Creative Financial Instruments

Finance bros, now is your time!

Patrick McKenzie (@patio11) regularly unpacks how basically every modern industry – from airlines to window repair – depends on sophisticated financial engineering to function smoothly. Arguably, without things like third-party loan originators or credit-card point systems, many parts of modern life would be more expensive and higher friction. But to our knowledge there has been almost no financial innovation around scientific research. (Speaking of things that are expensive and high friction!)

As a whimsical example of innovative science financing, one could imagine bootstrapping an entire lab banking system off of “payday loans” for labs. Frugal labs that manage to get research done under budget could loan excess funds to labs who have grants in the pipeline but need to get started now. (Who better to judge how likely it is that a grant will succeed than other scientists!) Once the grant comes in, the lendee lab pays the lender lab back with interest. Once this system is in place, other systems of credit and exchange could follow. Of course, you’re not allowed to just lend money to other labs, but this restriction could be avoided by just happening to need a pile of fungible, divisible experimental supplies like gold or high-grade fiber optic cable. This is an absurd idea, but it hints at the whole space of possibilities for new financial instruments in science.

To some extent, this is already happening – one reason for researchers to work at a university is to smooth out payment timing. Technically, universities are fronting grantors the money for months or years. But extending the system could both enable more research and enable labs across universities or independent organizations to interact.

Slightly more realistically, John Hull and Andrew Lo have proposed massive portfolios with securitized debt for “long shots” that have extremely long timescales but potentially huge payouts like groundbreaking drugs.

There are good reasons why there has been less financial innovation in science. The biggest reason is that it’s not just a matter of pulling captured value from the future to the present. Most financial innovation is based on the idea that some party will have a large amount of money in the future if only they or some other party has a smaller amount in the present. However, the nature of research is that even incredibly impactful work often puts little money in any specific pockets.

It’s likely that any financial instruments for research will need to be backed by something other than pure market value. Paul Christiano and others have proposed “impact certificates” wherein a funder promises a pot of money for solving some problem or achieving some impact like curing a disease or figuring out a way to eliminate mosquitoes cheaply. If that pot is big enough, investors can then finance the projects they think are most likely to win that money by buying “equity” in an eventual payout. The ACX grants actually tried implementing the idea. Impact markets likely only work for a subset of work that has clear outcomes that some deep-pocketed supporter cares about a-priori. But they hint that there may be many other things to try – it just requires a different sort of creativity than most of the people in the scientific community are used to applying. Finance bros, now is your time!

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