pacific Conference on Business Incubation, let us commit to ourselves and the world that we will apply the same level of innovation to our thoughts and deliberations as we expect from our entrepreneurial community. Let us not perpetuate the myths and legends which have cost global economies billions of dollars in futile social and business infrastructure and at least three decades of fruitless wandering. Rather, let us rise in this occasion to the new day. A day which sees Heritable Innovation honored, that sees domestic production and innovation validated with customers, and that sees the masses rise on the innovation recycled from neglect and misuse and repurposed for a cleaner, greener, ethicological future.