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Collateralized Innovation Obligations

by Dan Robles on June 9, 2009

Collateralized Debt Obligations (CDOs) are a type of structured asset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets. In the case of the current financial crisis, the underlying assets were home mortgages.  It is not necessary for the CDO buyer or seller to know who lives in the home and what they produce; the asset is a contract backed by future productivity.

CDOs vary in structure and underlying assets, but the basic principle is the same. To create a CDO, a corporate entity is constructed to hold contracts as collateral and to sell packages of predictable future cash flows to investors.  The more money handed out in home loans, the more money could be collected in CDOs

You are a liability.

While corporate leaders proclaim that people are the greatest asset, corporate accounting practices specify otherwise.  Employees are an expense and their salaries, benefits, and pensions are liabilities to be reduced any time the opportunity arises.  So what’s the problem?  Liabilities can’t innovate.

Suppose for a moment that people were in fact an asset on the accounting sheet and their salaries, benefits, and pensions were “investments”.

Collateralized Innovation Obligation (CIO):

The CIO would obviously be a type of structured asset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets, specifically, the output of productive and motivated people.

Like the CDO, a CIO would vary in structure and underlying assets, but the basic principle is the same. To create a CIO, a corporate entity is constructed to hold assets as collateral and to sell predicted future cash flows to investors.  It is not necessary for the CIO buyer or seller to know who is innovating or what they are producing; the asset is a contract backed by future changes in productivity. The more money handed out in innovation loans, the more money could be collected in CIOs.  For all practical purposes, we could call it an Innovation Bond.

Enter Social Media:

Social media is teaching us an important lesson about innovation.  Every time you get a diverse group of people together to share ideas, new ideas form.  Every idea is useful as long as it is shared; thousands of bad ideas must expire before the good one appears.  Conversational currency is the vetting mechanism of all ideas.  While not every good idea becomes a great invention, every great invention is built from good ideas.  Machines cannot produce ideas and no single company, country or person holds a monopoly on ideas.  Innovation and the creation of all wealth arise from the social, creative, and intellectual interaction of people.

Conversational Currency: The underlying asset

The underlying asset that supports both the Collateralized Debt Obligation and the Collateralized Innovation Obligation is a person and their ideas; one is an asset and the other is a liability.  Both types of people go to work every day to interact with other people.  They both share ideas and create better ways of doing things.  People increase human productivity through fault tolerant networks and support systems. They transform information into knowledge and innovation – and both pay their mortgage.

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The New Economic Paradigm: Part 7; Monetization of Knowledge Assets

by Dan Robles on April 20, 2009

The New Game in Town:

We have specified a structure for a new economic paradigm by simply integrating the the knowledge economy into the same structure as the financial system.  The result is a completely new way for entrepreneurs to create wealth.

Primordial soup:

A. We specified that Information is the currency that is convertible to knowledge assets and innovation assets through a mathematical relationship.

B. The decimal classification and logic system provides a machine-enabled accounting and inventory system for knowledge assets.

C. The factors of production for the new economy are: social capital, creative capital, and intellectual capital.

D. Social Networks provide vetting, perfect information, and self-regulation.

These ingredients allow the spark of entrepreneurship to illuminate the supply and the demand for knowledge assets outside the construct of traditional corporations, government, or academia; instead catalyzing innovation enterprise within and among social networks.

An economy is born:

Entrepreneurs now have all the information that they need for matching surplus knowledge assets to deficit knowledge assets as a means of increasing productivity of these assets in a highly predictable manner.  Advances in Social Media will keep the game organized, localized, transparent, self-regulating, and fair.  The Unit Business transaction can be assembled in infinite combinations to support countless ‘new-to-this-world’ innovation enterprise.

Show me the money.

Monetization is the process transforming a product or service into a universal tangible currency; specifically, a Dollar, a Euro, Yen, etc.  Very few people fully understand how money is created in the first place. The following video series gives an excellent overview of this process. It is highly advised that the reader invest 40 minutes in viewing this documentary:

Money represents future productivity:

In short, money is created from debt.  Banks are given the authority by a government through the fractional reserve system to literally scribe money into existence.  This money is not backed by gold or silver, rather, money is backed by the promise of the borrower to pay it back in the future.

Ultimately, the value of money is a social agreement; a promise based on an estimation of future productivity.  When those promises cannot be kept, the value of economy diminishes. When the promise is exceeded, the value of economy appreciates.

Blood brothers or distant cousins?

Debt and innovation have one very important feature in common; both are a proxy for future productivity. Therefore if debt can be used as a basis for a national currency, so can innovation.  Everyone should be willing to honor the social agreement because the currency would not change, only the basis of the currency.

The only way to sustainably create more money is to increase human productivity.  The only way to increase human productivity is to innovate.

The Risk Factor:

Our financial system has developed over 400 years a variety of systems, methods and analysis tools to manage risk in monetary transactions.  Innovation economics has applied the same system to the  management of risk for transactions of knowledge assets. The correlation is as follows:

The Financial Bank: the entrepreneur assumes that they have the knowledge to execute a business plan and then they go to the financial bank to borrow the money.  The remaining risks are knowledge related.

The Innovation Bank: the entrepreneur assumes that they have the money to execute a business plan and they go to the innovation bank to search for the knowledge. The remaining risk is finance related.

They hedge each other.

The Virtuous Circle:

The more knowledge you can assemble, the more money you can borrow.  The more money you can assemble, the more knowledge you can borrow. With both banks acting together – the risks cancel each other out and an economy of risk free innovation emerges.

Amalgamation of predicted cash flows:

With a computer readable knowledge inventory, diverse communities of practice, a percentile search engine, and the virtuous circle of finance; cash flows associated with innovation enterprise can be predicted much more accurately and with far lower risk than any current innovation system.

Were risk is predictable, a portfolio of innovations can be diversifies so if one innovation fails there is an equal chance that another will succeed and the risks cancel each other out.  The predicted combined cash flow of all the innovation enterprises can be depicted as a single large steady cash flow with low volatility.

Call Street:

Much like today’s companies do to raise money for expansion, the innovation bank can issue bonds on the open market.  A bond is a debt based on future innovation and will act as the transitional instrument to monetize innovation economy. Options can be sold on futures of innovation enterprise.

For example: a bond can issued by a bank or a government with coupon price of 1000 dollars paying a risk adjusted interest rate and redeemable in 8 years.  The proceeds can now be used to fund innovation enterprise which, by definition, are qualified and quantified on the basis of increased human productivity. Investors can buy options on promising algorithms for knowledge assets.

This system is exactly how mortgages are financed through global networks of bonds, options, and hedge funds. The current economic crisis happened because estimations of future human productivity failed to support the estimated value of the assets being represented.

The Innovation Economy is the hedge against financial crisis and consumption capitalism -  now and in the future.

The New Gold Rush:

Innovation Enterprise can easily exceed the 7-12% return that is normally expected on Wall Street.  Venture Capitalists only entertain innovation expected to return 1000%-5000% return.  There is a huge market of innovation enterprise in the regime between 12%-1000% that is currently uncapitalized.  If innovation bonds and associated options return only 25% consistently, the flow of global capital will be intense and our nation will be transformed far beyond any current expectation.  The opportunity is, however, even much greater than that; Innovation will reflect social priorities rather than Wall Street priorities.

The epiphany.

The epiphany of innovation economics is that technological change must always precede economic growth.  Humanity has been going about the process of globalization as if economic growth can precede technological change.  This has been the singular flaw in modern market economics that has created the unsustainable system that we have today.  The financial instrument of the innovation bond reverses this flaw and will open the next economic paradigm to extraordinary human progress.

Future modules in this series will discuss the implication and specific embodiments of an innovation economy.

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The US Financial System – Tail Wagging Dog

February 10, 2009

Finance and Innovation in the US is engaged in the dangerous dance of tail wagging dog. Innovation is as Wall Street does; not the other way around. This is wrong, this is very wrong.

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The Capitalization of Knowledge – Innovation Bonds

September 18, 2008

With a computer readable knowledge inventory, local communities of practice, a percentile search engine algorithm, and the virtuous circle of finance, then future innovation cash flows can be predicted much more accurately and with far lower risk than with, say, the venture capitalists acting alone. Were risk is predictable, cash flows are predictable and the [...]

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The Capitalization of Knowledge – The Virtuous Circle

September 18, 2008

We have set up a new game for entrepreneurs to play called Innovation Economics. We have defined a currency and an inventory where knowledge is visible outside the construct of the corporation – and resident in social networks. We have also described a way for entrepreneurs to visualize the knowledge asset and the supply and [...]

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