Download Can Financial Engineering Cure Cancer Solve the Energy

Can Financial Engineering l
Cure Cancer Solve the Energy
Cure Cancer, Solve the Energy Crisis, and Stop Global Warming?
Crisis, and Stop Global Warming?
Andrew W. Lo, MIT
2012 MIT Research & Development Conference
November 15, 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Lessons From The Financial Crisis?
Cancer
Real Home Price Index (1890-2006)
200
Index o
or Interest R
Rate
180
160
140
120
100
80
60
1880
1900
1920
1940
1960
Year
Source: Robert J. Shiller, Irrational Exuberance, 2nd. Edition.
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
1980
2000
2020
To get back to longrun average, we need
45% real drop
( 35% nominal
(=
i ld
drop))
Slide 2
Lessons From The Financial Crisis?
Cancer
U.S. Bond Market Debt Issuance ($Billions)
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
1
Municipal
185.2 220.7 286.8 227.5 200.8 287.7 357.5
357.5 382.7 359.8 408.2 386.5 429 3
429.3 389.5 409.8 433.1 Treasury1
612.4 540.0 438.4 364.6 312.4 380.7 571.6
571.6 745.2 853.3 746.2 788.5 752 3
752.3 1,037.3 2,185.5 2,303.9 Mortgage‐Related2
479.7
577.6
1,118.1
985.4
660.0
1,663.9
2,283.0
3,084.3
1,879.0
2,182.4
2,088.8
2 186 2
2,186.2
1,362.2
2,041.4
1,742.7
Corporate
Debt3
343.7
466.0
610.7
629.2
587.5
776.1
636.7
775.8
780.7
752.8
1,058.9
1 127 5
1,127.5
707.2
901.8
1,062.7
Federal Agency
Securities
277.9
323.1
596.4
548.0
446.6
941.0
1,041.5
1,267.5
881.8(4) 669.0
747.3
941 8
941.8
984.5
1,117.0
1,032.6
Asset‐Backed
168.4
223.1
286.6
287.1
281.5
326.2
373.9
461.5
651.5
753.5
753.9
509 7
509.7
139.5
150.9
109.4
Total
2,067.2
2,350.5
3,336.9
3,041.8
2,488.8
4,375.6
5,264.2
6,717.0
4,524.3
5,512.1
5,823.9
5 946 8
5,946.8
4,620.2
6,806.4
6,684.5
H
How Did This Happen??
Did Thi H
??
Interest bearing marketable coupon public debt.
Includes GNMA, FNMA, and FHLMC mortgage‐backed securities and CMOs and private‐label MBS/CMOs.
3 Includes all non‐convertible debt, MTNs and Yankee bonds, but excludes CDs and federal agency debt. 4 Beginning with 2004, Sallie Mae has been excluded due to privatization.
Beginning with 2004 Sallie Mae has been excluded due to privatization
2
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Source: SIFMA
Source: SIFMA
Slide 3
Lessons From The Financial Crisis?
Cancer
Who Benefited From This Trend?:
 Commercial banks
Commercial banks
 Credit rating agencies (S&P, Moody’s, Fitch)
 Economists
 Government sponsored enterprises
 Homeowners
 Insurance companies (multiline, monoline)
I
i ( l ili
li )
 Investment banks and other issuers of MBSs, CDOs, and CDSs
 Investors (hedge funds, pension funds, mutual funds, others)
Investors (hedge funds pension funds mutual funds others)
 Mortgage lenders, brokers, servicers, trustees
 Politicians
 Regulators (CFTC, Fed, FDIC, FHFA, OCC, OTS, SEC, etc.)
“A Rising Tide Lifts All Boats” (Everybody
g
Benefitted)
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 4
Finance Is Becoming More Important
22 Oct 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Cancer
Slide 5
Why?
Cancer
Innovation Requires Financial Infrastructure!
 Private investment
 Accounting, legal, regulatory structures
Accounting legal regulatory structures
 Systemic stability
 Well‐functioning capital markets
 Proper design of securities
Proper design of securities
 Incentives
Fear Works Faster, But Greed Lasts Longer
22 Oct 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 6
The Power of Global Capital Markets
Cancer
Consider The DARPA Network Challenge
 Find 10 red balloons in fixed locations in U.S.
Find 10 red balloons in fixed locations in U S
 $40K prize to first team to find all 10 locations
 MIT team won
 8:52:41!
 How??
 Financial engineering!
 $4,000 per balloon if they won
= $2,000 to locator +
= $2 000 to locator +
$1,000 to person who asked locator +
$ 500 to person who asked person + …
+ remainder to charity
remainder to charity
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 7
The Power of Global Capital Markets
Cancer
E = mc2
Real Home Price Index (1890-2006)
200
Index o
or Interest R
Rate
180
160
140
120
100
80
60
1880
1900
1920
1940
1960
1980
2000
2020
Year
Source: Robert J. Shiller, Irrational Exuberance, 2nd. Edition.
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 8
The Power of Global Capital Markets
Cancer
What If We Could Focus This Power For “Good”?




Financial engineering with a Financial
engineering with a “conscience”
conscience
Apply expertise to solving society’s biggest challenges
Finance facilitates collaboration; collective intelligence
Finance facilitates collaboration; collective intelligence
With the proper financial engineering, I believe we can solve the following problems in 20 years or less:
the following problems in 20 years or less:
1. Cancer
2 Energy Crisis
2.
Energy Crisis
3. Global Warming
How??
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 9
Curing Cancer: Would You Invest?
Cancer
Typical Drug Development Program:
 $200MM out‐of‐pocket costs, 10‐year approval process
$200MM t f
k t
t 10
l
 Probability of success in oncology is 5%
 If successful, annual profits of $2B for 10‐year patent
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 10
Curing Cancer: Would You Invest?
Cancer
Typical Drug Development Program:
 $200MM out‐of‐pocket costs, 10‐year approval process
$200MM t f
k t
t 10
l
 Probability of success in oncology is 5%
 If successful, annual profits of $2B for 10‐year patent
p = 5%
+51.0%

$
$200MM
1  p = 95%
15 Nov 2012
–100
100.0%
0%
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 11
Curing Cancer: Would You Invest?
Cancer
What If We Invest In 150 Programs Simultaneously?:
 Requires $30B of capital
R
i $30B f
it l
 Assume programs are IID (can be relaxed)
 Diversification changes the economics of the business:
 But can we raise $30B??
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 12
Curing Cancer: Would You Invest?
Cancer
What If We Invest In 150 Programs Simultaneously?:
 Given the reduction in risk, debt‐financing is possible!
Gi
th
d ti i i k d bt fi
i i
ibl !
 $16.8B of Aaa debt can be issued
 With securitization, debt capacity is even larger
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 13
Curing Cancer: Would You Invest?
Cancer
Fernandez, Stein, Lo, Nature Biotech, October 2012
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 14
Is This Realistic?
Cancer
With Some Imagination, We Can Do Better!
 Imagine creating a $30B “Cure For Cancer” megafund
I
i
ti
$30B “C
F C
”
f d
 Imagine creating an advisory board of experts:
– Francis Collins, Al Gilman, Eric Lander, Bob Langer, Phil Sharp, Harold Varmus; Warren Buffett, Bill Gates, Jacob Goldfield, Bob Merton, Jim Simons, George Soros, Bill Sharpe
,
g
,
p
 Imagine 10MM households investing $3,000 each
 Imagine corporate pension funds, foundations, Imagine corporate pension funds foundations
endowments, insurance companies investing as well
 Imagine government tax incentives, credit I
i
i
i
di
enhancement, etc. (think Fannie Mae, Freddie Mac!)
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 15
Is This Realistic?
Cancer
Is There Capacity From Investors? In 2010:






U.S. bond market: $35T
U
S b d
k t $35T
Mutual funds: $12T
Money‐market funds: $1T
Norwegian sovereign wealth fund: $537B
Norwegian sovereign wealth fund: $537B
CalPERS: $226B
T
Target return of 126 public funds (2010): 8%
t t
f 126 bli f d (2010) 8%
In 2010, the Size of the Entire VC Industry Was:
In
2010 the Size of the Entire VC Industry Was:
$176B
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 16
Is This Realistic?
Cancer
What Are Some of the Potential Challenges?  Size:
Size: managing large portfolios of complex R&D projects may managing large portfolios of complex R&D projects may
require new management and governance structures (e.g., Manhattan Project)
 Centralization: must preserve the benefits of diversity as scale increases  Capacity: is the talent pool large enough to match the scale of C
it i th t l t
ll
ht
t h th
l f
this venture?
 Complexity: can investors understand the risks and rewards of Complexity: can investors understand the risks and rewards of
RBOs?
 Excesses: if successful, the potential for abuse will also increase
 Ethics: how to balance profit motive vs. social objectives for cures?
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 17
Conclusion
Cancer
Don t Declare War On Don’t
Declare War On
Cancer…
Put A Price Tag On Its Put
A Price Tag On Its
Head Instead!
With Sufficient Scale, We Can Do Well By Doing Good
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 18
Conclusion
Cancer
“Can We Afford It?”
Not To Try?”
– heart disease, Alzheimer’s, dementia, diabetes, obesity, H1N1, energy crisis, climate change solar flares
climate change, solar flares
With the Proper With
the Proper
Financial Structure,
Financial Structure, Anything Is Possible!
15 Nov 2012
© 2012 by Andrew W. Lo
All Rights Reserved
Slide 19
Thank You!