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A Case Study in the Unintended Consequences of Financial Market Regulation: The Death of the Small Cap U.S. IPO?

The first 100 days of the Obama administration are widely expected to usher in a new era of U.S. capital markets regulation designed to restore the public’s trust in the decimated institutions that provide much of the liquidity infrastructure for the global capitalist system.  It is imperative that improved financial oversight be achieved swiftly through the enactment of effective regulation so that the markets can re-equilibrate and resume their normal function.  Without these necessary changes, global economic growth will continue to falter.

At the same time, we must recognize that regulations enacted in haste can have severe, negative unintended consequences.  The current moribund state of the American IPO market is a real-time case study in such unintended regulatory consequences.  Of equal import is the fact that the IPO drought is structural, not cyclical, and this has far reaching implications for the future of innovation in America. 

On November 19^th, Grant Thornton released a white paper, “Why Are IPO’s in the ICU?” written by David Weild, former Vice Chairman of the NASDAQ, and Edward Kim, former head of NASDAQ product development, both now principals at Capital Markets Advisory Partners. 

To download the white paper click Download Why are IPOs in the ICU_11_19 :  

The paper was presented to the NYSE and National Venture Capital Association’s Blue Ribbon Regional Task Force, which has been convened to make specific recommendations to the Obama administration in January regarding changes that must occur if America is to restore the small cap IPO as a compelling and differentiated positive feature of our capital markets.

The paper is concise and makes a cogent case as to how we got here.  If you want to understand why the IPO market has died and why the middle market for public emerging growth companies has effectively ceased functioning, you must read this paper.

 I agree with the paper’s overall thesis and with a number of its important assertions, including:   

* While conventional wisdom may say the U.S. IPO market is going through a cyclical downturn, exacerbated by the recent credit crisis, many are beginning to share a view of a new and much darker reality: The market for underwritten IPOs, given its current structure, is closed to most (80 percent) of the companies that need it. 

* The lack of an IPO market has caused venture capitalists to avoid financing some of the more far-reaching and risky ideas that have no obvious Fortune 500 buyer. Gone are the days when most venture capitalists would so willingly pioneer new industries and technologies (e.g., semiconductors, computers and biotechnology) that have no obvious outlet other than the IPO market.

* Regulators may have unwittingly done a real disservice to mom and pop investors by enabling traders to hijack the markets for speculation. This phenomenon can be seen by the large Wall Street firms who have witnessed their top 10 (by revenue) institutional investors — which only a decade ago were “long- only” mutual funds such as Fidelity and Alliance — be displaced by hyper-trading long-short hedge funds.

* The U.S. will lose its competitive advantage in developing, incubating and applying new technologies. Technologists are already returning to foreign jurisdictions like China and India where government has devised an increasing array of economic and capital markets incentives to compete.

The lack of IPO’s in the U.S. has broad, negative implications for continued risk taking by U.S. venture capitalists. If we have no public market liquidity for emerging growth companies, there will be no next generation of American technology giants. The demise of the technology IPO has also contributed to the structural breakdown in the broader cycle of research and development that underlies the American innovation crisis heralded by Silicon Valley thought leaders such as Judy Estrin.

 

If you have constructive recommendations for reforms that you believe should be enacted to support a renewed IPO market, please contact me at pascal@levp.com, and I will forward your suggestions to the NVCA.

Why I am Voting for Barack Obama for President of the United States

I have been a registered Independent voter since 1994.  Like many Americans, I've given more thought to this election than to any previous political contest. Many of us share a deep sense of unease as we witness a degree of instability and see a snowballing lack of confidence in  our country's economic and political institutions that was considered impossible in America. I feel strongly that my vote in 2008 may well be the most important exercise of this civic duty in my life. 

In supporting Barack Obama, like General Colin Powell, I also believe that Senator Obama is a "transformational figure".  I trust Barack Obama's judgment and believe in his ability to successfully lead this country through the dark period that engulfs our national psyche.  I also believe he is sincere in his desire to "do the right thing" for America.  His specific position on eliminating capital gains taxes for start-ups supports long-term investing through innovation and venture capital.  This approach recognizes that there are no quick fixes to our economic problems and that America needs to resume a path toward sustainable long-term economic growth through new job creation.  

In my view, the Washington Post's endorsement of Barack Obama for President on October 17 most closely reflects my own personal opinions.  Below, I have quoted some excerpts from the Post's editorial which capture the essence of my strong support for Barack Obama:

"Mr. Obama is a man of supple intelligence, with a nuanced grasp of complex issues and evident skill at conciliation and consensus-building. At home, we believe, he would respond to the economic crisis with a healthy respect for markets tempered by justified dismay over rising inequality and an understanding of the need for focused regulation. Abroad, the best evidence suggests that he would seek to maintain U.S. leadership and engagement, continue the fight against terrorists, and wage vigorous diplomacy on behalf of U.S. values and interests. Mr. Obama has the potential to become a great president. . . .

A McCain presidency would not equal four more years [of the Bush administration], but outside of his inner circle, Mr. McCain would draw on many of the same policymakers who have brought us to our current state. We believe they have richly earned, and might even benefit from, some years in the political wilderness. . . .

There are two sets of issues that matter most in judging these candidacies. The first has to do with restoring and promoting prosperity and sharing its fruits more evenly in a globalizing era that has suppressed wages and heightened inequality. Here the choice is not a close call. Mr. McCain has little interest in economics and no apparent feel for the topic. His principal proposal, doubling down on the Bush tax cuts, would exacerbate the fiscal wreckage and the inequality simultaneously. Mr. Obama's economic plan contains its share of unaffordable promises, but it pushes more in the direction of fairness and fiscal health. Both men have pledged to tackle climate change. . . .

Mr. Obama also understands that the most important single counter to inequality, and the best way to maintain American competitiveness, is improved education, another subject of only modest interest to Mr. McCain. . . .

A better health-care system also is crucial to bolstering U.S. competitiveness and relieving worker insecurity. Mr. McCain is right to advocate an end to the tax favoritism showed to employer plans. This system works against lower-income people, and Mr. Obama has disparaged the McCain proposal in deceptive ways. But Mr. McCain's health plan doesn't do enough to protect those who cannot afford health insurance. Mr. Obama hopes to steer the country toward universal coverage by charting a course between government mandates and individual choice, though we question whether his plan is affordable or does enough to contain costs. . . .

It is almost impossible to predict what policies will be called for by January, but certainly the country will want in its president a combination of nimbleness and steadfastness -- precisely the qualities Mr. Obama has displayed during the past few weeks. When he might have been scoring political points against the incumbent, he instead responsibly urged fellow Democrats in Congress to back Mr. Bush's financial rescue plan. He has surrounded himself with top-notch, experienced, centrist economic advisers -- perhaps the best warranty that, unlike some past presidents of modest experience, Mr. Obama will not ride into town determined to reinvent every policy wheel. Some have disparaged Mr. Obama as too cool, but his unflappability over the past few weeks -- indeed, over two years of campaigning -- strikes us as exactly what Americans might want in their president at a time of great uncertainty. . . .

...Mr. Obama, as anyone who reads his books can tell, also has a sophisticated understanding of the world and America's place in it. . . .We hope he would navigate between the amoral realism of some in his party and the counterproductive cocksureness of the current administration, especially in its first term. On most policies, such as the need to go after al-Qaeda, check Iran's nuclear ambitions and fight HIV/AIDS abroad, he differs little from Mr. Bush or Mr. McCain. But he promises defter diplomacy and greater commitment to allies. His team overstates the likelihood that either of those can produce dramatically better results, but both are certainly worth trying. . . .

Thanks to the surge that Mr. Obama opposed, it may be feasible to withdraw many troops during his first two years in office. But if it isn't -- and U.S. generals have warned that the hard-won gains of the past 18 months could be lost by a precipitous withdrawal -- we can only hope and assume that Mr. Obama would recognize the strategic importance of success in Iraq and adjust his plans. . . .

We also can only hope that the alarming anti-trade rhetoric we have heard from Mr. Obama during the campaign would give way to the understanding of the benefits of trade reflected in his writings. A silver lining of the financial crisis may be the flexibility it gives Mr. Obama to override some of the interest groups and members of Congress in his own party who oppose open trade, as well as to pursue the entitlement reform that he surely understands is needed. . . .

… the stress of a campaign can reveal some essential truths, and the picture of Mr. McCain that emerged this year is far from reassuring. To pass his party's tax-cut litmus test, he jettisoned his commitment to balanced budgets. He hasn't come up with a coherent agenda, and at times he has seemed rash and impulsive. And we find no way to square his professed passion for America's national security with his choice of a running mate who, no matter what her other strengths, is not prepared to be commander in chief. . . .

… Mr. Obama's temperament is unlike anything we've seen on the national stage in many years. He is deliberate but not indecisive; eloquent but a master of substance and detail; preternaturally confident but eager to hear opposing points of view. He has inspired millions of voters of diverse ages and races, no small thing in our often divided and cynical country. We think he is the right man for a perilous moment."

Driving in the U.S. DECLINES over 4% since last year-- let's get it down 10% by year-end!

The Department of Transportation revealed a very important statistic today:

Compared with March a year earlier, Americans drove an estimated 4.3 percent less -- that's 11 billion fewer miles, the DOT's Federal Highway Administration said Monday, calling it "the sharpest yearly drop for any month in FHWA history." Records have been kept since 1942.

Americans are starting to act. This is a good thing. How's that for a grass roots twin initiative in American foreign policy and energy security policy? And nobody in Washington even called for it. Imagine what could happen if we had leadership in this country?

Don't Forget What Makes America Great-- Our Diversity

As we celebrate this Memorial Day weekend and remember those who have died for our country in military service, let's not forget that our young men and women continue to fight to preserve our democratic society and the personal freedoms that define our way of life.

In his new book, The Post-American World, Council on Foreign Relations member Fareed Zakaria reflects on many of the challenges that we face as a country in the 21st century. He also reflects on the strengths that make America unique.

When I describe what makes the Silicon Valley eco-system for entrepreneurs unique and, in my view, exceedingly difficult to duplicate, my description mirrors what Zakaria describes as America's core strength:

" Per capita, it turns out, the United States trains more engineers than either of the Asian giants. ... America's hidden secret is that most of these engineers are immigrants. Foreign students and immigrants account for almost 50 percent of all science researchers in the country. . . . Half of all Silicon Valley start-ups have one founder who is an immigrant or first generation American. The potential for a new burst of American productivity depends not on our education system or R&D spending, but on our immigration policies. If these people are allowed and encouraged to stay, then innovation will happen here. If they leave, they'll take it with them. More broadly, this is America's great-- and potentially insurmountable-- strength. It remains the most open, flexible society in the world, able to absorb other people, cultures, ideas, goods, and services. The country thrives on the hunger and energy of poor immigrants."

I am a first generation American who, by the good fortune of being born and raised and Puerto Rico, was an American citizen before my immigrant parents were naturalized. But for the ultimate sacrifices made by American soldiers against the Nazis in World War II, I would not be here.

This Memorial Day, let's also not forget that the lifeblood of innovation and entrepreneurship comes from many places, but it has found a uniquely fertile soil in an America that embraces and celebrates diversity.

Democracy in America Revisited-- The Rise of Authoritarian Capitalism [Sixth of a Series]

I haven’t found anyone who will argue vigorously against the notion that China and Russia have thoroughly abandoned their Communist roots- but the elites who wield power in these countries certainly continue to embrace authoritarianism, only now under ‘freewheeling’ if not free market capitalism. Authoritarian behavior can be contagious. Consider the U.S. policy of unilateral military interventionism that has been in place for over five years since the Iraq invasion—does that feel a little authoritarian to you?

Authoritarian capitalism is an attempt to solve the crisis created by inadequate political institutions that have failed to forge a national citizenry. In a socio-political environment where America’s leaders define the nation’s political agenda through the fear of terrorism and consequent social disorder, convenient excuses (another terrorist attack on American soil) could easily lead to the loss of civil liberties and the rise of authoritarianism in America. Authoritarian Capitalism appears to currently be the default regime of choice for societies lacking the political will and the political institutions to empower marginalized socio-economic groups by allowing the expression of dissent.

Kissinger Eulogizes William F. Buckley and Comments on Knowledge and Faith

Anthony Ramirez of The New York Times published an article on April 5 describing the funeral service at St. Patrick's Cathedral in New York for William F. Buckley, who died on February 27th at age 82. One of the most influential American political conservatives of his generation, Buckley is widely respected for his powerful intellect. The founder of The National Review, he is recognized for the central role he played in shaping the blend of anti-communism and libertarian economics that became the core american political ideology of President Ronald Reagan.

Speaking at the funeral service, former Secretary of State Henry Kissinger made emotional comments about how Buckley had come to reconcile the gap between objective knowledge and religious faith:

'Over a decade ago,'' he [Kissinger] said, clearing his throat, ''Bill and I discussed the relationship of knowledge to faith. I surmised it required a special act of divine grace to make the leap from the intellectual to the spiritual. In a note, Bill demurred. No special epiphany was involved, he argued. There could be a spiritual and intellectual drift until, one day, the eyes opened and happiness followed ever after. Bill noted that he had seen that culmination in friends. He did not claim it for himself."

I was struck by these comments, both because of the speaker and the context. Secretary Kissinger, himself a man of powerful intellect and a German Jew whose parents fled the Holocaust, has clearly considered deep questions of God and religion and was touched by the loss of a long-time friend. It is interesting to me that he focuses on the notion that, for individuals who are intellectuals and very data driven, perhaps an epiphany or revelation of some kind is necessary to bridge the gap between faith in the existence of God and knowledge of objective reality.

As I think of this perennial debate, the oft-repeated motto of the New New Atheists comes to mind-- "I don't need to believe in God to have a moral conscience." The atheists, in my view, totally miss the irony of their own assertion. That little voice in your head that tells you the difference between right and wrong is evidence of a little bit of God that's inside every one of us. No epiphany required.

"The Untold Cyber War"-- Huffington Post Reports on Upcoming 2nd Annual IT Security Entrepreneurs Forum

I was recently interviewed by Karen Salmansohn, who writes a regular column for the Huffington Post, while I was at the Aspen Institute attending a Socrates Society Forum seminar on Energy Security.  Her article, 'The Untold Cyber War' , comments on an area of increasing personal and professional interest for me-- protecting our nation's vulnerability to a cyber attack that could cripple our critical data and communications infrastructure.

We are engaged in a full-on cyber war right now-- and the bad guys aren't just laptop-toting 17 year-olds fueled by Red Bull in the Ukraine.  Well-funded, organized groups (translates to state-sponsored) are constantly probing for exploitable weaknesses in our data network infrastructure, and they are not discriminating between the private sector and the government.  We must collaborate and share best practices to win this war-- the costs of losing it will be severe, pervasive, and will wreak havoc across our socio-economic system very quickly.

To learn more about how to promote public private partnerships and see the agenda for the second annual IT Security Entrepreneurs Forum, go to www.publicprivatepartnerships.org.

"We are Robbing Posterity to Live Today."

I am at the Aspen Institute to attend a Socrates Society seminar this President's weekend, and the headline for this post is a quote by Zeke Emanuel, Chair of the Department of Bioethics at The Clinical Center of the National Institutes of Health, who is moderating a session on "Resolving Bioethical Dilemmas" (believe it or not, his session is exclusively for teenagers-- see Teen Socrates).

Zeke made this comment during our opening dinner panel discussion in the context of answering the following:

"What is a key question that you believe the next President of the United States should consider upon taking office?"

This simple statement is a profound and concise rendering of the American malady.  Think about it-- American society has devolved to the point where virtually everything we experience is driven by a lust for instant gratification-- from the mainstreaming of pornography to celebrity-seeking reality TV shows; from hasty tax stimulus packages to hedge funds; from inscrutable financial derivatives to ignorant day traders.

The popular media is consumed with the NOW.  The basic concept of long-term stewardship in public policy, of the obligation that we have as a society to bear responsibility for our children and their children, is a novelty.  Many people debating the impact of accelerating rates of climate change on the future of the world are missing the point-- it's all about posterity.  Have we truly forgotten that we are here on earth for something more than just our brief and individually insignificant moments of existence in time? 

I come to the Aspen Institute, where I currently co-chair the Socrates Society Advisory Board with Laura Lauder, for the luxury of being able to learn, for the gift of being able to step outside the narrow hallway of thinking that governs my everyday business life.  I come to the Aspen Institute to be able to hear truly insightful observations from brilliant people like Zeke Emanuel.

Tonight, 65 of us who are participating in four different seminars were fortunate to be able to hear other answers to this question from former CIA Director Jim Woolsey, senior fellow for U.S. foreign policy at the Council on Foreign Relations Isobel Coleman, former Republican congressman from Oklahoma Mickey Edwards,  and Princeton University Professor of History Sean Wilentz. 

Now what are we going to do to get more people who can impact the future to remember that posterity matters?

Why We Need to Find Common Ground With Islam Through Education

Babar Ahmed is a talented up-and-coming movie director ("Royal Kill") and the son of Professor Akbar Ahmed, who first taught me about the history of Islam at the Aspen Institute's Socrates Society.  Babar recently spoke about Islam at a gathering in Palm Beach.  The Palm Beach Post reported on his remarks:

"And so why are we seeing suicide bombings if Muslim history is so good?" he asked.

Because Islam is divided into three groups, Ahmed theorized, the conservative, the moderate and the extremist, the latter of which is "growing every single day."

In the aftermath of the Soviet Union's occupation of Afghanistan, Ahmed said, orphans were driven over the border to Pakistan, where they were taken in and educated by the most primitive tribal schools, run by illiterates who could not read or properly interpret the Koran.

"In driving the Soviets out of Afghanistan," Ahmed said, "the United States developed relationships with military dictators which continue to this day. That may have worked in the short term, but it left the orphans poor, desperate and angry, without any skills except how to use a gun."

The current movie, Charlie Wilson's War, makes the same point, he noted.

The solution, Ahmed said, is education, because the majority of Muslims are young. In Pakistan alone, he said, 40 percent of the population is under 16, and more receptive to radicalism.

"One half of the world's population is Muslim, Christian or Jewish," Ahmed said, "and if we don't start finding this common ground, we are going to be heading for a very turbulent century."

Babar is right on point.  One of the few successful models of bilingual interfaith educational success in the Middle East is Hand in Hand in Israel-- the madrassas have a long way to go, but there is light at the end of the tunnel, and we can act to make sure that it is not on oncoming train...

Luddites, Technology, and the Gini Coefficent

  A recent article in the January 26th edition of The Economist, "Briefing: The world's silver lining",  cited interesting data on globalization and the contribution of technology to rising inequality in developing countries.  The data is drawn from the IMF's World Economic Outlook October 2007 and focuses on something called the Gini coefficient, an unfamiliar concept to me prior to reading the article.

What is the Gini coefficient?  According to Wikipedia, "The Gini coefficient is a measure of statistical dispersion most prominently used as a measure or inequality of income distirbution or inequality of wealth distribution. It is defined as a ratio with values between 0 and 1: the numerator is the area between the Lorenz curve of the distribution and the uniform distribution line; the denominator is the area under the uniform distribution line. Thus, a low Gini coefficient indicates more equal income or wealth distribution, while a high Gini coefficient indicates more unequal distribution. 0 corresponds to perfect equality (everyone having exactly the same income) and 1 corresponds to perfect inequality (where one person has all the income, while everyone else has zero income). The Gini coefficient requires that no one have a negative net income or wealth."

One of the most interesting points to me in The Economist article is that the influx of new technology into developing countries initially exacerbates inequality in those countries.  Why? Because initially only a small number of local people in those countries are sufficiently educated to take advantage of the technology to make money.  Local elites continue to grab the low hanging economic fruit with new technology tools, and you experience an immediate greater concentration of wealth as the whiole economic pie also grows, or, in economic parlance, a higher Gini coefficent.

This reality only reinforces my view that we are still in the early innings of the globalization game.  21st century Luddites who claim to be looking out for the welfare of the least advantaged ignore the fact that technology, by catalyzing change, also contributes to the initial socio-economic dislocation that will ultimately erode the economic status quo.

As The Economist points out "technology in its broadest sense-- the flow of new ideas-- is the only way of getting growth rates up to 5-10% a year, the rate which enables poor countries to catch up with the West.  Without it, growth would be dependent on labour and capital inputs, and growth would be just a few percent.  To reduce technological progress-- even supposing one could do it-- would be to condemn poor countries to stay poor."

Those who decry globalization and the transfer of technology to developing countries are missing at least two key points: (1) that the absolute income level of the bottom fifth of these countries is rising steeply and has been since the mid-1990s (coincidentally the dawn of the Internet age); and (2) that this overall increase in income from sustained high economic growth rates will reach a tipping point that reverses the initial negative readings from the Gini coefficient. 

So much for the Luddites, again.