The Milken Institute's signature tool for generating solutions is the Financial Innovations Lab.® Each Lab assembles a multidisciplinary group of investors, industry experts and public officials to tackle a specific financing or policy question. During an intensive daylong workshop, they explore the problem from every angle. It's a roll-up-your-sleeves approach that encourages collaboration and practicality. The results are fully documented in our Financial Innovations Lab Reports — and the recommendations are ready to be put to work in the marketplace and the policy arena.
Environmental Innovations in Israel: Revolving River Restoration Fund
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.Read More
Housing: Beyond the Crisis
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.Read More
Developing Archaeological Discovery and Conservation
Santa Monica, CA
The demand for archaeological artifacts has encouraged a billion-dollar black market and the destruction of the world's cultural heritage through looting and vandalism. From Peru to Thailand, this destruction not only causes tremendous artistic and historical loss, but also strips local economies in developing nation of potential revenue streams.
The trade of antiquities blends the legal with the illicit; much of the illegal trade moves within an established and respected market. A murky chain of events exists between the looter and the dealer or curator, which often makes it difficult to determine, for example, whether Incan pottery on the New York auction block was in fact stolen from a site or released from a long-held private collection. It may be impossible to quell the desire to own a piece of the past, but much can be done to regulate the supply.
To address these critical issues, the Milken Institute hosted a Financial Innovations Lab focused on incentives, market structures and regulatory mechanisms that would foster legal archaeological discovery while generating local economic development to stem looting and promote site preservation.
Participants included museum curators, conservators, archaeologists, governmental officials, academics, lawyers, auctions houses, collectors, antiquities dealers and economists, as well as other experts from the capital markets.
Participants identified the major problems facing the market, including:
Many of the Lab's experts feel that archaeological artifacts belong to the country of origin and that sales of objects should be prohibited unless deemed appropriate by the state. Other experts, however, feel that antiquities are part of the collective global identity and "belong" to the international community.
During the regulatory session, much of the debate focused on the Portable Antiquities Scheme, the legal trade of artifacts in the United Kingdom. The Scheme, fiercely opposed by archaeologists as legitimizing looting, has seen relative success in the U.K. in tracking antiquities and educating the public on its cultural heritage. It allows citizens to sell a portion of any antiquities found in a legal market, and was created in response to the increased use of metal detectors to locate Roman coins by local communities. Participants debated the likelihood that this program could be replicated in less developed nations, given the limited resources available.
The financial solution session focused on long-term leases, museum sponsorship and archaeological development bonds. Participants, especially those from the archaeological community, were reluctant to promote solutions that place an unbalanced focus on artifacts, as opposed to cultural heritage as a whole.
Archaeological development bonds would channel investment from private investors, philanthropies and governments to countries of origin to increase site protection and generate capital for local communities. By pooling potential revenue streams, including tourism, object leases and media licensing, the bonds would create sustainable funding for excavations around the world.
Participants agreed that more research must be done to better understand the size of the current market for antiquities, as well as to develop legally and culturally appropriate solutions to the looting crisis.Read More
Financial and Policy Medical Innovations Lab
Capping a tremendous year for the Israel Center, Milken Institute Chairman Mike Milken completed a visit to Israel in December 2007, meeting with Prime Minister Ehud Olmert, President Shimon Peres and Israel's top scientists to galvanize the country's human, social and financial capital around a nascent but promising biotech sector.
Widely covered by the media, the highlight of his visit was a Financial and Policy Medical Innovations Lab, held in Jerusalem and attended by more than 100 scientists, policy makers, entrepreneurs and business leaders to look at the challenges and opportunities of Israel's biotech sector, building on the strengths of its high-tech human capital. The Lab was designed by the Milken Institute at the request of President Shimon Peres.
Milken engaged the gathering at the Lab in a look at the potential of the nation's human capital - noting that Israel has more scientists per capita than any other developed country and, extrapolating from Nobel laureate Gary Becker's calculations, "the human capital of Israel is worth several multiples of the officially reported size of Israel's assets as published by the Bank of Israel."
However, Milken also warned that Israel's education system inadequacies needed to be swiftly and effectively addressed to avoid depreciation and further drain on the human capital assets.
"Israel must address the challenges within its educational infrastructure. Continuing and increased focus on the country's elementary and secondary education system for all citizens will better prepare the next generation to participate in the global knowledge industries of the future," he said.
He also noted improvements needed in the financial infrastructure and regulatory systems, "Barriers need to be reduced to allow for easier entry for entrepreneurs, the capital market needs to be expanded and the concentration of ownership in the banking system needs to be cut."
President Shimon Peres agreed with Milken, calling for more regulatory flexibility and financial support for entrepreneurs. He also stated that the need for medical services and products in developing regions, such as Asia and Africa, presents a key opportunity for both goodwill and sustainable business opportunities.
"We have to think differently, mobilize our talents to make ourselves a better people and show the world that goodwill may be the real force of our time," Peres said.
Prime Minister Ehud Olmert also attended, focusing his comments on his vision of dedicating 10 percent of Israel's GDP to research in development, which in turn would attract foreign investment. Thanking Milken for his tremendous contribution in drawing attention to the importance of the industry and to the Milken Institute for organizing the event, Olmert said, "This is one of the most important seminars, in terms of practical ramifications for the Israeli economy, which has been held in Israel in many years."
Other participants included Yarom Ariav, Finance Ministry director-general; Professor Shlomo Ben Haim, biotech entrepreneur and investor; Professor Raphael Walden, chair of medical programming for the Jerusalem Congress and Deputy Director of the Tel-Hashomer General Hospital; Dr. Ora Dar, Director of Life Sciences, Office of the Chief Scientist; Professor Shlomo Mor-Yosef, CEO of the Hadassah Medical Organization; and Dr. Orna Barry, a biotech and venture capitalist expert.
The Milken Institute brought to the Lab a set of conceptual tools that could leverage great success from the country's existing biotech industry resources. These concepts, which can be found throughout the work of the Milken Institute, the Milken Institute's FasterCures/The Center for Accelerating Medical Solutions and in another Milken organization, The Prostate Cancer Foundation, include using the capital markets as an agent of change to increase global prosperity, transferring successful financial technologies to new regions and industries, using philanthropy to leverage increased funding from public and private sources, and sharing research and medical data to accelerate the development of cures.
Through a mix of presentations and working group discussions, Lab participants were brought up to date on the latest information and ideas, and also had an active role in brainstorming new ideas to break up roadblocks and discover new routes to foster growth in Israel's biotech sector.
Those present noted that Israel faces challenges in the areas of under-investment in technology transfer, a lack of locally based financial services infrastructure and shortfalls in the training and retention of researchers.
"It is much harder today to bring a medical device to market than in the past. Regulation is stricter, there are changes in intellectual property laws, and the process for insurance reimbursement has become longer and more complicated. If I once was able to bring a new medical device to the sales stage for $20 million, today it could cost at least $100 million" said Professor Shlomo Ben-Haim.
In specially designed workshops, Lab members tackled these issues and developed several solution-generating ideas for both policy and financial innovation. These ideas included:
•Development of Israel as a global medical financial center, to include strengthening the graduate education systems in business and finance, developing Israeli-based financial services to provide a full spectrum of funding and financing services, and fostering acumen in the specifics of medical research and biotech financing
•Increasing information technology infrastructure for health records and clinical trials to accelerate medical solutions
•Creating global collaborations in curing infectious and chronic disease, with specific programs for Turkey, India, Kazakhstan, China and other rapidly developing regions.
The next steps are to compile a report on the content of the Lab, the creation of working groups to further develop the solution concepts and to bring the Israeli biotech community back together to work on implementation during the Jerusalem Congress in May 2008.
We also expect to present the findings and a current update on implementation during the 2008 Milken Institute Global Conference.
Media coverage of the Milken Institute Financial and Policy Innovations Lab can be found online at:
Additional articles at Globes Online available, if registered, by searching for "Milken" in the archives.
See related documents:
Financial and Policy Medical Innovations Lab Program (PDF)
Catastrophic Risk: Cat Bonds and Beyond
The increasing incidence of disaster -- from Hurricanes Katrina and Rita to tsunamis and earthquakes -- has highlighted the need for catastrophe protection and insurance for individuals, communities and companies.
In response, the Milken Institute hosted a "Financial Innovations Lab for Catastrophic Risk: Cat Bonds and Beyond" on October 25, 2007, at the Metropolitan Club in New York City. The Lab focused on identifying and analyzing capital market solutions for financing catastrophic risk management.
Participants included insurance professionals, investment bankers, academics, lawyers, rating agencies and risk-modeling experts, as well as other experts from the insurance and capital markets. The goal of the Lab was to identify obstacles to the expansion of the market for catastrophe (cat) bonds and risk-linked securities, and to develop strategies to tackle those barriers.
The agenda identified four primary barriers that translated into four sessions featuring presentations, case studies and the lively participation of the 48 participants. At the start of the day, Markus Schmutz from Swiss Re provided an industry overview of risk-linked securities. Schmutz noted that the market for catastrophe bonds has grown substantially, from around US $700 million in 1997 to approximately US $13.5 billion outstanding at the moment. He also outlined the benefits of cat bonds -- such as full collateralization and multi-year pricing of contracts -- as attractive alternative sources of capital.
The first identified barrier dealt with limits in the secondary market and concerns about liquidity. Gerald Ouderkirk of Goldman Sachs and Albert Selius of Swiss Re, who both head trading desks for cat bonds, described the market for the bonds as liquid and pointed to the lack of issuances as one of the barriers of expansion. Selius provided an overview of exchange-traded instruments and recent developments on derivative exchanges, which are currently active in catastrophic risk trading. Ouderkirk noted that hedge funds were the primary participants in the secondary market space over the past 12 months.
One session was dedicated to the role and perspective of investors in the cat bond market. Eric Silvergold of Guggenheim Partners explained that despite the attractiveness of these bonds (including low correlation with other asset classes), fixed-income investors typically do not have the economics to invest in them. There is a need, he said, to democratize access to risk-assessing tools.
Rating agencies play a crucial role in the issuance of risk-linked securities, Rodrigo Araya of Moody's noted that they can help develop the market lies by educating investors and offering sponsors a clear and reasonable rating approach.
Another session dealt with transaction costs. Jeff Cooper of Allstate Insurance Company highlighted the many hesitations insurers have in becoming buyers of cat bond coverage. Cooper estimated that currently the transaction costs for cat bonds run at approximately 20 percent higher than for typical reinsurance contracts. However, Michael Millette from Goldman Sachs pointed out that the higher transaction costs result from the novelty of capital market insurance solutions and said he expects them to decline substantially.
The final session of the day addressed the importance of public-private partnerships in tackling the challenges of providing risk coverage to communities and nations. Stuart Miller of AIR Worldwide gave a presentation on an innovative issuance by the Government of Mexico, which placed the first sovereign cat bond in history to provide funding for emergency losses in the aftermath of an earthquake in Mexico City.
Click here for a detailed report of the Lab's findings.Read More
Achieving Energy Independence
The Milken Institute conducted its third Financial Innovations Lab for Achieving Energy Independence on Tuesday, October 23, 2007, at the Metropolitan Club in New York. The purpose of the Lab was to address the real state of the art with regard to alternative energy.
The Milken Institute's Financial Innovation Labs are proprietary research tools that bring together researchers, policy-makers, and business, financial and professional practitioners to create market-based solutions to business and public-policy challenges.
Participants in this Lab included members of SAVE, the Strategic Action Volunteer Effort, inaugurated by Michael Milken in April 2006, to bring together volunteer teams adept at deploying state-of-the-art financial technologies and capital-market solutions to tackle particular issues. Those attending also included leading scientists and technologists from Sandia National Laboratories, the National Renewable Energy Laboratory, the California Institute of Technology and Stanford University.
The goal of the working session was not to provide answers about technologies to a group of capital market leaders, said Ron Stoltz, Head of the California Liaison Office of Sandia National Labs, at the start of the day. Rather it was to provide the informational context that would lead to better questions.
Professor Arnulf Grubler of Yale University and a lead author of several studies by the Nobel-Prize winning Intergovernmental Panel on Climate Change, introduced a term that reappeared throughout the day: "timescales." The IPCC climate-change scenarios, and the history of previous large-scale changes in energy supply, point to timescales of 30, 70 and 100 years, he said. Within this long-term framework, government policies and fluctuations in prices play an insignificant role in the climate and technology outcomes.
The key driver of outcomes is demand, as experienced through end-use applications, he said. For example, Thomas Edison invented the light bulb and then started an electric company to supply its power. That power company built its delivery systems around alternating current (AC) electricity, rather than the direct current (DC) system prevalent at the time, because AC is a better fit for the light bulb -- the end-use application.
An important finding in Grubler's research, he explained, is that markets select dominant technology clusters based of end-use requirements. This insight leads to a new and different set of questions for both policy analysts and capital market participants, he said.
So what is the potential for renewable energy? Dan Arvizu, Director of the National Renewable Energy Laboratory, recalled being asked this question in Washington, D.C., at a meeting with political leaders. Using transportation fuels as an example, he replied that the United States could achieve energy independence quickly if it relied in equal parts on domestic oil, biofuels and higher fuel efficiency.
That answer illustrated an important insight of the day: carbon reduction is not a single-technology solution, but a combination of current and new technologies and greater energy efficiency.
Two gaps persist in the renewables landscape, said Arvizu: delivery of renewable technologies at less than $30 per barrel and investment in energy efficiency. One example of the latter is the zero-energy home, which he characterized as a low-hanging fruit.
Terry Michalske, Director of Biological and Energy Sciences at Sandia National Laboratories, provided a nuanced road map on biofuels. Moving the discussion beyond the use of ethanol, he suggested a broad scope of use and an important role for biofuels in an economic transition to reduced carbon emissions. The optimal sources of cellulose vary significantly across the varied climates of the United States, he said. Each source requires a tailored biological process for conversion efficiency, and thus a different infrastructure (production facilities, distribution systems, and auto fuel systems). He added that biofuels do release carbon and that as the U.S. economy becomes more carbon-efficient, it is expected that their use will decline. Michalske also pointed out that the emerging biofuels industry has yet to take advantage of the bountiful tool set developed in the biotech industry, and its adoption will greatly enrich and speed biofuel development.
Franklin Orr, who directs the Global Climate and Energy Project at Stanford University, reinforced two frequent themes of the day: the enormous scale of the climate change problem (and consequently its solution) and the need for a portfolio of technologies. To illustrate the magnitude of the challenge, he explained that for carbon sequestration alone, the country would need a new infrastructure 40 percent the size of the infrastructure developed for the global oil industry.
Sequestration in geological cavities created by oil and gas extraction is possible in the near-term, said Orr, adding that at current rates, there is capacity for 10 years of emissions. More research is needed for sequestration in saline aquifers and the cavities created by coal extraction, but they have a 100-year capacity. Carbon, once emitted, remains in the atmosphere for about 300 years before sinking into the ocean, so carbon capture at the point of emission is needed. (Further, it is more expensive to extract carbon from the atmosphere, and carbon-intense oceans are profoundly harmful to our marine ecosystem, he warned.) Consequently, new coal plants must be sited close to the geological opportunities for sequestration. The United States has abundant geological capacity for sequestration, he said, but China does not, again suggesting that there is no single technology solution for carbon emissions from coal power plants.
But what if carbon emissions could be transformed from a "bad" to a "good"? Andrew McIlroy of Sandia National Labs, used the example of algae for biofuels. Carbon is a nutrient for algae growth, he said, and there are R&D projects focused on the opportunity to take carbon out of the air to use to feed the organic material used to make biofuel. Another example is the use of CO2 for enhanced oil and gas extraction, with a current price of $50 per ton.
McIlroy also identified opportunities in non-carbon greenhouse gases, each hundreds and thousands of times more harmful to the climate than carbon. These gases are emitted in smaller quantities than carbon, but because of their concentrated impact, the right incentives could make a big difference in emissions. He also noted that carbon credits or the $25 million Earth Challenge Prize offered by Richard Branson could motivate breakthrough streams of research.
To view the lab presentations, click on any of the links below:
Dan Arvizu: "Alternative Energy: Solar, Wind, Geothermal"
Terry Michalske: "Biofuels"
Franklin Orr: "Carbon Sequestration"
Andrew McIlroy: "Novel Concepts: Carbon Sinks and Carbon Recycling"
Arnulf Grubler: "Putting Climate Change in Context"
See related documents:
Financial Innovations for Achieving Energy Independence
AB32 and Beyond: A Laboratory on the Next Steps in California's Policy on Global Warming
Santa Monica, CA
When Gov. Arnold Schwarzenegger signed into law AB32, which mandates the widest restrictions on carbon dioxide emissions in the nation, the focus of debate immediately shifted to how the state would implement the new law.
In an effort to help sort that out, the Milken Institute hosted a workshop,"AB32 and Beyond," that brought together public policy leaders, heads of industry, financial executives and others to examine the implications of the legislation, particularly on the expanding carbon trading and alternative energy markets.
The session, moderated by Joel Kurtzman and Glenn Yago of the Milken Institute, included a primer from Dan Skopec, undersecretary of the California Environmental Protection Agency, who has been instrumental in educating different stakeholder groups on the major features of the bill. He laid out the preliminary timeline for the implementation of AB32, emphasizing that the next few months will be crucial for the market advisory committee, which must recommend emissions-trading guidelines and design features to the state's Air Resources Board.
Richard Sandor, founder and CEO of the Chicago Climate Exchange (CCX), the world's first greenhouse-emission registry, reduction and trading system, spoke about the origins of the exchange and how it will be able to help California industry comply with AB32 mandates.
Jane Brunner, a councilwoman in the City of Oakland, one of the earliest government members of CCX, discussed her city's sustainability and carbon-reduction programs. Measuring and verifying the impacts of their programs were the motivations behind joining CCX, she said.
Joe Pettus, a senior vice president of Safeway, explained why his company felt the need to join both CCX and the California Climate Action Registry. His company, which is one of the largest commercial users of electricity in the U.S., was motivated by the desire to know exactly when, how much and from where their energy (and hence carbon emissions) flowed. Determining their ecological footprint was important to them not only from a business standpoint but also from a reputation and stewardship standpoint.
Other panelists were Dennis Albiani, former deputy legislative secretary with the Schwarzenegger administration, who talked about the genesis of the bill; Dan Braun, director of Global Environmental Finance at Stark Investments, who provided the capital-market perspective and value propositions resulting from AB32; and Bill Marcus of Calyon Financial, a key player in domestic and international carbon-trading regimes.
Participants realized that every move California makes in this area will be closely scrutinized, and therefore, careful planning and consideration of complex economic and social issues cannot be overlooked, they agreed.Read More
Investing in Emerging Market SMEs
The Milken Institute and the Boston College Institute for Responsible Investment co-hosted this Financial Innovations Lab on investing in emerging-market small and medium enterprises (SMEs). Attendees included institutional investors, emerging-market analysts, private equity funds, corporations, foundations, rating agencies, capital aggregators and international development agencies.
A robust SME sector can contribute significantly to the growth and stabilization of emerging-market economies. Expansion can generate strong returns for investors, and these firms create jobs and wealth. Additionally, they often produce solutions to a country's pressing social and environmental challenges.
However, despite increasing investor interest, challenges in accessing information and mitigating risk limit the ability to tap this opportunity, attendees said. The session examined these challenges and, most importantly, generated solutions and action items that participants and others can pursue.
During the day-long session, participants explored mechanisms for increasing investment in emerging-market firms. These included, among others: definition of terms related to emerging-market SME investment, increased partnerships between aggregators and investors, developing common standards for reporting, and clarification of the SME business model and value chain.
Participants worked through specific investment instruments designed to increase capital flows to SMEs and produce financial and extra-financial returns. Some highlights:
- Christine Eibs Singer of E+Co, a capital aggregator investing in clean-energy enterprises, described her firm's successful blended value investment model. This model focuses on triple-bottom-line returns on investment: financial, social and environmental. She also spoke of the need for technical assistance for SMEs.
- Andrew Gaines of Gaines Partners discussed risk mitigation strategies to combat the three "C's" associated with investing in emerging market SMEs: country, currency and credit risks. Using a single portal that harbors a variety of insurance tools would help investors reduce their risk.
- Noah Beckwith of Aureos Capital described the challenges of private equity investment in the SME space. These include legal, financial and scaling constraints that make private-equity investment costly and cumbersome. However, as the market grows, so may the tools to mitigate these constraints.
Other participants suggested various innovative tools, including creation of a SME trade association; establishment of a global currency, credit enhancement and/or technical assistance fund; increased reporting; and a shared services platform to reduce costs. Participants also noted the importance of local partnerships, in particular citing empowerment of local banking institutions as a key to serving SMEs.
The findings and results of this lab will be summarized in a report to be published in 2007.Read More
Achieving Energy Independence - A Lab of the Strategic Action Volunteer Effort (SAVE)
|Glenn Yago of the Milken Institute, right, leads the SAVE Financial Innovations Lab discussion, which examined alternative-energy investment gaps and oppportunities.|
On Nov. 9, 2006, the Milken Institute conducted its first Financial Innovations Lab for Achieving Energy Independence at the Bloomberg headquarters in New York City. Participants included a select group of high-level representatives from the worlds of finance and energy.
The hands-on workshop sought to clarify alternative-energy investment gaps and opportunities, with a particular focus on the transportation sector and the alternative fuels and technologies available today that will help us move away from oil and petroleum.
Two promising developments in the sector were given special consideration: bio-fuels and coal-to-liquid technology. Participants sought to identify and work through specific investment instruments designed to increase capital flows to the alternative-energy sector and produce financial returns.
While everyone agreed that there is an urgent need to increase investment in and accelerate adoption of alternative fuels and new technologies, much of the discussion revolved around asset and risk management in an industry that is perceived as young and uncertain.
Participants debated the issues of attracting long-term investors, scalability, the mechanisms required to hedge - or insure - against volatile oil prices, and the role of government and legislation in addressing both the supply and demand sides of the alternative-energy equation.
The discussion resulted in some creative financial solutions: an insurance policy against falling oil prices; green bonds and BTU-backed bonds; the creation of a fixed-income product or a futures market for alternative fuels; credit enhancement or a finance lease from the government; and, most importantly, the bifurcation of credit risk and equity risk to hedge against the long-term volatility of oil prices.Read More
A Recovery and Economic Development Plan for Northern Israel: The Day After, II
Following up from the first Financial Innovations Lab held in Santa Monica, which examined a large array of financing options for Northern Israel's post-war recovery, a diverse group of financial, legal and philanthropic experts met in New York to discuss implementation of the two top solutions: development of a bond authority for infrastructure and public-private projects, and expansion of the KIEDF Small Business Revolving Loan Fund Model.
A representative from the Israeli Finance Ministry stated that many existing and statutorily approved infrastructure and business finance projects remain unexecuted due to budgetary constraints.
The group decided that a Northern Israel Bond Authority would generate capital to develop these promising projects for the region. Financial and legal experts suggested that the bonds may be issued by a U.S. conduit in partnership with an Israeli project sponsor.
The group explored several financing options. They also determined that adding a layer of credit enhancement to any financing model would decrease risk and increase the likelihood of investment. With sufficient legal support oversight and evaluation, the implementation of the bond authority could become a reality in the coming year.
Participants discussed the success of the KIEDF Revolving Loan Fund model for small-business growth. Through the fund, KIEDF puts philanthropic dollars to work in the private sector, providing small-business, micro-enterprise and microfinance loans to entrepreneurs. Because the model is already effective, little discussion on improvements or challenges occurred during this session. Rather, participants encouraged KIEDF to continue and expand its work. The group thought particular emphasis should be given to small businesses that, because of the war, currently have restricted bank accounts.
Lab participants suggested that the small-business loans provided by KIEDF, and small-business loans in general, be securitized in a targeted collateralized loan obligation (CLO). A targeted Northern Israel CLO would allow KIEDF and banks to go one step further in lending, providing further liquidity in the constrained small-business credit sector.
The lab concluded with a discussion of next steps for implementation of the bond authority and the Northern Israel CLO. A report with the findings and next steps will be released in the coming months.Read More
A Recovery and Economic Development Plan for Northern Israel: The Day After, I
Santa Monica, CA
In the aftermath of the war in Lebanon, the Northern region of Israel is struggling to recover. According to the Israeli Finance Ministry, the July 2006 Second Lebanese War will cost up to $5 billion.
Even before the war, the Northern region had already experienced a relatively weak labor and housing market, and lower performance in commercial and industrial activities than the national average.
To successfully achieve growth and development, the region requires an influx of capital. But traditional funding sources, such as government agencies or foreign aid, are typically insufficient or cumbersome to access, particularly for Northern Israel. Therefore, the region needs to focus on alternative funding options.
As part of the Financial Innovations Lab series, the Milken Institute researched and explored several alternative financing options for facilitating recovery and growth in post-war Northern Israel. The first of these labs was held at the Milken Institute in Santa Monica. The second was held on Sept. 15 in New York City (view summary).
Participants at the first lab explored an array of financing options. Over the course of discussion, participants determined that two alternative funding options were the most feasible and pressing: development of a bond authority for infrastructure and public-private projects, and expansion of the KIEDF Small Business Revolving Loan Fund model.
Through development of a bond authority, the government and private partners can raise capital for needed infrastructure, such as expanded highways and renovated rail lines, which will bring business to Northern Israel. With expansion of the Small Business Revolving Loan Fund model, the area's entrepreneurs will receive a much-needed influx of working capital at favorable rates.Read More
L.A. Economy Project: Financial Innovations for Capital Access
Santa Monica, CA
This lab brought together business leaders, bankers, community organizers and researchers to act on the capital-access recommendations presented in the Milken Institute's Los Angeles Economy Project report. It was one of several meetings of L.A. leaders prompted by the release of the project's report in December 2005.
"These meetings," said Los Angeles City Council President Eric Garcetti, "act as a bridge between research and legislation and action...with the goal of increased participation in the Los Angeles economy."
Key speakers at this lab included Kirsten Snow Spalding of the California Pollution Control Financing Authority, who talked about the California Capital Access Program (CalCAP); Ian Cudlipp of Four Corners Capital Management, who discussed collateralized loan obligations; and Shari Berenbach of the Calvert Foundation, who presented information on community investment notes.
Several recommendations and action items emerged from the meeting:
Use L.A. partners to increase California Capital Access Program activity in Los Angeles.
This program would operate within CalCAP, and would bolster CalCAP loans to L.A.-based businesses. In the state program, the lender and borrower generally each pay 2 percent of the loan amount into a loan loss reserve, and the state contributes a 4 percent match. This 8 percent reserve mitigates the lender's risk. CalCAP has a provision for an independent contributor to create incentives by helping to cover the borrower's or lender's costs. In an L.A.-focused program, the independent contractor could be the City of Los Angeles or a local foundation. In addition to, or in lieu of, offsetting the borrower's or lender's contribution to the loan loss reserve, the contributor might also help pay the lender's cost of marketing and loan origination, increasing outreach and usage of the program. The program could be sector- or neighborhood-specific, and would make use of existing infrastructure.
Next Steps: Gain mayoral and City Council support; secure an independent contributor.
Develop an L.A. Community Investment Note
The Calvert Community Foundation can help structure an L.A.-targeted Community Investment Note, to be marketed to local institutions and investors. Notes would likely be at least $5,000 (though could be as little as $1,000), with a flexible interest rate to be chosen by the investor (generally between 0 percent and 3 percent) and term between one and 10 years. Funds raised by the notes would be invested in local community development financial institutions. Local foundations and philanthropists could credit-enhance the loan pool to help mitigate the risk as well as help support the cost of marketing and originating loans, and due diligence and placement of proceeds. In addition to small-business lending, funds could be used for affordable housing and community development. Calvert has created similar customized note programs, including a geographically focused effort for the Gulf Coast in the wake of Hurricane Katrina.
Next Steps: Identify lenders, philanthropic organizations, individuals and government agencies who might contribute to the cost and management of the program; explore structuring options with the Calvert Foundation.
Develop an L.A.-focused Small-Business Collateralized Loan Obligation
Collateralized loan obligations (CLOs) can increase lending activity by purchasing loans and offering lenders liquidity. If the loans are packaged and credit-enhanced with a layer of equity (perhaps from a local foundation) or insurance wrap, the resulting security could be rated and prove attractive to institutional investors (e.g. LACERS, CalPERS) or banks seeking CRA credit. Currently some small-business loans are securitized, but an L.A.-focused CLO would pool many more local small-business loans. A diversity of industries and types of loans could be included. The servicing of the loans could be maintained by the original lender or passed to the purchaser. Philanthropic support could help cover the marketing costs.
Next Steps: Identify pools of potential loans to be included; identify potential philanthropic and government partners.
For more information about the Los Angeles Economy Project, visit www.laeconomyproject.com.Read More
Financial Innovations for Faster Cures: Securitization of Medical Solutions II
Following up on the first Financial Innovations Lab, which examined how creative financial techniques may be able to bridge the funding gaps in medical research, a diverse group of financial, legal, philanthropic, insurance and medical-research experts met in New York to discuss the specifics of how this can be done.
With the cost to produce new drugs growing more expensive (reportedly, as much as $800 million), increased regulatory scrutiny and fewer blockbuster drugs to help the bottom line, research-and-development activity has declined at the major pharmaceutical companies, resulting in fewer new drugs being discovered.
One problem is the enormous risk to investors because of the long time frame involved for bringing new drugs to market, and the huge uncertainty of whether they'll pan out.
So the question to those attending this lab was simple: What innovative financial structures have evolved that could be applied to the biopharmaceutical industry that would reduce this risk to investors and pump more money into medical research especially early-stage drug discovery?
"Why is it that the large pharmaceutical industry, which was once a full-service provider in drug development, has continued to withdraw from risky early-stage discovery and development?" asked Glenn Yago, Director of Capital Studies at the Milken Institute. "Why is it that the venture capital market and equity investors have been avoiding support for risky early-stage discovery and development? And how do we overcome this?"
Attendees spent the day looking at a variety of potential mechanisms, such as special-purpose vehicles, structured finance and the securitization the pooling of assets that can be sold as a security of intellectual property, like drug patents.
Jeffrey Brandt, a patent attorney, agreed that a well-assembled portfolio can have a value greater than the sum of its parts. But there are risks.
"Owning intellectual property is like having a tiger by the tail," said Brandt, who is President of JLB Consulting Inc. "The good news is you own a tiger. The bad news is you've got it by the tail. You're probably going to have to do something with it. You need to understand what you own in terms of using it."
Among the major issues are finding the right financial instrument, the right disease, the right patents and the right stakeholders to reduce the risk and ensure the best outcome. Jay Eisbruck, Managing Director of Moody's Investors Service, said this would not be easy.
"The only way to make it work would be to cross-collateralize all these different drugs into one deal," he said. But "everyone is going to think their drug is going to be more successful than everyone else's, so they're going to not necessarily want to share the benefits of that. To make this work, you would have to find a way to get people to at least subordinate some of the benefit of their drugs for the benefit of the overall transaction to make it work."
Many venture capitalists have pulled out or cut back on their investments, attendees said.
"Venture capitalists are becoming more risk-averse," said Martha Amram, an author and Founder of Growth Options Insights, LLC. "So we have a gap here of how to reduce the risk further so additional funding sources will come in."
By involving many of the different players in these discussions insurance companies and foundations, for example, that could help bridge the financing gap Milken Institute researchers hope to forge agreement on new ways to fund drug research.
The objective of the labs is to explore a range of market-based alternatives to closing the early-stage funding gap and accelerate cure development for infectious and chronic diseases.
The findings and results of this lab and the first one, held in Santa Monica on Nov. 29, 2005, are summarized in a report available here.Read More
Financial Innovations for Faster Cures: Securitization of Medical Solutions I
Santa Monica, CA
Much progress has been made against some of our most deadly and debilitating diseases. But despite these advances, cancer, Alzheimer's, diabetes and other illnesses continue to devastate individuals and families.
One of the primary weapons in this battle is the development of new drugs that can cure or offset the effects of these diseases. But because of the enormous costs of developing new drugs, the length of time to get them to market and the high risks for investors, the discovery of new life-saving medicines has slowed.
This financial innovations lab, and a similar one in New York City on Dec. 13, focused on how we can use creative financial techniques to increase investment in medical research and commercialization. A diverse group of experts in finance, medicine, philanthropy and intellectual property met to help figure out what new financial instruments and strategies could be created to break the drug-discovery finance logjam.
"People are dying who shouldn't be dying," said Glenn Yago, Director of Capital Studies at the Institute, who hosted the event.
Attendees agreed that fundamental shifts that have taken place in the pharmaceutical industry over the past five years that make it more difficult to fund research for promising, but early-stage drugs.
With the cost of getting a new drug to market estimated at $800 million, many drug companies now rely on smaller biotechnology firms to pay the bill for this research. But venture capital funding for these small companies has dried up because investors don't want to take the risk of losing their money on unproven drugs. They're more interested in drugs that have proven themselves in late-stage clinical trials.
As a result, it's tough to put deals together that will help move these potentially life-saving drugs along the research pipeline, they said.
"Pharmacology is the most difficult (industry) I've faced," said Joe Daniele, chief operating officer of Acorn Technologies, Inc., who has completed more than 350 IP deals over the years.
Lab members talked about what has worked and not worked to help fill this funding gap, such as special purpose vehicles and structured finance, and how you value intellectual property such as drug patents.
But much of the focus was on a financial instrument strongly supported by research at the Milken Institute: securitization or the pooling of assets that can be sold as a security.
Is there a way, for example, to estimate the future value of royalties over a number of years from a portfolio of patents relevant to a particular disease group or medical problem? This portfolio could then be turned into marketable securities, which would provide capital to accelerate research.
Attendees also discussed how insurance companies or foundations whose missions are aligned with particular diseases might help bridge the financing gap by, for instance, providing loan-loss guarantees. This would require a fundamental shift in the thinking of foundations, many agreed.
The objective of the labs is to explore a range of market-based alternatives to closing the early-stage funding gap and accelerate cure development for infectious and chronic diseases. Designing capital structures with credit enhancement, advanced sales and other financial, marketing or business strategies that align interests of foundations, investors, patients, governments and businesses is expected to advance health solutions.
The findings and results of the two labs are summarized in a report available here.
The labs were made possible, in part, thanks to the generous support of Adjoin and Bioacclerate.Read More
Hydrogen Highway Financial Innovations Laboratory
Santa Monica, CA
It is the stuff of novels, television drama and scientific conferences, but is the Hydrogen Highway a reality or mere wishful thinking?
In January 2004, California Gov. Arnold Schwarzenegger introduced the California Hydrogen Highway Network to accelerate the introduction of a hydrogen-powered transportation system in California. Its purpose is to create a network of hydrogen stations throughout the state by 2010, reaching 2,000 stations and 2 million vehicles by 2030.
Is it viable? Many in the field seem to think so.
The Hydrogen Highway Financial Innovations Laboratory held Nov. 18 at the Institute brought together 30 experts in public and private finance, technology, industry and policy to discuss viable pathways to creating a "hydrogen economy." At the end of the day, the participants, who broke into focus groups addressing financing mechanisms, technological development, societal issues and cross-cutting solutions, came up with recommendations to be submitted to Schwarzenegger.
The essential ingredients of a viable hydrogen economy, the group agreed, were political will and cash. Despite formidable barriers to implementation, motivation is also a driving force toward achieving that end. Early-stage key players identified by the group were hydrogen producers and equipment manufacturers. These include government, project financiers, big auto OEMs, energy utilities, hydrogen retailers (stations) and renewable-energy players. Initial end users identified were fleets and government, and only in the long-term, public consumers.
A clearly identified downside was the lack of private capital available for infrastructure. Venture capitalists are not interested in government-subsidized markets, nor will private investors fund projects that have no revenue stream for at least five years. Private investors need clearly defined, focused opportunities, they said, as well as a broader market than one limited to California. On the upside, while infrastructure will have to be funded by public means, models exist for converting government-built infrastructure to private projects, among them, the solar industry and the defense industry.
In the technology and public policy arenas, members determined that the central issue is how to direct current technology toward the policy of hydrogen economy. They also looked at existing infrastructure that could be utilized in this regard, including railroad and cell-phone infrastructure, military bases and Cal Trans stations, and agreed to study natural gas to determine the existence of a parallel track.
Among the societal drivers cited were energy scarcity, energy diversity, carbon dioxide emissions and global warming, yielding benefits such as better air quality, job creation and export opportunities.
The general consensus emerged that hydrogen is the energy future, leaving the question of how California becomes a leader in that future. Public awareness and buy-in were considered critical by the group and they raised the possibility of an initiative similar to the voter-approved stem cell initiative as a starting point.
The technology team felt that, realistically, hydrogen would gain a major foothold among the population closer to the year 2030, citing the cost of the car as one factor and hydrogen's adoption as a commodity by major oil companies as another.Read More
Financing Hydrogen: A Look at the Year Ahead
Milken Institute Conference Center
The California Hydrogen Business Council presents a special event Thursday, March 4, 4-8 p.m. at the Milken Institute.
This event, Financing Hydrogen: A Look at the Year Ahead will explore near-term opportunities for investors, entrepreneurs and industrial concerns in the emerging Hydrogen Economy.
The event will begin with "2003: The Year in Review," an assessment of recent investment activity, provided by Reed Global Advisors.
Two panel sessions will follow:
Investments In Hydrogen Infrastructure and
Investments In Hydrogen Technologies.
A buffet and beverages networking session will follow the presentations.
Participants include NextGen Partners, the Rustic Canyon Group, Garage Technology Ventures, Chrysalix, ChevronTexaco, Praxair, The Hydrogen Car Company, PriceWaterhouseCoopers, South Coast Air Quality Management District, California Treasurer's Office, and many more.
PREREGISTRATION IS REQUIRED and attendance is limited.
Advance registration (payment received before Feb. 26) is $65 for CHBC members and $100 for nonmembers. Late registration is $100 for members and $150 for nonmembers. Registration deadline is March 2.
Download the meeting registration form at http://www.hydrogen.la/chbc/registration03-04-04.doc or at http://www.hydrogen.la/chbc/registration03-04-04.pdf
or, you may contact:
California Hydrogen Business Council
Attn: Melissa Stock
3532 Katella Avenue, Suite 108
Los Alamitos, CA 90720
Public parking for this event is available in Public Parking Lot #1 on 4th street, immediately adjacent to the Milken Institute.Read More
Market-Based Solutions through Environmental Finance: the Case of the Chicago Climate Exchange
Back when he came up with the idea of creating a public exchange that would trade the rights to carbon dioxide, many on both sides of the equation the financial community and environmentalists thought his chances of success were, well, small.
After all, the markets were down and the U.S. had pulled out of the Kyoto Protocol, which could have helped jumpstart the initiative.
But Richard Sandor, who created the idea of trading financial futures in the 1970s, knew it could work. And in December 2003, through perseverance and perhaps a little luck, he saw his dream come true in the form of the Chicago Climate Exchange, a self-regulatory exchange that administers a voluntary greenhouse gas reduction and trading program for North America.
At a Milken Institute roundtable meeting with government officials, environmental organizations and members of the financial community, Sandor said the Exchange has been wildly successful in its first two months.
Already on board as members are such firms as Ford, DuPont, IBM, Motorola and American Electric Power, as well as the city of Chicago and the University of Oklahoma. And the trading of carbon dioxide has nearly tripled since the Exchange opened on Dec. 12.
"This is going to dominate the environmental forefront," Sandor said of the idea of cap-and-trade programs. It could even expand into the areas of trading the rights to air and water.
"They are our most important commodities, and they have to be rationed," he said. He added that markets are the best way to do that much better than armies fighting over it.
The meeting was part of the Milken Institute's ongoing series of presentations of financial innovations addressing long-standing public policy problems bringing together financial practitioners, policy makers and change agents in the public and private sector.
Dr. Sandor, Chairman and CEO of the Chicago Climate Exchange, was the recipient of the Milken Institute's 2003 Award for Financial Innovation and the subject of recent in-depth reports in Time and Forbes magazines. He is a director on numerous boards, including the Intercontinental Exchange, an electronic marketplace for commodity and derivative products, and is a member of the design committee of the Dow Jones Sustainability Index.
For more information about the Exchange, visit www.chicagoclimateexchange.com. (Note: This link takes you to a web site outside of milkeninstitute.org. To return, hit the back button on your web browser.)Read More
Springboard Enterprises Bootcamp
Milken Institute Conference Center
Santa Monica, CA
As part of its ongoing efforts to support programs for entrepreneurs and encourage investment in markets that stimulate the economy, the Milken Institute hosted a workshop by Springboard Enterprises on Dec. 5, designed to prepare and connect women-led businesses to investors in the equity capital markets.
The in-depth, one-day "BootCamp" brought together more than 50 women entrepreneurs and local business people to talk about how to raise needed capital for their growing firms. It included a talk by Katrina Garnett, founder of CrossWorlds Software, case studies, panel discussions with leading industry experts and a fast-pitch session highlighting four local entrepreneurs.
Garnett, Managing Director of Garnett Capital, opened the program. She drew from her own inspiring story to illustrate to the audience how to map out their course, detect opportunity to create a new space in the marketplace, stay afloat financially and be flexible when the need arises. Her key pieces of advice were to file patents early on and find the right niche. She also discussed the importance of educating the market about your company's product and knowing how to use the media. Other key points: raise money before you need it, know everyone customers, analysts and vendors and let your customers speak for your brand to bring you credibility. In sum, she said, know your vision, execute in phases and have an exit strategy.
Don Fracchia of Wells Fargo Bank spoke about raising capital in general terms. Wells Fargo has long been a small-business friendly bank, said Fracchia, and he advised the attendees to show discipline, focus and have a plan beyond their entrepreneurial vision and passion.
Three brass-tacks panels filled the next several hours. The first, moderated by Betsy Zeidman, head of the Milken Institute's Emerging Domestic Markets Program, discussed the key elements of a growth business. The panelists represented venture capital, banking, law and accounting, and included a former Springboard participant. They discussed financing models and how to assess the competition so that your product stands out above the rest. Their key points: analyze and evaluate the competition as well as barriers to sale, bring in a team that can execute and be credible.
The next panel took it one step further: doing the deal. The panelists focused on due diligence, good connections and good corporate housekeeping. They touched on the structure of different deals and stressed the importance of knowing which fund is the right one for your business. Most of all, they agreed, be patient.
The lunch session, moderated by the Milken Institute's Director of Capital Studies, Glenn Yago, discussed today's economic realities investors are now looking for companies with high margins, typically 45 to 65 percent, with experienced management teams. The definition of "early stage" financing has migrated upward and investors expect significant milestones before considering a firm. Again, infrastructure, a solid business base and good corporate governance were at the forefront. But investors are still interested in good ideas and consumer product companies. When it came to where the capital would come from, a common theme emerged: match your company's needs with the right fund.
The day then shifted from panel discussions to a case study of a successful woman-led firm, SatisFusion, presented by its chairman, Fay Wood. She was followed by four fast pitches presented by local entrepreneurs who were treated to feedback by a panel of investors.
For more information about its programs, visit the Springboard Enterprises web site.Read More
Milken Institute-CommerceNet Business Risk Management Roundtable
Milken Institute Conference Center
Santa Monica, CA
This event assembled business, finance, manufacturing and policy-making leaders to discuss the impact and current and future use of financial risk management in non-financial markets. They sought to identify areas that need non-market intervention that would, in turn, advance and accelerate the use of sophisticated risk management tools and frameworks in intra-enterprise and inter-enterprise trading networks.Read More
Examination of S&Ls Roundtable
The Anderson School of Management
What Can an Examination of S&Ls Reveal About Financial Institutions, Markets and Regulation?
Some 50 specialists in financial services gathered at the UCLA Faculty Center on January 25, 2002, to assess the lessons of the 1980s S&L mess for financial institutions, markets and regulation in the years ahead. The give and take at the invitation-only meeting, co-hosted by the Milken Institute and UCLA's Anderson School of Management, reflected the diverse backgrounds of the participants. Some argued that today's financial markets are in much better shape than they were 20 years ago, while others asserted that not nearly enough has been done to prevent future problems. The glass-is-half-full view was expressed most clearly by James Wilcox of the University of California's Haas School of Business. Among the lessons learned:
The value of diversification
We have seen what happens when institutions are not permitted to diversify their investments. Diversification across sectors, geographic regions and services, all make a difference.
The need for risk management
We now have a much better understanding of how much interest rate and credit risk are in the system, and how these risks can be handled. Financial institutions have more latitude to hedge now than they did 20 years ago.
The imperative for closure
Instead of letting firms try to grow out of problems, we should opt for "reincarnation" reorganizing struggling institutions, bringing them back with different managers, different owners and perhaps different balance sheets. Other participants, including Susanne Trimbath of the Milken Institute, were less sanguine. In the long term, she noted, the share of U.S. financial assets held by banks and thrifts is falling. "We might well look to pension funds and mutual funds as the next set of institutions to become vulnerable if a conflict arises between asset classes and market conditions," she argued. A forced divestment of company stock from pension plans, for example, could leave those financial institutions vulnerable.
"Exactly the same things happened in Superior," a recently failed Chicago thrift, as happened in the 1980s, seconded George Kaufman of the Center for Financial Studies & Policy at Loyola University. Kaufman appends to Santayana's admonition that those who forget history are bound to repeat it.
"What do those who do remember do? They agonize first and then do it again."
To focus the discussion, the day included sessions on government policy, the public record, and the parallels in international banking. The final session summarized the day's discussion.
Government policy: were there unintended consequences?
Government policy left S&Ls vulnerable to shifting market forces, including interest rate volatility, deteriorating asset quality and increasing industry competition. "Public policy at the time included a rigid institutional design," explained Glenn Yago, director of capital studies at the Milken Institute. "That design inhibited the ability of S&Ls to adapt to technological developments, federal and state deregulation that came after the industry was in serious trouble, and tax law changes that weakened the financial condition of savings and loan institutions by adversely affecting real estate values."
Public record: was there fair and accurate coverage?
News coverage mediates society's understanding of events and often becomes the accepted history. The media frames the coverage, promoting certain issues as problematic, certain outcomes as undesirable, and certain strategies as inappropriate. In representing the S&L industry in the 1980s, it generally failed to go beyond terms like "crisis" and "bailout," which fit into 30-second sound bites. "Catch a crook" attracted more attention than how thrifts could fulfill their historical mission to "build a house."
Martin Regalia of the U.S. Chamber of Commerce reminded the conferees that "for the most part, newspapers are not the guardians or watchdogs of our society, but just another business trying to make a buck. And that is not all bad."
U.S. S&L experience: are there parallels in other countries?
The problems of financial institutions in the 1980s anticipated or paralleled those of other countries. When problems occur here, U.S. analysts prefer to look to unique circumstances or the failings of individuals. When problems occur elsewhere, they find systemic causes with simple solutions.
But what happened to the S&Ls was not so different from financial disruptions that occurred overseas both before and after the 1980s. For example, James Barth of the Milken Institute points out that "S&Ls were essentially directed toward the politically motivated investments in residential real estate." Equivalent policy-directed investments are common in other countries with state-owned or controlled financial systems.
Summing up: do S&Ls provide a useful perspective?
The 1980s witnessed the collision of vulnerable financial institutions with frenetic regulatory policy. An examination of the portfolios of institutions that invested in similar assets shows that the S&Ls were treated differently in a systematic way. Banks were underwater at the same time as thrifts, yet the banks were not closed. The seizure of S&L assets amounted to an extraordinarily large perhaps the largest ever nationalization of private assets. The S&L case was more visible than other examples of policy mixing poorly with markets because government deposit insurance put the S&Ls in a very visible position. Government- insured institutions were naturally subject to political competition over who was to blame for their demise. But looking below the surface, the similarities in these conflicts generally exceed the differences.
Future roundtables in the series will focus on different forms of financial institutions and different types of asset classes. The conferences will be represented in a book series from Kluwer Academic Publishers, the Milken Institute Series on Financial Innovation and Economic Growth.
The book from this event, The Savings and Loan Crisis: Lessons From a Regulatory Failure, is available through Kluwer Academic Publishers. Read summary.
- Michael Klowden, President and CEO, Milken Institute
- Timothy Anderson, former banking consultant
- James Barth, Auburn University and Milken Institute; formerly Chief Economist, Office of Thrift Supervision and Federal Home Loan Bank Board
- Philip Bartholomew, International Monetary Fund; formerly Federal Home Loan Bank Board; U.S. House Banking Committee
- Gordon Bjork, Economics Department, Claremont McKenna College,
- Elijah Brewer, Federal Reserve Bank of Chicago
- R. Dan Brumbaugh, Senior fellow, Milken Institute; formerly Federal Home Loan Bank Board
- Charlotte Chamberlain, Jefferies & Company; formerly Federal Home Loan Bank Board
- Michael Darby, Anderson School of Management, UCLA; formerly Assistant Secretary, U.S. Treasury
- Mollie Dickenson, Author; Worth magazine
- Stephen Ege, Elias, Matz, Tiernan & Eric; formerly Special Assistant to the Chairman of the Federal Home Loan Bank Board
- Robert Eisenbeis, Director of Research, Federal Reserve Bank of Atlanta
- Peter Elmer, Director of Mortgage Analysis, Deloitte & Touche; formerly FDIC, RTC, FSLIC
- Catherine England, Department of Finance, Marymount University;
formerly Cato Institute
- Ernest Fleischer, Blackwell Sanders Peper Martin; formerly Chairman, Franklin Savings
- James Freund, Director of Research, Research Institute for Housing America, Mortgage Bankers Association of America
- Catherine Galley, Cornerstone Research
- Peter Haje, Time Warner Inc.; formerly Paul, Weiss, Rifkind, Wharton & Garrison
- William Hamm, Law & Economics Consulting Group; formerly World Savings
- Jean Helwege, Max M. Fisher College of Business Ohio State University; formerly Federal Reserve Bank of New York
- Anne Henry Farchmin, Ralls,Wagoner; Regulatory Watchdog;formerly Overland Park Savings & Loan
- Paul Horvitz, Department of Finance University of Houston; Shadow Financial Regulatory Committee; formerly Director of Research, FDIC; Director, Federal Home Loan Bank of Dallas
- Michael Intriligator, Burkle Center, UCLA; Senior fellow, Milken Institute
- Edward Kane, Wallace E. Carroll School of Management, Boston College; past President of the American Finance Association
- George Kaufman, Center for Financial Studies & Policy, Loyola University; Shadow Financial Regulatory Committee
- J. Livingston Kosberg, Chairman,Remington Partners; formerly CEO Gibraltar
Savings and First Texas Financial
- William Lang Deputy Director, Office of the Comptroller of the Currency
- Arthur Leibold, Dechert Price & Rhoads; formerly General Counsel, Federal Home Loan Bank Board
- David Malmquist, Director of Economic Analysis, Office of Thrift Supervision
- Stephen Neal, Cooley Godward, LLP; formerly of Kirkland & Ellis
- Richard Nelson, Wells Fargo; formerly Chief Economist, Federal Home Loan Bank of San Francisco
- Gerald O'Driscoll, Director, Center for International Trade & Economics, Heritage Foundation; formerly Federal Reserve Bank of Dallas
- Peter Passell, Editor in Chief, Milken Institute Review
- Martin Regalia, Chief Economist, U.S. Chamber of Commerce; formerly Director of Research, Savings & Community Bankers of America
- Richard Roll, Anderson School of Management, UCLA; past President of the American Finance Association; formerly Director of Mortgage Securities Research, Goldman, Sachs & Co.
- Jeffrey Scott, Vice President, Wells Fargo Bank; formerly Federal Home Loan Bank of San Francisco
- William Shear, Assistant Director, Financial Markets and Community Investment, U.S. General Accounting Office
- Lewis Spellman, Department of Finance, University of Texas
- Kenneth Spong, Federal Reserve Bank of Kansas City
- Michael Staten, Director, Credit Research Center, McDonough School of Business, Georgetown University
- Kenneth Thygerson, Digital University, Inc.; formerly CEO, Imperial Corporation of America and Freddie Mac
- Susanne Trimbath, Research Economist, Milken Institute
- Robert van Order, Chief Economist, Freddie Mac
- Kevin Villani, Economist; formerly CFO, Imperial Corporation of
- George Wang, Director, Market Research, Commodity Futures Trading Commission; formerly Federal Home Loan Bank Board
- Lawrence White, NYU Stern School of Business; formerly Board Member, Federal Home Loan Bank Board
- James Wilcox, Haas School of Business, University of California at Berkeley; formerly Chief Economist, Office of the Controller of the Currency
- Glenn Yago, Director of Capital Studies, Milken Institute Read More