Andy Grove: Patents Are Like Mortgage Backed Securities

from the and-innovation-will-suffer dept

Intel co-founder and former CEO Andy Grove gave quite a speech this weekend at the National Inventors Hall of Fame, where he explained how patents are looking increasingly similar to the sort of financial derivatives that have brought down today's economy:

The true value of an invention is its usefulness to the public. Patents themselves have become products. They're instruments of investment traded on a separate market, often by speculators motivated by the highest financial return on their investment....

The patent product brings financial derivatives to mind. Derivatives have a complex relationship with an underlying asset. While there's nothing wrong with them in principle, their unfettered use has damaged the financial services industry and possibly the entire economy.

Do these patent instruments put us on a similar road? I fear our patent system increasingly serves those who invest in the patent products... It may be time to use Jefferson's principle as a test and ask if we meet it.

It's an interesting comparison and one that does seem apt the more you think about it. In separating out the "security" from the underlying asset, we tend to distort things. It was that distortion that resulted in the financial crisis, as it enabled those who wanted to sell risky things to obscure the actual risks and pretend that their securities were safer than they were. With patents, the system has been distorted to present the patent itself as being valuable, rather than the ability to execute and implement an idea in a manner that the market appreciates. It's definitely an area that could stand further thought and scrutiny.

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Leverage, Derivatives And Dog Food: How Wall St. Screwed Up

from the and-what-comes-next dept

Following my post on the makings of the financial crisis, some folks noted that I didn't really discuss the issues of leverage and derivatives, and how they ended up screwing up Wall Street something fierce -- as, instead, I focused much more simply on the issue of "risk" and sort of swept those details under the rug. I'd been intending to tackle the subject this week, but it looks like Andy Kessler has already done the job for me, with an excellent description of how Wall Street went from helping people trade stocks into a bunch of cowboy hedge fund traders who didn't even realize what they were trading, but knew they were making tons of money -- so they kept borrowing to do more of it. They got suckered by their own dog food and ate until they became seriously overstuffed.

Still, those profits weren't enough. Their customers were making great money buying Wall Street's derivatives. But why should banks and pension funds and hedge funds have all the fun? What a perfect use for all that capital on their huge balance sheets and cheap financing from low interest rates. Wall Street, en masse, started buying all these high yielding derivatives for their own account. They ate their own dog food, if you will.

It was the easy trade. Borrow at 3 percent and make 6 percent or 8 percent or 10 percent. They liked it so much, they levered up. Meaning instead of just borrowing a dollar for every two dollars of assets they owned (which by the way, thanks to the 50-percent margin requirement, is the amount of leverage that you and I are allowed to buy stocks from these same firms), they borrowed 20 to 1, 30 to 1, and even 50 to 1, if they could get away with it. And man, it was a lucrative trade. So why not?

I'll tell you why not. Because all of a sudden, Wall Street is no longer a business of traders or stock brokers or investment bankers, it's a giant hedge fund. And they have no idea what they are doing. None. I ran a hedge fund for a lot of years and learned rather quickly that if a trade was too good, if everyone was doing the same trade, then I should absolutely turn around and run for the hills. But no one on Wall Street did. The spreadsheets flashed green. Risk was a four-letter word best not said in polite company. Wall Streeters became hedge fund cowboys and loved the spoils, until a tiny little downturn in housing sent everyone rushing to get out of the pool at the same time.

It's a good read. Kessler and I agree that a new sort of Wall Street will come out of this -- and that's for the best. Money will flow again, but there will be new opportunities for banks to get back to basics.

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