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from Felix Salmon:

Two views of financial innovation

The final hour of Frontline's Money, Power and Wall Street documentary will air on Tuesday; I'll be participating in an online chat about the program with producers Martin Smith and Marcela Gaviria on Thursday at 1pm ET. I watched a preview this weekend, while also reading the World Economic Forum's 92-page report on "Rethinking Financial Innovation".

The two could hardly be more different. Frontline concentrates on international finance's discontents, most of whom are convinced that no matter how assiduous financial-market regulation, the big banks will always find a way to extract enormous rents for themselves. The WEF, by contrast, is convinced that financial innovation is nearly always a good thing, and that a few tweaks to internal risk controls, and maybe a high-level council of graybeards thinking deeply about systemic risk, should suffice to protect us all from any downside it might have.

The WEF report is not an easy read. Literally: it's printed in a light-grey sans-serif font on a white background. And for anybody hoping for an indication that the highest levels of the financial-services industry are taking the problems with financial innovation seriously, it's particularly depressing. Taken as a whole, the report is a full-throated defense of financial innovation, says that substantially all financial innovations are good things, and downplays all possible downsides to the maximum possible extent.

The first words of the executive summary are "Financial innovation has a long history of success" -- and that very much sets the tone for the rest of the report. Weirdly, the success of financial innovation is invariably asserted, rather than argued. For instance, on the left you can see the report's list of financial innovations since the debit card. "Many of the historical examples of financial innovation listed in the timeline have at some point been misused and misapplied by market participants, and have contributed to significant financial system disruptions," says the report. "Over time, however, most have been accepted as beneficial." The passive voice is telling: nowhere are we informed who is accepting these things as beneficial, or what criteria they may be using.

Looking at this list, I can see three unambiguously good innovations: point-of-sale terminals, ACH, and CHIPS. All of them represent evolutionary improvements in the banking system's payments and clearing architecture. With the rest, I certainly see a lot of innovations which resulted in banks and other private-sector finance players making lots of money. But was the publication of the Black-Scholes equation really a great thing for society as a whole? Are we better off now that we've moved from defined-benefit to defined-contribution pensions? Or, to take a slightly earlier innovation which the report dates to 1968, did the originate-to-distribute securitization model really help society as a whole?

It's disappointing that over the course of its 92 pages, the WEF report never attempts to answer these questions. Instead, we just get lots of unsupported assertion, like the statement on page 40 that "most financial institution failures and insolvencies are not linked to financial innovations". Well, I'm glad that's cleared up. Eventually, we end up with a series of recommendations for regulators. The very first one? "Acknowledge the importance of innovation and its role in a competitive, free-market structure."

from Felix Salmon:

Can financial innovations help the eurozone?

For all that financial innovation has got itself a pretty bad name recently, there's no shortage of people with bright ideas as to how to address the euro crisis. Robert Barro is one. He thinks the euro should be phased out entirely, and has a plan for how to do just that:

Germany could create a parallel currency—a new D-Mark, pegged at 1.0 to the euro. The German government would guarantee that holders of German government bonds could convert euro securities to new-D-mark instruments on a one-to-one basis up to some designated date, perhaps two years in the future. Private German contracts expressed in euros would switch to new-D-mark claims over the same period. The transition would likely feature a period in which the euro and new D-mark circulate as parallel currencies.

Other countries could follow a path toward reintroduction of their own currencies over a two-year period. For example, Italy could have a new lira at 1.0 to the euro. If all the euro-zone countries followed this course, the vanishing of the euro currency in 2014 would come to resemble the disappearance of the 11 separate European moneys in 2001.

Is this workable? It all depends, I think, on the degree to which contracts could and would be switched over to German law during the two-year period of parallel currencies. While many people might be happy to see their euros converted to Deutschmarks at a rate of one to one, many fewer would be happy to see their euros converted to lire at the same rate. Which means that there would have to be some serious coercion -- and a lot of court cases, too -- before people holding euro contracts in Italy were forced to see those contracts redenominated in lire.

So while Barro is correct that this approach would help solve the sovereign debt problem, by allowing the likes of Italy to simply print new money to pay off their debts, it would also be a legal nightmare, as every contract turned into a fight between creditor and debtor over which currency it should become. The creditors, of course, would all want the contract to become Deutschmarkized, while the debtors would probably all want their debts to be converted to drachmas at that one-to-one rate. Given that the whole point of European monetary union was that it would become a single monetary union, trying to break it up into 17 component parts is certain to be a legal and logistical nightmare.

Would it be easier, then, to come up with a clever way of keeping the eurozone together? Because Jed Graham has one of those: he calls it Safeguard bonds, which is actually an acronym: Sovereign Approvable First-loss EFSF-Guaranteed Upfront Automatically Recallable Debt.

Graham's idea is not that easy to understand, so I called him up and asked him to explain it to me. Basically, if countries signed up for a fiscal austerity program, they would be allowed to issue a certain quantity of Safeguard bonds, which would be guaranteed by the EFSF. Then, if at any point they broke free of their fiscal constraints, they would have to pay down 10% of the bonds, immediately, in cash. If you held €1,000 in Italian Safeguard bonds and the country ended up borrowing too much money one year, then Italy would automatically pay you €100 for 10% of your holding, and you'd be left with €100 in cash and €900 in Safeguard bonds; failure to do so would constitute an event of default.

The idea is that this would act as a real fiscal constraint: if a country were to avail itself of this facility, it would then be in a position where any fiscal slippage would be very expensive -- because it would have to borrow at a very high rate to make the bond payment. Meanwhile, the EFSF-guaranteed bonds would trade at much lower yields, because of that EFSF guarantee, and because, under Graham's plan, the ECB would step up and guarantee all Safeguard bonds in the event that EFSF monies ran out.

from MacroScope:

Two cheers for financial innovation

Protests against Wall Street and the U.S. financial system are hanging over an annual gathering of economists and social scientists in Chicago. Yale economist Robert Shiller offered two cheers for capitalist finance, saying that while the U.S. free market system has contributed to higher living standards, the vehemence of the recent public outcry points to a need for greater democratization. This is how he put it in a speech:

Occupy Wall Street … was something that in some sense you could see coming. I think we have increasing concerns about inequality, which is getting worse, about the distribution of power.

But rather than throw the financial system out, Shiller called for tinkering. Financial institutions and structures such as insurance or mortgage securitization have a role in improving social and human welfare, Shiller argued. U.S. economic success is due to a financial system that has evolved over centuries and helped improve the quality of life, he added.  A shortcoming of the Occupy Wall Street movement is that it doesn’t accept those contributions, he said.

Changes in financial structures could make the financial system more responsive to people’s needs, said Shiller. For example, a new type of corporate entity that is allowed in six U.S. states – the “benefit corporation” -- could provide incentives for firms to link success more closely to improvements in social welfare. This charter allows the for-profit companies to explicitly pursue a social purpose as well as its business goal. By law, regular corporations have a fiduciary responsibility to their shareholders to be profitable, while a benefit corporation also has some accountability, overseen by a third party, to perform a public good.

Shiller also wonders why there can’t be a mortgage that has automatic work-out provisions built in. Such a mortgage could require changes to terms and conditions if the borrower experienced job loss or other financial strains. The lender would price in the possibility of such losses at the beginning and cautious borrowers might be willing to pay a higher price for the insurance, Shiller said. In effect, a 30-year fixed rate mortgage is a similar instrument, since it allows lenders to pay a higher interest rate for a long-term loan that that they can refinance.

To contain income disparity, there could be a tax indexed to inequality, the Yale professor suggested. When the income of the top 1 percent of U.S. wage earners exceeds a certain multiple of the nation's median income, the tax would kick in. In 2006, that multiple was 36, up from 12.5 in 1980, he said.

Shiller was not subject to the “mic check” interruption that the Occupy movement uses to disrupt some public officials’ speeches. But some thought he was taking too rosy a view of the benefits of the financial system and the public’s willingness to view financial executives sympathetically. Reynold Nesiba, an economics professor at Augustana College in Sioux Falls, South Dakota, said:

from MediaFile:

SuVolta takes wraps off battery-friendly chip technology

Silicon Valley start-up SuVolta is giving the electronics industry a peek under the hood at its new technology that it claims will drastically boost the energy efficiency of microchips.

That's something chip designers are focusing more and more on as people increasingly rely on smartphones and tablets that chew up battery charges.

SuVolta says it can halve the amount of power used by chips without affecting their performance, and it is debuting the details of its technology to scientists at the 2011 International Electron Devices Meeting on Wednesday in Washington, DC.

The company says its "Deeply Depleted Channel" technology reduces voltage variability in transistors, drastically cutting the amount of energy that turns into heat and is wasted as microchips crunch data.

Backed by venture capital firm Kleiner Perkins Caufield & Byers, SuVolta has already licensed the new technology to Fujitsu Semiconductor. Fujitsu has been testing it at in one of its fabs and will present the technical paper jointly with SuVolta.

Qualcomm, Texas Instruments and Samsung dominate the mobile chip market using low-power designs licensed by Britain's ARM Holdings and they are potential customers for SuVolta.

from MediaFile:

Congress plans Facebook “hackathon” to boost engagement with public

Top legislators on both sides of the aisle in the U.S. House of Representatives said on Thursday they will work with Facebook engineers and independent developers to make it easier for the public to engage with lawmakers and follow the legislative process.

The first-ever Congressional Facebook Developer Hackathon will take place Dec. 7 at the Capitol, bringing together lawmakers, academics and developers to find ways to make Congress more transparent and accessible.

A hackathon, a term coined by computer programmers over a decade ago, generally refers to a meeting where new programs and applications are collaboratively developed.

With the growing influence social media like Facebook and Twitter has in people's everyday lives, "it is essential that Congress fully incorporate these platforms into its daily operations," House Majority Leader Eric Cantor said.

Cantor will host the event along with Democratic Whip Steny Hoyer.

"Americans have a right to petition government, and new online technologies are giving that right exciting new possibilities," Hoyer said in a statement.

While logistics will not allow for the all-night coding sessions typical of hackathons, the event will look at how legislative data that the House has already made available can be used by developers to build apps the public can easily understand and garner information from.

from MediaFile:

Chipmakers most creative, drugmakers least?

Chipmakers including Intel and Qualcomm make up the world's most innovative industry, according to a new analysis of patents by Thomson Reuters that is equally notable for some of the companies it does not include.

Thomson Reuters has just released its "Top 100 Global Innovators" list, which it compiled by scrutinizing patent data around the world using a peer-review methodology it developed.

"We tried to take an objective look at technology innovation and apply a composite measure not just of volumes, but also of influence in terms of citations of later published patents, in terms of globalization of patenting," says Bob Stembridge, the lead analyst behind the study.

Other companies related to semiconductors on the list include Samsung, Analog Devices, SanDisk and Applied Materials, which invents and builds the equipment used to manufacture chips.

But a handful of companies currently seen as leading players in the chip industry are missing from the list.

Britain's ARM Holdings, whose intellectual property has taken the tablet and smartphone industry by storm in the past few years, was absent from the compilation.

Also missing was Texas Instruments, the world's No. 3 chipmaker and leader in analog semiconductors.

from MacroScope:

When speculation squashes innovation

Paul Volcker famously joked in the wake of the 2008 credit crisis that the most important financial innovation of the last few decades had come not from Wall Street's fancy footwork but rather the engineering acumen that created the ATM. A paper published by the National Bureau for Economic Research lends some academic credence to Volcker's view. In particular, the research of Alp Simsek, a Harvard economist, finds the very uncertainty that esoteric new securities introduce into financial markets eats away at benefits arising from greater credit availability:

Financial innovation always decreases the uninsurable variance because new assets increase the possibilities for risk sharing. My main result shows that financial innovation also always increases the speculative variance. This is true even if traders completely agree about the payoffs of new assets. The intuition behind this result is the hedge-more/bet-more effect: Traders use new assets to hedge their bets on existing assets, which in turn enables them to place larger bets and take on greater risks. This effect suggests that financial innovation is more likely to be destabilizing in more complete financial markets and when it concerns derivative assets.

The author argues that rules prohibiting too many new types of securities from being introduced at once – so that traders don't go too crazy too quickly – isn't enough. As the crisis showed, when push comes to shove, hard-and-fast rules deliver better results than efforts at industry self-discipline.

Staggering the introduction of new assets is likely to be ineffective because it reduces traders' speculation simultaneously with their learning. A more viable alternative appears to be temporary position limits on new assets, which can be implemented with temporary capital requirements.

from Entrepreneurial:

Why governments don’t get startups

– Steve Blank is a serial entrepreneur. He teaches at Stanford University, U.C. Berkeley’s Haas Business School and at Columbia. He is the author of “The Four Steps to the Epiphany” and “Not All Those Who Wander Are Lost”. This article originally appeared here. The views expressed are his own. –

Not understanding and agreeing what “Entrepreneur” and “Startup” mean can sink an entire country’s entrepreneurial ecosystem.

I’m getting ready to go overseas to teach, and I’ve spent the last week reviewing several countries’ ambitious attempts to kick-start entrepreneurship. After poring through stacks of reports, white papers and position papers, I’ve come to a couple of conclusions.

1) They sure killed a ton of trees

2) With one noticeable exception, governmental entrepreneurship policies and initiatives appear to be less than optimal, with capital deployed inefficiently (read “They would have done better throwing the money in the street.”) Why? Because they haven’t defined the basics:

What’s a startup? Who’s an entrepreneur? How do the ecosystems differ for each one? What’s the role of public versus private funding?

Six Types of Startups – Pick One

from Entrepreneurial:

The coming brick wall in venture capital

-- Mark Suster is a former serial entrepreneur and a partner at Los Angeles-based venture capital firm GRP Partners. This article originally appeared on Suster’s blog “Both Sides of the Table”. The views expressed are his own. --

This is the final part of a three-part series on the major changes in the structure of the software and the venture capital industries. Read Part One and Part Two.

Or the Cliff Note’s version:

• Open source and cloud computing (led by Amazon) drove down tech startup costs by 90 percent
• The result was a massive increase in startups and a whole group of new funding sources: both angels and “micro VCs”
• With more competition in early-stage many VCs are investing smaller amounts at earlier stages. Some are going later stage to not miss out on hot deals. I call this “stage drift.”
• The opportunities for tech startups today are more immense than they’ve ever been with billions of people now connected to the Internet nearly all the time.

But …

Downsizing Venture Capital

The venture capital business itself is going through an even more fundamental change than just the entry of a new category at the earliest stage. The industry is shrinking back to a mid-90's level in terms of both dollars and numbers of firms.

from James Pethokoukis:

Not winning the future: more on Obama’s strange ATM comments

My pal Russell Roberts of George Mason University speaks Economic Truth to Political Power as he dismantles Obama's weird comments that ATM machines and automation kill jobs (via the Wall Street Journal):

Replace workers with machines in the name of lower costs. Profits rise. Repeat. It's a wonder unemployment is only 9.1%. Shouldn't the economy put people ahead of profits?

Well, it does. The savings from higher productivity don't just go to the owners of the textile factory or the mega hen house who now have lower costs of doing business. Lower costs don't always mean higher profits. Or not for long. Those lower costs lead to lower prices as businesses compete with each other to appeal to consumers.

The result is a higher standard of living for consumers. The average worker has to work fewer and fewer hours to earn enough money to buy a dozen eggs or a pair of shoes or a flat-screen TV or a new car that's safer and gets better mileage than the cars of yesteryear. That higher standard of living comes from technology. It isn't just the rich who get cheaper TVs and cars, plus the convenience of using an ATM at midnight.

Somehow, new jobs get created to replace the old ones. Despite losing millions of jobs to technology and to trade, even in a recession we have more total jobs than we did when the steel and auto and telephone and food industries had a lot more workers and a lot fewer machines.

Why do new jobs get created? When it gets cheaper to make food and clothing, there are more resources and people available to create new products that didn't exist before. Fifty years ago, the computer industry was tiny. It was able to expand because we no longer had to have so many workers connecting telephone calls. So many job descriptions exist today that didn't even exist 15 or 20 years ago. That's only possible when technology makes workers more productive.

Indeed, American needs to focus more on increasing productivity through innovation. And then means better tax, regulatory, education and immigration policy. And as this chart from McKinsey shows, we are headed in the wrong direction in many areas: