Digital Matters - Issue 34

Assume for the moment that Celera Genomics or the publicly funded Human Genome Project completes the sequencing of the human genome sometime in 2000. And assume, for the sake of argument, that the sequencing leads to breakthrough discoveries in health care and pharmacology. (Wall Street already makes both of those assumptions.) Now imagine that genetically modified foods can be produced that not only provide consumers with basic nutrients but that also contain genetic instruction sets that suppress the onset of arthritis or the possibility of stroke -- products known in the genomics world as "agriceuticals," products that many agricultural experts believe are, at most, five years away from existence.

Now go back to Europe. If agriceuticals are in fact made available in the next five years, the EU will be left with a choice: Either it can continue using about half of its budget for harvesting great-tasting carrots and corn that contain all of the basic nutrients, or it can buy genetically modified carrots and corn that are equally tasty and nutritious -- and that also reduce the likelihood of stroke by, say, two-thirds. Which way will it go?

EU bureaucrats probably won't buy the genetically modified vegetables. But everyone else in the world will. As a result, European-grown carrots and corn will quickly become noncompetitive in the global marketplace. And, in turn, the EU will have to devote even more of its budget to agricultural subsidies, and its citizens will be forced to eat food products that have no added value.

As it happens, three big companies -- DuPont, Monsanto, and Novartis -- own roughly 66% of the world's genomic seed technology. It's likely that in seven years, the value of agriculture in its entirety will be housed inside those corporations. And the EU will be spending perhaps more than half of its budget on agricultural products that will no longer be competitive. If you manage $10 billion or $20 billion or $300 billion on Wall Street, you can't not bet on genomics-based agriculture, no matter what you think of DuPont or Monsanto or Novartis -- or how you feel about the welfare of EU citizens. And so it should be no surprise that all of the major investment firms are heavily loaded up on those very companies.

It is said, over and over again, that we live in a time of unprecedented change. That's an understatement. There are two great divides in modern life: the Internet divide and the genomics divide. If Wall Street believes that a company is on the "right" side of those divides, it awards that company a value at unprecedented multiples. Companies that Wall Street perceives as being on the "wrong" side of those divides can't catch a break.

Does betting on the "right" side of those divides constitute a speculative frenzy? Or does it reflect a reasonably sensible estimate of where future value will be found? The question is the answer. It isn't a mirage if you can touch it. Which is not to say that the financial markets are safe. There's still a certain level of danger involved -- but overvaluations and eventual company failures aren't what you have to worry about. In fact, those two prospects are, to some extent, inevitable -- and have been since the Industrial Revolution. The real danger in the financial markets today can be summed up in one word: leverage. The democratization of corporate finance has brought with it two unintended consequences: a huge derivatives market that hedges and covers bets, and an unprecedented lending and buying of financial instruments on margin.

In simple terms, here's what happens: Someone buys 1,000 shares of Microsoft stock, borrows $50,000 against that investment, buys 500 more shares of Microsoft stock, borrows $25,000 against that investment, buys another 250 shares of Microsoft stock, and borrows against that investment. All is well if the face value of Microsoft stock continues to rise. Our investor gets richer, borrows more to buy more stock, and gets richer still. But if the price of Microsoft stock starts to fall, and continues to fall, our investor is leveraged into disaster.

Leverage is the genuinely scary thing about the new economy on the new Wall Street. Practically every bet on the future value of financial instruments is doubled and tripled and quadrupled by derivative bets and margin buying. The slightest unanticipated development can send shock waves through the whole system.

Remember Long-Term Capital Management, the hedge fund that all but collapsed in 1998? A bunch of rich guys in Greenwich, Connecticut ended up losing their shirts. And because of the derivative fallout from those guys' losing their shirts, several of the world's largest investment firms -- including Bear Stearns, Goldman Sachs, and Merrill Lynch -- came within a button of losing their shirts. Only the intervention of Alan Greenspan and the Federal Reserve Board kept the United States from experiencing the financial equivalent of a grand mal seizure -- and taking the whole world down with it.