I don’t pretend to be an economic expert, but as a recovering former entrepreneur, I want to share some observations about the participation of capital in the economic world inhabited by most Americans.

I started my business in 1993 with a small stake I got from an employee stock plan earned in my first job when that company had a mildly successful IPO. I started very slowly putting the business plan together and accomplished nothing for the first couple of years. In 1995, the company got its first in a series of Small Business Innovation Research grants (from USDA, many Government agencies dispense SBIR grants in many different fields) and it was able to move into a newly opened biotechnology incubator facility.

As I tried to move beyond government funding into private funding, I found over and over that availability of investment capital ebbed and flowed based on major trends of capital movement on Wall Street and beyond. My first encounter with this trend came in the summer of 1998. We were in the very late stages of negotiating an agreement for an investment in the company by a family owned investment fund that was a third generation of honest to goodness railroad robber baron money. The investment was going to be a very complicated one, but fell apart at the last minute when the Long Term Capital Management crisis hit. The investors mumbled something about a call on their capital and then simply stopped returning our phone calls.

Just over a year later, we did get a venture investment and were able to expand the company and move it out of the incubator facility. This came at the height of the dot com boom, when venture capital money was flowing very freely. Many jobs were created very quickly at the height of this boom. My modest enterprise reached a peak of twentysome employees at that time.

Not too long after getting this venture investment, however, the dot com boom started to slow and then bust. Many people blame 9-11 for the bust, but the flow of venture money came virtually to a halt in late 2000. My company held on for a while, even getting an investment from a New York Stock Exchange company to go with the venture money, but we wound the company down a few years later when the venture fund dried up and the NYSE company filed Chapter 11 just as we hit our next technology milestone that would have triggered their next tranche of funds.

I remember wondering, in late 2000, as I watched the flow of venture money dry up, what was going to be done with all of the "dry poweder" I kept reading about. The money still existed, but the venture capitalists simply stopped using it to invest in new companies or expand existing companies.

Reading this AP article today helped to answer that question. The article outlines the proposed new regulatory scheme that the Obama Administration is contemplating, but this is the passage that caught my eye:

Credit default swaps, which trade in a $60 trillion global market without government oversight, are contracts to insure against the default of financial instruments like bonds and corporate debt. They played a prominent role in the credit crisis that brought the downfall of investment banking giant Lehman Brothers Holdings Inc. last fall and nearly unraveled AIG, forcing the government to provide more than $180 billion in support.

Hedge funds, vast pools of capital holding an estimated $1.5 trillion in assets, operate mostly outside of government supervision. As the market crisis deepened last fall, hedge fund selling was widely cited as one of the reasons for increased volatility that pounded stocks and bonds. Hedge funds also suffered huge losses last year, notably from investments in securities tied to subprime mortgages.

It seems to me that large investors made a decision in late 2000, as the dot com boom was leveling off, that there was nothing left in the US economy for direct investment. For most of our industrial history, new American jobs have come from businesses starting and expanding with access to investment capital that comes on fair terms. Somehow, at the end of dot com, investors seemed to decide, en masse, that this model no longer works. I don’t know if it was based on their appetite for huge returns or their buying into the concept that we have become a service economy that no longer produces real goods.

Whatever the reason, this belief that there was nothing left to invest in made the investors invest in nothing. Credit default swaps are the ultimate investment in nothing. Although the quotation above mentions that some of the swaps were based on corporate bonds, we know that much of the CDS activity was based on bundled mortgages. Because there was such a huge market, leveraged at 30 to 1, chasing these investments, the real estate bubble was created through the insatiable demand for more mortgages on which to speculate. What still seems incomprehensible to me is that so much more investment money wanted to chase the imaginary investment instruments like CDS rather than to participate directly in the economy through investing the capital directly into the economy through funding for mortgages and corporate bonds.

My advice (with a value of zero) to the Obama Adminstration as they contemplate regulating the markets for complicated instruments like CDS and regulating hedge funds is to make sure that these markets are not allowed to remove the real "working capital" from the economy. Perhaps there should be a requirement that a certain percentage of money in hedge funds and in complicated instruments like CDS is injected directly into the economy in a way that produces real jobs. Think about even a small fraction of these funds now in CDS and hedge funds being put to work re-tooling steel mills to produce wind turbines, starting new manufacturing capacity in the US to produce solar cells, building a more efficient energy distribution grid and rebuilding our crumbling infrastructure. The funds to do this are now sitting on the sidelines of our economy, invested in nothing.