Labs

2011

18

November 2011

Developing Innovative Energy Infrastructure Financing

Washington, D.C.

Communities around the country are looking for new avenues to promote job creation. But since government budgets are shrinking and the financial sector is increasingly risk averse, what will jumpstart economic growth? And what types of innovative investment products can help?

One answer - supported by economists on both sides of the aisle - is to scale up both public and private funding for infrastructure development. The energy sector, for example, could benefit from substantial investment. There are currently huge unmet needs, from updating the nation's aging electricity grid to creating improved distribution networks for renewable products. But the right government incentives must be structured to deliver financing at the right times to the right companies.

To address the challenges in financing energy infrastructure, the Milken Institute, in conjunction with the U.S. Department of Agriculture's Office of Energy Policy and New Uses, convened a group of energy experts, financial and corporate investors, bankers, scientists, technologists, U.S. government representatives and researchers from national laboratories.

Participants discussed successful models of infrastructure finance that could be replicated in the U.S. energy sector, from the debt and equity products offered by the Overseas Private Investment Corporation (OPIC) to the structured and project finance mechanisms leveraged by the Export-Import Bank, to successful programs run by state governments. Learning from best practices in other industries and regions, these mechanisms would facilitate long-term, low-cost financing for energy infrastructure development, impacting rural communities and urban areas alike.

The Lab served as a useful platform to refine new and existing investment models as well as credit enhancements and other risk-mitigation tools that can be deployed to finance large-scale infrastructure projects. The session examined how each model could impact the entire value chain, noting that each stage of technology innovation has specific financing needs.

Following the Lab, participants reconvened for smaller working sessions to further explore potential models and products discussed during the initial session. Ideas suggested included a green bank and a one-stop financing facility.

Results from the Lab, including recommended next steps for implementation, can be found here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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07

October 2011

Affordable Housing and Entrepreneurship in the Lower Rio Grande Valley

Weslaco, Texas

Valerie Piper from the Department of Housing and Urban Development and Bobby Calvillo of Affordable Homes of South Texas discuss successful government programs that have enabled broader access to lower-cost capital for home buyers.
Lisa Prieto of the University of Texas-Pan American suggests a task force organized by the university to facilitate greater collaboration among valley stakeholders.
The lower Rio Grande valley of Texas, encompassing four counties on the U.S.-Mexican border, is plagued by high unemployment, low wages and limited access to decent housing. The region's 1.3 million people face poverty and limited opportunities for entrepreneurship. Banks and other financial institutions have traditionally been reluctant to lend to the valley's residents, many of whom lack real assets and have poor credit scores. Whether they are looking to purchase a new home, retrofit an existing structure or start a small business, residents of these underbanked communities face a significant hurdle in trying to tap the capital markets.

To address the region's access to capital, the Milken Institute, in conjunction with the Ford Foundation, convened a group of community development organizations, investors, government leaders, academics and private-sector practitioners. Other participants included the U.S. Department of Housing and Urban Development, the Community Development Corporation of Brownsville, the University of Texas Pan American, Homewise, EDCO Ventures, the U.S. Department of Agriculture and many other engaged organizations. Their representatives discussed incentives and models to re-engage the capital markets in lending to valley residents, promoting economic growth and job creation.

The Ford Foundation, which has a strong history of investment in social development, gave an overview of its long-term goals for the region: creating living-wage jobs and developing housing, transportation and land-use opportunities. They hope to achieve these aims by bringing together regional stakeholders to work together to remove barriers to development.

Because Lab participants represented a diverse set of interests in the lower Rio Grande valley, much of the conversation focused on how development efforts could become less fragmented and more unified. Currently, most of the innovative community development projects operate in independent silos; there is no comprehensive valley-wide initiative in place to coordinate the key stakeholders.

The Lab served as a useful platform for launching a more holistic development plan. Tangible next steps were identified, including the creation of a new valley council that will coordinate various group efforts, as well as other related policy and economic recommendations to leverage public incentives to create more attractive lending policies.

Results from the Lab, including recommended next steps for implementation, can be found here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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19

July 2011

Financial Innovations for Translational Medical Research

New York

Turning science into medical solutions requires innovators to leap all kinds of hurdles, but one of the biggest is the financial "Valley of Death," where many underfunded early-stage ventures meet their demise.

To help bridge this funding gap, dozens of investors and innovators convened for a Financial Innovations Lab to explore the approaches being used to advance initiatives in medicine and other industries. Organized by FasterCures and the Milken Institute, the Lab was designed to explore whether these financial tools could be applied to translational medical research.

The Lab spotlighted models for partnering in research and development, and identified finance instruments and incentives, some of which are described below.

  • The "distributed partnering model" utilizes product definition companies (PDCs) that identify and license promising early-stage assets from research institutes, manage product definition research, and sell de-risked assets to later-stage stakeholders. The PDCs make $3 million to $5 million investments aimed at attracting additional funding.

  • BioPontis Alliance is a hybrid investment fund and product development company that aggregates technologies from a consortium of universities. It screens these assets, develops them through a translational development network and then licenses them to strategic pharmaceutical partners. Its activities are supported by a $50 million fund. The model encourages sourcing of early-stage assets from academia by pooling and sharing the value of intellectual property, and helps ensure later-stage funding by establishing relationships with pharmaceutical companies. This proposition is made more attractive to universities via a master IP licensing agreement that expedites the process and grants universities a pro-rata share of the total value created by the assets.

  • Fast Forward, a wholly owned subsidiary of the National Multiple Sclerosis Society, represents a new venture philanthropy model. It provides leveraged, philanthropic funding to translate academic research and further develop biotech research into new treatments. The technologies are identified and evaluated by scientific and business advisors. Fast Forward makes investments in the range of $250,000 to $1 million.

  • The Israeli Life Sciences Fund uses a standard venture capital-structured fund with the government and the private sector as limited partners. The Israeli government, which takes the first loss before the other limited partners, has committed $80 million to boost returns for private investors.

  • Flow-through shares, which originated in the Canadian resource industry, encourage higher-risk investments through tax incentives. Oil and mineral exploration companies issue these shares as a way to pass government tax deductions for exploration on to investors, effectively halving the risk of investment.

    There was broad agreement that the medical research system has much to learn from financial models that have worked in other industries such as filmmaking, telecommunications, and oil and gas. But participants cautioned against simplistic analogies, noting the unique circumstances that define the medical research process. Science is unpredictable, and failure to fully vet a product has consequences that are measured in terms of life or death.

    Results from the Lab "Fixes in Financing: Financial Innovations for Translational Research" can be found here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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  • 05

    May 2011

    Structuring Israel's Sovereign Wealth Fund

    Beverly Hills, CA

    Eugene Kandel, head of the National Economic Council, discusses Israel's long-term strategic goal to use revenue from the recent gas discoveries to benefit both current and future generations.
    Karnit Flug, deputy governor of the Bank of Israel, explains the potential impact of the growing foreign exchange reserves on the Israeli economy. Also pictured is Sir Ronald Cohen of Bridges Ventures and The Portland Trust.
    Israel is anticipating a dramatic surge in income from foreign exchange reserves from high-tech exports and the massive natural gas fields that were recently discovered. This capital flow could quickly increase foreign exchange reserves and strengthen the shekel, creating undesirable economic side effects.

    The billions of dollars in potential revenue could lead to drastic currency appreciation that would threaten the competitiveness of the country's export sector while building inflationary pressures domestically.

    Many resource-rich countries - from Norway to Singapore and South Korea - have created national sovereign wealth funds (state-owned sovereign investment funds) to invest revenues globally as a way of moderating inflation risks and creating an effective investment mechanism for national economic development. In fact, the total assets under management of sovereign wealth funds exceed $4 trillion, far more than private equity and hedge funds in the global financial markets.

    Sovereign wealth funds are not a homogeneous group with a shared goal. They are driven by different objectives that include fiscal stability, internal development, future savings and increasing returns on foreign exchange reserves. Based on its objective, each fund holds a different position in the spectrum of risk tolerance and uses different investment strategies.

    The Milken Institute, at the request of Israel's National Economic Council, conducted a Financial Innovations Lab to discuss and map potential designs for an Israeli fund, including its legal structure, governance framework and investment strategy. The session brought together a diverse group of policymakers, scholars, investment fund executives, financial industry and sovereign wealth fund advisors, and representatives from NGOs for practical advice on how to structure the fund and address pot ential challenges.

    Experience shows that in some countries these funds have been compromised by political pressures and require more effective corporate governance. Participants examined various best practices to ensure adequate governance and asset management with the goal of carving out new channels of capital for savings and investment in Israel's dynamic economy while avoiding inflationary pressures. Additionally, Lab participants examined trade-offs between investment vs. sovereign debt retirement or restructuring. The Lab reviewed methods for allocating gas revenues toward investment or debt retirement.

    After presentations on Israel's macroeconomic condition, participants debated the purpose of an Israeli fund and examined its potential to further enhance and secure national retirement insurance. The group suggested that Israel establish as soon as possible a small fund that can be expanded later. A benchmark rate of return was also discussed, and participants agreed that revenue could be spent domestically on improving human capital and security once return thresholds were achieved.

    Results from the Lab, including recommended next steps for implementation, are available here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    10

    January 2011

    Financing Solid Waste Management in Israel

    Jerusalem

    Gilad Erdan, Minister of Environmental Protection, opens the Lab session with an introduction of the current challenges Israel faces in improving solid waste management.
    Each year, Israel generates millions of tons of waste. Given the scarcity of land and resources, the ever-growing challenge in solid waste management is coming to a head. The current landfill system is unsustainable, the overall recycling rate is less than 25 percent and efforts to change the status quo have proven ineffective to date.

    Over the past two years, the Ministry of Environmental Protection has led a concentrated effort to initiate the "solid waste revolution" in Israel, attempting to convert a troubling environmental nuisance into a valuable asset through recycling and waste-to-energy plants. New legislation, such as the packaging law and the landfill levy, has been taken up by the Knesset. Once approved, these new regulations will generate income, creating a pool of funds for building transfer stations, treatment plants and additional infrastructure for the separation of waste at the source. Nonetheless, the revenues from these new fees are insufficient to meet the financial needs for solid waste mitigation.

    Improving solid waste management requires a systematic approach to encourage cooperation from all market players. Unfortunately, there has yet to be a fully coordinated effort to approach the issue from both economic and technological perspectives. Although the new legislation defined potential sources of revenue, there are still many questions that need to be addressed in order to effectively leverage governmental funds with private capital.

    The Milken Institute, in partnership with the Ministry of Environmental Protection and with support from the Richard and Rhoda Goldman Fund, convened a Financial Innovations Lab to tackle this important issue. Its goal was to identify and consolidate various sources of capital, fully leveraging public and private funds to scale up solid waste solutions. The session brought together a diverse group of scientists, financial practitioners, governmental officials, foundation executives, and technology experts to design potential models.

    Participants heard presentations on specific programs in Europe, Asia and the United States, then debated which models could be best adapted to Israel. The approaches most likely to be effective in Israel include revolving loan funds, bond banks, and pilot grants using private-public partnerships and possible bank syndications for project finance.

    The Ministry has already begun promoting the ideas from the Lab to ensure that these solutions are quickly operational. Legislative language was changed to enable greater flexibility in the use of government revenues, such as loans or equity, in structured financial solutions as opposed to relying solely upon grant formulas.

    For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    2010

    15

    December 2010

    Creating Mechanisms for Biodiversity Conservation Finance

    Jerusalem

    Patrick O'Connor, of O'Connor NRM Pty Ltd. and the University of Adelaide, discusses mechanisms currently in place in Australia that could be replicated in Israel. These include an auction system that allows landowners to access funding for conservation services.
    Global warming has had a devastating effect on the world's biodiversity. As populations increase and the availability of open land decreases, the variety of species and habitats diminishes. This destruction threatens the health of the planet's ecosystems, affecting water quality, soil erosion and agricultural productivity.

    Nowhere is this situation more apparent than in Israel, where competition for land is fierce. Population density has grown steadily over the past decade. This has led to a sharp increase in commercial and residential development. Given the country's variety of species and diverse terrain, there is an urgent need for improved conservation. Previous efforts to protect the country's environmental assets have largely been policy-based, with a focus on designating protected areas through a national parks system. This has proven ineffective in stopping the loss of biodiversity in the region.

    Biodiversity, as a public good, is currently undervalued. Consequently, there has been little incentive to change market behaviors toward land use. In recent years, however, financial mechanisms have been created to sustain conservation. Payments for ecosystem services, land auctions and other compensation programs have been utilized in a variety of countries. Biodiversity banking, for example, creates opportunities for developers to trade the offsets of potential destruction while earning a profit on increasing land values.

    The Milken Institute, at the request of Israel's Ministry of Environmental Protection, convened a Financial Innovations Lab to evaluate potential incentive programs and other financial mechanisms that could be used to appropriately value Israel's biodiversity. The session brought together a diverse group of scientists, capital market experts, governmental officials, foundation executives, architects and land developers to design and structure potential models.

    Participants discussed how to achieve the optimal level of conservation while maintaining cost efficiency. Following presentations on specific programs in countries like the United States and Australia, participants debated which models could be most applicable to Israel. There was a focus on potential bottlenecks and barriers to the adoption of these models. Participants then suggested the creation of case studies that would further examine the feasibility of financial mechanisms to support environmental and economic growth.

    Results from the Lab, including recommended next steps for implementation, will be published in a full report. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    07

    October 2010

    Using Pull Mechanisms to Advance Food and Income Security in Sub-Saharan Africa

    London

    Dr. Musa Fanikiso, managing director of Midzi Agricultural Development Services, discusses the challenges of eradicating livestock disease in sub-Saharan Africa.
    Dr. Prem Warrior, senior program officer at the Bill & Melinda Gates Foundation, discusses incentives for farmers to utilize biocontrol products that reduce aflatoxin contamination. Also pictured is Dr. Salisu Ingawa, special advisor to Nigeria′s minister of agriculture.
    In sub-Saharan Africa, nearly two-thirds of the population depends on farming for their livelihood. Improving agricultural productivity is the key to raising the standard of living and reducing chronic hunger.

    But several factors threaten this progress. Contagious bovine pleuropneumonia (CBPP), a respiratory disease affecting cattle, is among the most serious livestock diseases in sub-Saharan Africa, imposing substantial costs on farmers and weakening the region's food security. Aflatoxin, a disease that affects maize, groundnuts and other crops, results in annual trade losses of almost a half-billion dollars and poses a real health risk.

    Solutions exist for both of these problems. Improving the inconsistent vaccine manufacturing process for CBPP is clearly achievable, and aflatoxin biocontrol is being used successfully in the United States. But various challenges prevent these interventions from being applied widely and efficiently in sub-Saharan Africa.

    The Milken Institute, in conjunction with the Bill & Melinda Gates Foundation, convened two half-day Financial Innovations Labs aimed at overcoming the challenges. Participants included authorities from finance, development finance institutions, philanthropy, academia, government and NGOs, as well as scientists, manufacturers and buyers. The Labs focused on the use of "pull mechanisms," whereby donors provide funding only when specified outcomes are delivered and adopted.

    Contagious bovine pleuropneumonia (CBPP)
    The CBPP Lab began with the question of how to incentivize R&D and manufacturing of a better vaccine for CBPP. William Amanfu, formerly of the U.N.'s Food and Agriculture Organization, described problems with the current vaccines: They confer less than full immunity, can cause side effects in vaccinated animals and require frequent boosters. Other barriers exacerbate the issue, including difficulties with vaccine distribution and quality, deterioration of vaccines in the field, incorrect administration and a lack of data on disease incidence and vaccinations.

    Developing a new vaccine would take 10 to 15 years, according to Declan McKeever, a professor at The Royal Veterinary College. Participants considered whether new technology was essential to CBPP eradication or whether alternatives - such as improving the existing vaccine, enhancing its distribution and administration, or expanding the use of antibiotics - might be more promising.

    Participants concluded that a mix of solutions and funding strategies is necessary. Push funding, or upfront grants, could be used to increase tracking of disease occurrence and vaccinations. Pull mechanisms, such as price guarantees from donors, could incentivize manufacturers to produce consistently high-quality vaccines. But the Lab concluded that the economic argument for public and private involvement must be better developed.

    Aflatoxin
    In the Lab session on aflatoxin, participants examined how to incentivize smallholder farmers to buy aflasafe, a biocontrol product developed in Nigeria. Ranajit Bandyopadhyay of the International Institute of Tropical Agriculture explained how aflasafe has performed successfully in trials, reducing contamination levels by 80 percent on average. Participants discussed other means of reducing aflatoxin and concluded that using biocontrol in combination with drying technologies is the best way forward. But encouraging farmers to buy biocontrol poses a challenge. Most of their crops are sold locally, where little distinction is made between contaminated and aflatoxin-free products. On the health side, the benefits are too uncertain or far into the future to be considered.

    Orin Hasson of the Gates Foundation discussed how pull mechanisms might be used to encourage farmer demand for aflasafe. A pay-for-performance model, in which individual farmers are rewarded for using biocontrol in their fields or national governments are paid based on macro-indicators of aflatoxin reduction, emerged as the most promising approach. Participants discussed the next steps needed to create a pilot program, from collecting data on the extent of the aflatoxin burden in the target country to mapping out surveys and awards.

    To read the results of the Lab, including recommended next steps for implementation, view the full report. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    29

    July 2010

    Opportunities for Restructuring in State and Municipal Finance

    New York

    Robert Litan, right, vice president for research and policy at the Ewing Marion Kauffman Foundation, takes part in a discussion of oversight mechanisms for cities in distress at the Financial Innovations Lab. With him are Glenn Yago and Betsy Zeidman of the Milken Institute.
    The Great Recession has had a devastating effect on state and municipal budgets throughout the United States. While an economic recovery will alleviate the cyclical components of today's crisis, tackling the structural aspects of budget shortfalls will be paramount for long-term stability within the nation's 91,000 local governmental units. Revenue/expenditure mismatches, trillions in unfunded or underfunded pension obligations, increasing longevity and the escalating cost of other post-employment benefits all need to be addressed.

    The Milken Institute, along with the Kauffman Foundation, convened a Financial Innovations Lab to identify solutions. Participants included state and local government officials, union representatives, capital markets experts, money managers, academics, public-sector attorneys and representatives from bond rating agencies.

    Michael Pagano, dean of the College of Urban Planning and Public Affairs at the University of Illinois, Chicago, said 2010 will mark the first time since the Great Depression that income, sales and property taxes will decline across the board. To strengthen tax receipts going forward, Pagano proposed broadening the sales tax to include services and extending the property tax to sites that are now exempt.

    Changes are likely in store for public pensions as well, said Robin Prunty, managing director in the Public Finance Ratings Group at Standard & Poor's, which uses public pension funding ratios to formulate state bond ratings. Noting that more than a decade has passed since the Governmental Accounting Standards Board last revised public pension rules, Prunty predicted major modifications for public pension accounting, reporting and pension obligation funding methods.

    Participants agreed that Chapter 9 bankruptcy and other pre-packaged proposals are an unappealing last resort for municipalities in distress. Henry Kevane, managing partner at Pachulski Stang Ziehl & Jones LLP, spoke from his past experience with Orange County's 1994 bankruptcy filing, calling the Chapter 9 process a costly, arduous gauntlet for municipalities. To better deal with municipalities on the verge of bankruptcy, participants suggested revisiting the concept of oversight control boards such as New York's Municipal Assistance Corporation of the 1970s, and models such as the Pennsylvania Intergovernmental Cooperation Authority.

    Among the more noteworthy remedies suggested were:

  • Adopting standardized actuarial assumptions for public pension retirement plans
  • Implementing multi-year budgeting plans for municipalities
  • Considering economies of scale through consolidation of service providers and even municipalities themselves
  • Revisiting the concept of rainy-day funds
  • Using short-term federal stimulus funding to nudge states and municipalities toward long-term restructuring

    Participants agreed that long-term solvency for states and municipalities will require structural, even painful paradigm shifts. But kicking the can down the road is no longer a viable option.

    To read the results of the Lab, including recommended next steps for implementation, view the full report. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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  • 27

    July 2010

    Delivering on the Potential of Industrial Biotechnology

    Washington, D.C.

    Putting their heads together at the Financial Innovations Lab are, from left, Alan Boyce of Adecoagro, Glenn Yago of the Milken Institute and Ronald Stoltz of Sandia National Laboratory.
    Industrial biotechnology has great potential to replace plastics and a wide range of other consumer goods with more sustainably produced products. Instead of petroleum, bioplastics use agricultural products as a feedstock. The products are biodegradable, the manufacturing requires less energy, and the novel process can reduce overall demand for oil.

    Industrial biotechnology ventures face intense competition from petrochemical companies in the consumer goods industry. These ventures are particularly sensitive to institutional and financial barriers that prevent growth and hinder commercialization.

    To help industrial biotechnology ventures overcome these hurdles, the Milken Institute, in conjunction with the U.S. Department of Agriculture's Office of Energy Policy and New Uses, convened a Financial Innovations Lab. The group included top scientists and economists in academia, institutional investors, policymakers, biotech company professionals, and industry association representatives.

    Biological innovation has grown rapidly, and the market for environmentally friendly products is expanding. But because the initial research is so costly, these products can't compete with petroleum-based alternatives on price. Marvin Duncan, Senior Agricultural Economist at the USDA, said the industry will require increased public investment in basic R&D.

    Bobby Bringi, CEO of the MBI International, said strategies for reducing risk to the industry should be applied to attract private investment. He suggested bundling intellectual property and sharing its value equitably among the players in product development, the most costly stage of the process.

    Recurring themes at the Lab included the importance of industrial biotechnology to energy security, its ability to create jobs (especially in rural America) and the role of government in supporting this nascent industry.

    Among potential solutions the participants suggested are:

  • Increasing public-private partnerships in the form of shared research and product testing facilities
  • Using government to push supply and pull demand, following the model of the USDA's BioPreferred program, which assures purchases by government agencies
  • Improving the supply and reliability of government assistance
  • Exploiting the unrealized value of intellectual property to leverage financing
  • Creating technology efficacy insurance to minimize the risk of new ventures
  • Employing standardized investment bonds similar to those found in Danish investment models.

    To read the results of the Lab, including recommended next steps for implementation, view the full report. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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  • 29

    June 2010

    Retirement Security: Overcoming the Legacy Costs of Private Pension Plans

    New York

    Bradley Belt, left, discusses the growing pension crisis, based on his expertise as chairman of Palisades Capital Advisors and as former executive director of the federally chartered Pension Benefit Guaranty Corp.
    As the baby boomers near retirement, a growing pension crisis threatens many workers' chances of receiving the benefits they were promised by their employers. Moreover, underfunded pension liabilities also threaten the valuations of a growing number of public corporations at a time when they are facing other capital constraints.

    In 2009, some 350 firms in the S&P 500 with defined benefit (DB) plans faced a funding deficit of $263 billion. The recent market downturn has sharply worsened underfunding; these companies' plans slid from being 94 percent funded in 2007 to being only 80 percent funded in 2009. Business-as-usual investment strategies are being challenged, and there is an increased risk of exposure for the Pension Benefit Guaranty Corporation (PBGC).

    The Milken Institute, along with the United Food and Commercial Workers (UFCW), convened a Financial Innovations Lab to explore strategies for overcoming the spiraling unfunded legacy costs of private DB plans for current and retired employees. The UFCW's David Blitzstein discussed alternative private pension plans, but pointed out that sponsoring companies will not be able to move toward a more sustainable future plan without resolving the existing unfunded liabilities.

    The restructuring and settlement process of the DB system's unfunded legacy costs requires involvement from all stakeholders: plan sponsors, companies, participants, unions, the PBGC and the government. Bradley Belt, chairman of Palisades Capital Management and former executive director of the PBGC, discussed the impacts on all stakeholders, constraints of current laws and regulations, and the limitation on PBGC's ability to act (currently, the PBGC cannot negotiate/establish a revised contribution schedule with ongoing plans, though it can set the terms of repayment for a terminated plan).

    A possible solution presented by economist Jeremy Gold includes a one-time move to full funding utilizing a bond swap between plan sponsors and PBGC. Participants noted that introducing PBGC bonds into capital markets would increase transparency both at plan levels and at PBGC.

    Lab participants agreed that a one-size-fits-all approach simply won't work. They concluded that existing plans need to be tested and then separated into three groups:

    1) The marching ahead: Unfunded liabilities for this group can be resolved using the strategy proposed by Jeremy Gold, or a similar mechanism.
    2) The walking wounded: The solution for this group is to give PBGC negotiation authority, change the plan structure and share the costs of restructuring among stakeholders.
    3) The walking dead: The unavoidable solution for highly distressed plans is for the PBGC to work out and refinance. Participants discussed how the sharing of the cost burden could be termed out with federal support on a basis that would isolate these liabilities and mitigate further losses.

    Emily K. Kessler, senior fellow at the Society of Actuaries (SOA), suggested financing unfunded liabilities through industry-specific taxes. Karyn Williams, managing director at Wilshire Associates, called for more focused capital market solutions. The competitive annuity markets, private insurance, liability-driven investing strategies, dynamic portfolio management enabling duration matching, and macroeconomic aspects were also discussed.

    To read the results of the Lab, including recommended next steps for implementation, view the full report. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    29

    April 2010

    Financing Alternative Fuels: How Israel Can Catalyze Global Oil Independence

    Santa Monica, CA

    Eugene Kandel, right, head of the National Economic Council in the Israeli Prime Minister′s Office, discusses how Israel can position itself on the cutting edge of the oil substitutes industry as a way to fuel its economy.
    Israel is in a unique position to catalyze a shift away from global oil dependence. With strong intellectual property and patenting experience, coupled with the vast expertise of its venture capital community, Israel can deploy a variety of policy and financial instruments to accelerate the development of its alternative fuel industry. This strategic decision could position Israel as a technology, innovation and financial center for the industry.

    Toward that end, this Financial Innovations Lab was convened to design economic models to speed the development and usage of fossil fuel substitutes. The session, held in conjunction with the National Economic Council of the Israeli Prime Minister's Office, explored specific, replicable policies and strategies to channel financial capital into alternatives to oil. The Lab focused on encouraging cross-border collaborations to develop and implement these solutions around the world.

    Lab participants recommended a systematic approach to expanding the nascent industry and creating viable, competitively priced alternatives to oil. This is accomplished in part by financial incentives and regulatory support that are specific to each stage of development. By building a research consortia focused on innovations, investing in emerging technologies, and scaling up more mature products, Israel can become a global leader in the sector while creating thousands of jobs and driving economic growth.

    Currently Israel's burgeoning clean-tech sector - alternative fuels, storage, wind, and solar technologies - faces a series of challenges in accessing capital. Across the innovation value chain are "valleys of death," where companies become trapped and unable to move to the next level of development because the tradeoff of risk and reward is not sufficiently attractive to investors.

    To bridge these valleys of death, Lab participants discussed how to best leverage public funding with private capital to scale up the overall industry. The focus is on a series of regulatory and financial mechanisms, including government incentives, funds, and public-private partnerships that would promote access to capital along every stage of the value chain.

    These steps were deemed the most critical to implementation:

  • Create a tax environment that would give Israel the most favored investment status globally for fuel substitutes
  • Early stage: a prize contest and a database to develop partnerships to leverage Israeli capital
  • Mid-to-late stage: incentives to attract foreign capital, including a venture capital (VC) fund and government incentives
  • Project stage: a fuel substitute financing facility that can benefit cross-border partnerships to drive scale

    For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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  • 2009

    17

    December 2009

    Antiquities as an Economic Development Resource

    Jerusalem

    Deputy Mayor of Jerusalem Naomi Tsur discussing the need for more sustainable funding sources for the city's archaeological sites.
    The Lab's participants, including experts from Israel and abroad.
    The demand for archaeological artifacts has encouraged a billion-dollar black market and accelerated the destruction of the world's cultural history through looting and vandalism.

    Nowhere is this issue more critical than in the Middle East, where demand for artifacts is feverish. To ensure legal archaeological discovery and conservation, the players must be given incentives to change. By shifting the focus from the value of specific objects to overall cultural appreciation, financial tools can increase funding for archaeological development and preservation in the countries of origin.

    With that goal in mind, the Milken Institute convened a Financial Innovations Lab in Jerusalem to focus on strategies for leveraging public funds with private capital to finance archaeological preservation and conservation. The ideas were based on a previous Lab held by the Institute in Santa Monica in January 2008. Specific models were examined to not only provide much-needed funding, but also to lessen the impact of the illicit trade of antiquities on the region.

    Participants included representatives from Israel's Antiquities Authority (IAA), the Nature and Parks Authority (NPA), the Tourism Ministry, local municipalities, international archaeologists, capital markets experts, finance specialists and representatives from international legislative bodies, including UNESCO.

    Cultural heritage is not often understood as an economic resource, and because equating antiquities with commodities is unpopular with archaeologists and governments in countries of origin, there has been little research into structuring sustainable funding sources. As Glenn Yago of the Milken Institute demonstrated, undervalued markets can be transformed once they are organized appropriately. For example, in environmental finance, pricing the value of carbon has revolutionized the approach to climate-change legislation.

    There are significant challenges in preserving Israel's archaeological resources and preventing further destruction through illegal looting. Ze'ev Temkin, architect of the popular sites Caesarea and Masada, explained that there is difficulty coordinating the various ministries and local governments, especially when it comes to launching archaeo-tourism.

    Other participants noted that the current policies of the Nature and Parks Authority hinder sustainability. Currently, all revenue generated from national parks, whether archaeological sites or environmental sites, is channeled back to the central office of the NPA. The parks that create the most revenue often never see any benefit, because their sales supplement the NPA's small budget to maintain all 66 total national parks and 190 nature reserves.

    Raanan Kislev, director of the Site Conservation Administration at the Israel Antiquities Authority, discussed how his team manages site preservation despite a very limited budget. The IAA is given an extremely small allocation from the national budget in comparison to other agencies, and the budget specifically for preservation, as opposed to excavation, is even more limited.

    Larry Coben of the Sustainable Preservation Initiative of the Archaeological Institute of America discussed how local communities can benefit from sites through microfinance and small business development. Brent Lane of the University of North Carolina presented a venture capital model, demonstrating how a portfolio of sites could be developed and funded though private investment. Glenn Yago presented the Institute's ideas from the previous Lab held on the topic, including an archaeological development bond and other public-private partnerships.

    Participants broke into working groups to review the potential revenue streams and local economic benefit of specific sites. Jaffa, Megiddo and Jerusalem were singled out as needing creative solutions to generate long-term preservation. Top priorities for participants were rethinking the marketing of each sites' historical narrative and understanding how to best digitize each site for mass consumption. All participants agreed that sites must work in coordination with local communities to promote preservation while generating economic development.

    A full report is available in English or Hebrew. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    12

    November 2009

    Scaling Investment in Residential Energy Efficiency

    New York

    Residential energy use accounts for 20 percent of the greenhouse gas emissions in the United States. Numerous studies have found that nationwide energy efficiency upgrades would not only pay for themselves but also would significantly reduce emissions and create green jobs in the process.

    With that goal in mind, the Milken Institute, along with the Energy Programs Consortium and the Ford Foundation, convened a Financial Innovations Lab at the Ford Foundation in New York. This daylong session focused on strategies for leveraging public funds with private capital to finance home weatherization. It also identified residential energy efficiency financing models that could bring home retrofit markets to a national scale.

    Participants included federal and state energy officials, U.S. government officials, bank executives, institutional investors, secondary market experts, community organizers, foundation officials, and representatives from think tanks and clean-tech industry associations.

    There is still very low market penetration for efficiency upgrades despite the existence of multiple programs. The Milken Institute's Betsy Zeidman pointed out the difficulties consumers face. But above all, there is insufficient amount of private capital available for energy efficiency upgrades. The estimated cost of weatherizing the nation's homes comes to $1.2 trillion, and that kind of government funding is unlikely.

    There are already hundreds of state and local energy loan programs, but only a fraction of the potential energy savings has been achieved. States are considering alternate leveraging strategies and program designs that be implemented on a wider scale.

    The use of public funds presents a challenge, noted Martha Amram, CEO of Ennovationz and a senior fellow at the Milken Institute. She outlined the need for a financial instrument that is cost effective at scale and can drive down interest rates, emphasizing the need for conformity in rules so the mechanism can work across multiple states. This will be difficult to launch in our currently moribund securitization and mortgage markets.

    Participants presented examples of energy efficiency financing models that could be used to scale investment. Mike Lappin of the Community Preservation Corporation (CPC) discussed multi-family housing development based on the CPC financing model, which involves a formal application process, credit review and an energy audit.

    John Berdes of ShoreBank Enterprise Cascadia discussed on-bill repayment through utilities. This loan product is aimed at single-family markets and has no up-front or out-of-pocket costs. Loan repayments are paid via an energy bill, with energy savings generally covering the cost.

    Throughout the session, experts described the advantages and challenges of other possible approaches, including the Property Assessed Clean Energy (PACE) model, energy efficiency mortgages and unsecured energy efficiency home improvement loans offered through contractors. Keith Welks, deputy treasurer of Pennsylvania, described Pennsylvania's Keystone Energy Efficiency Loan Program, while Louise Kelly, president and CEO of EnerBank USA, shared EnerBank's experience with unsecured home improvement loans.

    Participants split into working groups to discuss the barriers and implementation steps for taking individual energy efficiency financial products to national scale. They concluded that: 1) one size doesn't fit all; 2) the endorsement of a reliable sponsor may improve consumer confidence; 3) private capital is needed to scale up residential energy efficiency; 4) it's important to design a one-stop shop that is easy, quick and convenient for the consumer; and 5) credit enhancements can lower interest rates and free up capital for secondary markets.

    A full report is available here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    23

    September 2009

    Scaling Enterprise Finance and the Future of Biofuels

    Washington, D.C.

    Alan Boyce, President and CEO of Adecoagro, leads a discussion about obstacles to second-generation biofuel production.
    The popularity of biofuels as a commodity and an investment has grown significantly in the past few years. Major market players have begun investing in these alternative fuels, and producers' revenue is expected to almost triple from 2008 to 2018. In addition, the Obama administration expects biofuels to be pivotal in addressing climate change and creating a greener economy.

    Yet many institutional, technological and financial barriers still exist, slowing the development of a solid biofuels market.

    To find out how finance might channel more capital into biofuels production, the Milken Institute, in conjunction with the U.S. Department of Agriculture's Office of Energy Policy and New Uses, convened a Financial Innovations Lab in Washington, D.C. The diverse group of participants included leading scientists and technologists, biofuel producers, rural stakeholders, banks, institutional investors, venture capitalists, public decision-makers, think tanks and clean-tech industry associations.

    Background

    Joel Kurtzman, Executive Director of the Milken Institute's SAVE initiative, discussed the opportunities that biofuels present for the environment and investors alike. Some of the challenges he identified were misallocated funding, badly designed incentives and inconsistent policies. Stephen Kaffka of the California Biomass Collaborative discussed how regulations and environmental assessments had affected biofuel crops.

    Christopher Groobey of Wilson Sonsoni Goodrich and Rosati gave the history of project finance as it relates to biofuels, and participants reviewed how insufficient expertise, scarce working capital and backlash from the food industry had damaged investors and the biofuel industry at large. This history lesson was important, Groobey said, because it changed the financing methods and expectations of new project lenders.

    Other barriers discussed ranged from the political to the practical. Biofuels production faces opposition because of questions about its contribution to food shortages, the energy returned on investment and its environmental impact. In addition, companies can't maintain a consistent supply of raw materials, in part because they can't provide enough product to satisfy the contractual demands of potential buyers, creating a chain that hurts the industry's long-term goals.

    Corinne Young is the director of Government Affairs for Myriant Technologies LLC, which develops second-generation biofuels.

    Potential solutions

    Some options explored were hedging strategies for biofuels producers, product diversification and loan guarantee programs. One notion that met with favorable reviews was establishing a chartered corporation that would guarantee biofuel securities and loans. Another was attaching "toll arrangements" to biofuel payment agreements, or guaranteeing profits to biofuel producers on the condition that a share of those profits go directly toward expanding production.

    Also popular was the idea of creating a working group involving the Environmental Protection Agency, the Department of Energy, the U.S. Department of Agriculture and the U.S. Treasury to improve communication on energy goals and to enable joint decision-making.

    A full report is available here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    21

    July 2009

    Feeding the World's Hungry: Fostering an Efficient and Responsive Food Access Pipeline

    Washington, D.C.

    More than 1 billion people will go hungry each day this year, according to the Food and Agriculture Organization (FAO) of the United Nations. With a staggering need fueled by the global financial crisis, repeats of last year's food riots in the developing world loom.

    High food and fuel prices, climate change and natural disasters, weak local and regional markets, and mismatches between supply and demand - these factors have challenged the world's ability to end hunger. Procuring and distributing food aid efficiently and quickly is critical to food security, but organizations that provide humanitarian food assistance - including international relief agencies, national governments and non-governmental organizations (NGOs) - often face significant obstacles to obtaining food at the best price and delivering it quickly to those in need.

    In response to these challenges, the Milken Institute, with support from the Bill & Melinda Gates Foundation, hosted a Financial Innovations Lab on fostering an efficient and responsive food access pipeline. The daylong workshop at the University of California's Washington Center brought together a diverse group of experts from around the world, including representatives from development finance institutions, humanitarian organizations, commodity exchanges, the U.S. government, foundations, financial institutions, and research organizations. Lab participants considered the current obstacles to delivering food aid and brainstormed possible solutions.

    Betsy Zeidman, director of the Center for Emerging Domestic Markets and a research fellow at the Milken Institute, outlined the scope of the problem. She described the challenges that humanitarian agencies face as falling into two categories:

  • Risk management challenges, which involve price and supply issues that compromise the agencies' ability to secure food at a reasonable price and in sufficient quantities.

  • Funding challenges, which involve the unpredictable nature of funding streams that rely largely on donations.

    Lab participants examined two potential solutions to risk management: physical grain reserves and alternative commodity procurement tools. They also explored models from other sectors that could address the unpredictability of funding.

    Improving Risk Management

    Grain reserves can mitigate supply risk by serving as an access point for humanitarian agencies in emergency situations. Brian Wright, a professor in the Department of Agricultural and Resource Economics at the University of California, Berkeley, gave an overview of how humanitarian agencies might incorporate grain reserves into their food access pipeline to improve their response time. These reserves also help smooth spikes in commodity prices, he said.

    Kshama Fernandes, vice president of IFMR Capital, discussed the benefits of warehouse receipts programs, storage facilities that allow farmers to use their stored commodities as collateral to gain access to financing. Lab participants saw various challenges with grain reserves, including where they would be located, the potential for fraud, and the need for strong management and clear rules for stock release and replenishment. Brian Wright noted that call options might serve as an even better alternative to physical reserves.

    Julie Dana, senior financial specialist at the World Bank, described forward purchases and alternative procurement tools that humanitarian agencies might use to manage price risk. She reviewed traditional procurement tools, such as reserves, in-kind commodity donations and spot purchases, and described the advantages of alternative tools, including pre-positioned stocks, forward purchases, call contracts, futures and options.

    As one example, the government of Malawi used a call option to assure supply and cap the price of maize during the lean season, Dana said. In addition, the United Nations World Food Programme (WFP) has had success with its forward purchase pilot, according to Robert Opp, special advisor to the executive director at the WFP.

    Some Lab participants expressed doubt that the boards of humanitarian agencies would fund call options premiums. But Panos Varangis, principal banking specialist at the International Finance Corporation, likened options to a form of insurance and stressed that they are worthwhile even if they are not always exercised because they can be huge cost-saving mechanisms in the event of a crisis.

    Stabilizing funding streams

    A humanitarian agency's funding will be inefficient by definition, as the clients are not the customers, said Michael Klein, an advisor to the WFP. Because outcomes do not affect donors directly, inefficiencies will naturally occur, he said.

    Although a number of sophisticated financial instruments have long been used in the private sector, they have not been used as widely by food aid agencies, Klein noted. Updating the tools humanitarian agencies use and improving their efficiency is critical, he said.

    Glenn Yago, director of Capital Studies at the Milken Institute, presented various financial models that have been used in other sectors to stabilize funding, including advance market commitments, the World Bank's Green Bond, the Caribbean Catastrophe Risk Insurance Facility and the International Finance Facility for Immunisation.

    Whatever the model, Lab participants stressed that the costs of funding day-to-day operations be separated from the costs of funding emergencies because the two needs differ substantially.

    Click here for a full report detailing the Lab's findings.

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  • 31

    March 2009

    Infrastructure Finance: The Grid, Renewables and Beyond

    Washington, D.C.

    The Milken Institute, in conjunction with the U.S. Department of Agriculture's Office of Energy Policy and New Uses, convened a Financial Innovations Lab in Washington, D.C., to address strategies for financing upgrades to the U.S. electrical grid.

    This event focused on how America can achieve long-term sustainability of energy production and consumption, as well as how rural communities can profit from the shift to wind and solar power. Participants included leading scientists and technologists, rural stakeholders, utilities, regulators, banks, institutional investors and venture capitalists, public decision-makers, think tanks and clean-tech industry associations.

    The Milken Institute's Joel Kurtzman highlighted key issues that need to be addressed in order to scale up generation and transmission of renewable energy. Not only has there been a lack of investment in the electric grid for the past five decades, but that neglect is compounded by the absence of comprehensive regional planning, complex cost allocation rules and inadequate financial incentives for new transmission developments. Piecemeal regulation and a lack of federal authority also create significant challenges for choosing sites.

    Richard Kauffman, CEO of Good Energies Inc., pointed out that both a "centralized" and a "distributed" solution for the development of renewable energies could lead to efficient outcomes. Renewable portfolio standards, for example, could be either national or regional. He also observed that capital market solutions could emerge to provide long-term financing for these assets of similar maturity. Doug Gotham of Purdue University noted that the job of utility forecasters is getting increasingly difficult due to growing congestion on the grid and the lack of long-term planning for generation and transmission resources.

    Substantial investment to expand the electrical grid is certainly needed, according to Richard O'Neill, chief economic advisor at FERC. But he argued that a lot can be done in the short term to optimize the operations of the actual configuration of the grid in order to accommodate as much renewable energy as possible.

    Carol Werner of the Environmental and Energy Study Institute discussed the challenges faced by community wind projects (i.e., locally owned, commercial-scale wind projects that optimize local benefits) on a daily basis. These include a lack of adequate financing instruments, lukewarm support from policymakers, the absence of a national market for community wind, and inadequate distribution and transmission infrastructure. Some possible solutions were outlined, such as the establishment of a "national community wind clearinghouse," expanded public financing options (such as state-revolving funds, grants and low interest-rate loans) and revised interconnection priorities.

    William Lazarus of the University of Minnesota analyzed the role of farm-based anaerobic digesters as a potential energy source. Although today there are only 125 operating manure digesters in the whole United States, with a total electric generation capacity of 35 MW, AgSTAR estimates that some 6,500 large dairy and swine operations could potentially operate profitable biogas systems. This mobilization could provide 802 MW of capacity to the electric system and significantly increase farmers' income.

    Juan Torres of Sandia National Laboratories noted the lack of technology options for storing electricity; the only viable opportunity for extensive energy storage lies on the generation side in the form of fossil fuels. Although it may not happen for 15 to 20 years, the breakthrough in this field could come the day when plug-in vehicles are deployed on a large scale, enabling all residential and commercial buildings to add storage capability to their own small-scale energy systems. Torres also analyzed the role of geothermal energy, a mature and attractive technology whose potential is still largely unexploited worldwide.

    The final panel of the day focused on possible financial solutions. Richard Pietrafesa of Destiny USA illustrated the financial model used to fund the development of his resort, a platinum LEED facility that sits on a former brownfield in upstate New York. Pietrafesa explained how, in partnership with government, Destiny USA was able to leverage Payments In Lieu Of property Taxes (PILOTs) and other government programs to finance all project development.

    Nancy Pfund of DBL Investors talked about two of the business ventures financed by her firm: Tesla Motors and Bright Source Energy. For Tesla, DBL Investors was able to obtain bond guarantees from the DOE, although the process required time and struggle. Bright Source Energy, the world's largest solar power plant, was financed almost exclusively through power-purchase agreements (PPA) with California utilities, thanks to the stringent renewable portfolio standard effective in the state. According to Pfund, though, inadequate transmission capacity remains the biggest challenge to the feasibility of such projects. Carol Whitman, a senior legislative principal at the National Rural Electric Cooperatives Association, stressed the difficulty of applying traditional financing methods to coops, which are not-for-profit, non-taxable entities.

    Carol Werner emphasized the need to standardize financial instruments and expressed some frustration at the risk-averse attitude of most banks when it comes to financing renewable projects.

    The remainder of the day was devoted to addressing regulatory issues. All participants agreed that these hurdles shouldn't excuse inaction. Predictability of regulation emerged as a crucial factor that could help investors take on more risk and inject more capital into the green energy sector and its infrastructure. The current financial and economic climate provides a one-of-a-kind opportunity to redefine the roles of the federal government, states, municipalities and the private and financial sectors in tackling the big challenge of sustainability. It's a moment we cannot fail to seize.

    A full report on the Lab is available here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    06

    February 2009

    Responding to the Affordable Housing Crisis

    New York

    The fallout from the mortgage meltdown has been most acutely felt in the nation's low- and middle-income communities, where families are losing their homes at higher rates and foreclosures are driving neighborhood deterioration. An increasing number of loans are in distress, and lenders continue to hold on to properties they can't sell. The prospects for a scalable approach to affordable housing are dim at exactly the time when it is most needed.

    The Milken Institute held a Financial Innovations Lab to explore mechanisms and strategies for addressing the issue. Is there a way to finance the acquisition and disposition of foreclosures while simultaneously easing the affordable housing crisis? During the daylong session, various proposals were debated by experts from banks, foundations, community development organizations, research institutions, and federal, state and local governments.

    Mary Tingerthal of the Housing Partnership Network (HPN) introduced the National Community Stabilization Trust (NCST), a partnership that brings together four leading community development nonprofits: HPN, Enterprise Community Partners, the Local Initiatives Support Corporation (LISC) and NeighborWorks America. The NCST coalition aims to stem the decline of communities awash in abandoned and foreclosed properties by providing a clearinghouse for distressed REO (real estate-owned, or foreclosed) homes. The group helps local communities obtain REOs from servicers and investors, converting them to properties that support affordable housing and stable communities. Working with major loan servicers, NCST is currently testing its model in the Twin Cities, New York City, Rochester and Memphis. Under NCST, the purchase price is an agreed-upon "net realizable value" - that is, the market value under normal conditions, less the costs the seller would avoid by participating in the program (e.g., holding costs such as maintenance, taxes and insurance; transaction costs; decline in value over the holding period; capital costs saved by early receipt of proceeds; etc.).

    Capital allocations are needed immediately to build a comprehensive affordable housing strategy at the local and state levels, according to Harold Simon of the Community Asset Preservation Corporation (CAPC) of New Jersey. CAPC uses a portfolio acquisition approach, works with multiple mortgage servicers and cross-subsidizes its properties. The organization prices assets from the ground up - identifying the actual cost to rehab and dispose of the property. Once those costs are identified, assets are targeted for demolition, land banking, sale at market rate, or rehab and development as affordable housing. The program began last year with the purchase of a portfolio of 47 loans. There is great opportunity for expansion right outside CAPC's front door, as vacant properties are rampant in Newark. While several years ago there were 350 REOs (of which 275 properties sold), Newark now has 950 REOs and posted only 100 sales last year. Simon urged immediate leverage of Neighborhood Stabilization Program funds (administered by the U.S. Department of Housing and Urban Development) at the state level.

    Tom Streitz, director of housing policy and development for the City of Minneapolis, presented details of a pilot program he is implementing. The city purchases only the most distressed properties in identified strategic areas, with some targeted for demolition and some for land banking. Funds are provided from the city budget as well as from HUD's Neighborhood Stabilization Program (NSP), which currently has $5.9 billion in funding to tackle the problem nationwide. Streitz commented that one of the biggest challenges is that municipalities aren't set up to act quickly enough to compete against private investors in the acquisition of foreclosed properties priced at distressed levels.

    The afternoon session focused on the disposition of assets. Bill Goldsmith of Mercy Portfolio Services described the Chicago Neighborhood Stabilization Program and mentioned real estate developers - both for-profit and nonprofit - as the main obstacle to building viable affordable housing solutions. Mercy Portfolio Services, together with the City of Chicago and the Chicago Neighborhood Stabilization Corporation, plans to acquire 1,400 vacant homes starting in March 2009 with the help of NSP funds. By the end of December 2013, most homes will be transferred to future homeowners using various strategies such as lease-to-purchase, interim rental and equity-sharing ownership. Two hundred of the 1,400 homes will be demolished and either rebuilt or used for the purpose of land banking.

    Bruce Marks, representing the Neighborhood Assistance Corporation of America (NACA), advocated a return to what he called "basic lending" and underwriting of mortgages, stressing the need for income verification and proper documentation. His organization developed and successfully uses an online software solution that features a user-friendly application process and stores a borrower's documents. This greatly facilitates the underwriting of mortgages, and enables NACA to offer a 30-year fixed-rate product with an interest rate of 4.25%, with no down payment and no closing costs. Only 0.0023% of homeowners who bought this product defaulted on their mortgages.

    The role and importance of the private market in reducing foreclosure rates and helping residents stay in their homes through restructuring individual mortgage loans was repeatedly discussed during the course of the day. One strategy brought forward was aggregating risk capital from accredited investors and matching these funds with those seeking equity investments, such as affordable housing agencies or individual prospective buyers.

    Further limiting the number of vacancies and foreclosure evictions was cited by many as the key to stabilizing low- and middle income communities. While the overriding sentiment among attendees was grave concern about the current housing crisis and its negative consequences for disadvantaged communities, some participants expressed great hope that this moment could be seized to build long-term affordable housing solutions. But they also highlighted the importance of being aware of unintended consequences in crafting new policy.

    A full report on the Lab's findings is available here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.

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    03

    February 2009

    Stimulating Investment in Emerging-Market SMEs

    New York

    Risk capital - patient, non-asset-based capital that facilitates growth of new and expanding companies - is too scarce for small- and medium-sized enterprises (SMEs) in developing countries. Although SMEs are critical engines of job creation and economic growth, risk capital remains largely unavailable to such businesses, undermining their ability to expand and benefit their communities.

    To address this issue, the Milken Institute (with support from Google.org) hosted a Financial Innovations Lab. Fund managers, investors, entrepreneurs, researchers, and representatives from development finance institutions and foundations gathered to identify the obstacles in expanding capital access for SMEs and to explore potential solutions.

    A major challenge in financing emerging-market SMEs is the difficulty of exiting the investments. Underdeveloped capital markets and a shortage of buyers in these countries make exits hard to achieve, thereby increasing investment risk and decreasing the number of potential investors.

    Lab participants explored both first-party exits, in which the entrepreneur buys back the investor's shares, and third-party exits, in which the company is sold to another financial investor or to a company within the same industry (i.e., a trade sale). Case studies of each exit type, prepared by Tom Gibson, president of the Institute for SME Finance, provided examples of successful SME investments and challenged participants to think about how to replicate these results.

    In addition to examining the structures of successful investments, participants considered ways to increase capital to emerging-market SMEs. Reducing costs - by making back-office functions more efficient, for example - is one way to increase overall return. Furthermore, use of technical assistance can help accelerate a company's value.

    Participants also highlighted the importance of the relationship between investor and investee, including good communication between the parties. Finally, several participants noted the value of the investor being local to the investment. Thierry Sanders, director and founder of the BiD Network Foundation, explained BiD's plan to use business angel networks to source deals and scale-up capital to where it is needed most.

    Innovative financial solutions were also considered. Wayne Silby, founding chairman of the Calvert Funds and president of the Calvert Social Investment Fund, discussed the potential creation of a permanent capital vehicle for SMEs. Jim Polan, vice president of SME Finance at the Overseas Private Investment Corporation, explained his idea for the development of an exit finance facility.

    Click here for a full report on the Lab's findings.

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    2008

    05

    November 2008

    Environmental Innovations in Israel: Revolving River Restoration Fund

    Jerusalem

    Jordanian, American, Palestinian and Israeli participants of the Financial Innovations Lab, November 6, 2008. Mishkenot Shananim.
    Booky Oren, former CEO of Israel′s water company Mekorot and the President of Miya Water and Eng. Sa'ad Abu Hammour, Deputy CEO of Jordan′s water company Miyahuna.
    U.S. financial and policy innovation pioneers Susan Weil of Lamont Financial, Steve Townley of the Missouri Environmental Improvement and Energy Resources Authority and Peter Taylor of Barclays Capital explained how a state revolving fund works as a finance mechanism during the lab.
    The Milken Institute Israel Center held a series of events in November 2008 to address water shortages, wastewater and environmental degradation issues facing Israel and its neighbors. Participants began with a tour of the Kidron River Valley, an important revitalization project in need of funding. The group of U.S. and Israeli water experts also met with Ministry of Finance officials to discuss possible finance models that could replace the current antiquated funding structure.

    The center then conducted two Financial Innovations Labs to discuss financing water restoration in Israel, Jordan and areas under control of the Palestinian Authority. Water engineers from the United States and the Middle East joined representatives from local municipalities, the capital markets and academia to design an implementation plan.

    The first session, held at Mishkenot Sha'ananim in Jerusalem on November 5, 2008 featured U.S. financial and policy innovation pioneers Peter Taylor of Barclays Capital, Susan Weil of Lamont Financial and Steve Townley of the Missouri Environmental Improvement and Energy Resources Authority, who explained how a state revolving fund works as a finance mechanism. This model allows government grants to be matched by local resources to ensure a steady flow of capital into river projects. The revolving structure allows the fund to make loans to local river/stream projects, which in turn generate income to repay the original investment and recapitalize the fund. Local river authorities can leverage their resources, which are secured by the revolving capital in the fund, to issue bonds for more than one project at a time.

    The second session, held the following day, focused on the ability of such a fund to work regionally, with the creation of a multinational committee to oversee restoration projects. According to Aaron Wolf, a professor of geography in the Department of Geosciences at Oregon State University and an expert in water conflict management and transformation, cross-boundary water solutions are only successful when all parties can move past political mistrust. Gidon Bromberg, director of the Friends of the Earth Middle East, also noted that a legal framework must be established for the creation of a multinational committee, with active participation from local communities.

    Two subsequent meetings were held to form steering committees, one focused on Israeli rivers, the other addressing regional issues. The work of the committees was complemented by research undertaken by the Koret-Milken Institute fellows assigned to the Ministry of Finance and the Knesset.

    The Lab resulted in two separate reports: one on the revolving river restoration fund and one on transboundary water issues that is available in English, Hebrew or Arabic.

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    07

    October 2008

    Housing: Beyond the Crisis

    Washington, D.C.

    From the subprime meltdown to the unprecedented government bailouts, the current turmoil in the mortgage market is sending shock waves across the political and financial landscape. Federal and state legislators are struggling to find the appropriate regulatory response, capital markets are refining their financing models and the future of housing in America is at risk.

    To address these critical issues, the Milken Institute hosted a Financial Innovations Lab at the German Marshall Fund in Washington, D.C. "Housing: Beyond the Crisis" focused on incentives, market structures and regulatory mechanisms that would enable home buyers to continue obtaining credit from banks, maintaining a flow of financing for affordable housing that is both efficient and attractive to investors.

    Bringing together researchers, policymakers, and business, financial and professional practitioners, the Milken Institute's Financial Innovations Labs aim to create market-based solutions to business and public policy challenges. Participants in this event included governmental officials, bankers, academics, lawyers, policy advisors, and representatives from rating agencies and nonprofit organizations as well as other experts from the housing and capital markets. The Lab was convened to explore financial innovations that would allow risk-sharing in the housing and mortgage markets, and most importantly, generate concrete plans of action.

    The Lab was split into two sessions: one on capital market solutions and the other on affordability products. Both sessions featured presentations and case studies, followed by lively and provocative discussion among the 45 participants. The morning session, moderated by Phil Swagel of the U.S. Treasury Department, focused on current capital market solutions: securitization, covered bonds and shared equity products.

    Panelists Tad Rivelle of Metropolitan West Asset Management, Tom Deutsch of the American Securitization Forum and Frank Nothaft of Freddie Mac analyzed the recent problems with securitized products and ways to use these products appropriately. The latest data demonstrates that the deterioration of collateral caused the current wave of massive deleveraging. Much of the discussion focused on the measures necessary to reboot securitization and other financial instruments to promote liquidity and lower costs while increasing transparency. All participants urged a return to the fundamentals of risk analysis in mortgage products and markets. Additionally, the panel recognized the need for a process to unwind securitizations to address bad loans.

    Trip Foley of the Treasury Department and Alex Pollock of the American Enterprise Institute focused on the increased use of covered bonds, noting their success in Europe. Unlike asset-backed securities, covered bonds remain on the issuer's consolidated balance sheet and are backed by a pool of assets in case the originator becomes insolvent. They hold great potential, but participants raised questions about how much regulation would be needed to define and standardize this market, as has been done in Europe.

    The concept of shared equity products, in which investors receive a portion of the equity in a home in exchange for providing a portion of the down payment, was analyzed by Ralph Liu of AeFT Inc. and Jim Gray of NCB Capital Impact. Gray argued that these products ensure occupancy, promote ongoing maintenance and avoid foreclosure; he believes they are effective, sustainable and durable. Liu presented his SwapRent model, in which distressed homeowners can essentially switch to renting their property through an economic landlord, who would credit full or partial monthly payments toward the homeowner's mortgage while sharing any appreciation in the value of the property.

    During lunch, the participants enjoyed a presentation by John Courson, incoming president of the Mortgage Bankers Association, who discussed the future of real estate as an investment and the industry's strategies in moving forward.

    The afternoon session, moderated by James Barth of Auburn University and the Milken Institute, shifted the focus to risk-sharing innovations and the potential for these products to revive the market. Dan Kildee of Genesee County, Michigan, presented the model of Genesee County's land bank, a public authority created to efficiently acquire, hold, manage and develop tax-foreclosed properties, as well as other vacant and abandoned properties. Kildee maintained that the use of land banks could help communities prevent foreclosures and spur housing renovations and new development.

    Catherine Godschalk of Self Help outlined her organization's lease-to-purchase product, which is currently being piloted in North Carolina. This model creates a credit enhancement in the securitization process, buying loans from lenders to be subsequently resold to Fannie Mae and repackaged. These 30-year fixed-rate mortgages would offer borrowers a lower mortgage payment than other saleable financing choices. The organization also stresses borrower counseling, an important factor in the day's discussion of transparency in lending.

    Adam Levitin of Georgetown University Law Center offered his perspective on how modifications in bankruptcy law could enable financially distressed individuals to renegotiate terms of their mortgages, lowering foreclosure rates and improving value recovery. Finally, John Weicher of the Hudson Institute discussed the limitations of payment assistance programs, especially seller-financed models, which seem to offer little benefit to homeowners while producing higher default rates. Other down-payment assistance programs that might be designed without such moral hazard were considered.

    Finally, Jason Bordoff of the Brookings Institution and David Wyss of Standard and Poor's exchanged views about how the election will influence the direction of the housing and mortgage markets and what lies ahead when the next president takes office.

    Click here to read a full report.

    On October 2, the Milken Institute hosted a related Forum in Santa Monica, "Demystifying the Mortgage Meltdown: What It Means for Main Street, Wall Street and the U.S. Financial System." Click here to read a summary or watch the video.

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