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Crazy or creative? MIT finance whiz suggests a twist on CDOs for R&D

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MIT finance engineering professor Andrew Lo caused a stir this week when he expounded on an unorthodox idea for financing drug research. Lo's notion, according to Financial Times columnist John Gapper, is to create CDOs--collateralized drug obligations--which can invest in a set of drug development projects and pay returns on successful treatments.  

Starting from the rather shaky premise that venture capital groups, the NIH and Big Pharma are essentially played out, incapable of successfully financing a new generation of therapies, Lo treated the audience at the Milken Institute Global Conference with the potential of a variation on the CDOs that spawned a housing bubble and triggered a global financial crisis. In this case he would look for debt investors willing to put up $50 billion to $100 billion to fund 150 experimental drugs over 10 years.

According to Gapper, Lo believes that we're headed into an era of underfinancing in drug R&D. And while these new CDOs might tempt a fresh financial catastrophe, society can ill afford the impact of a swoon in research.

Noted Lo: "If there's a cancer bubble, I can live with that."

Gapper's column has issues. The 43% drop in venture funding in the first quarter could be a mere blip on the screen following a surge late last year. And the repeated warnings over a shortage of R&D cash for early-stage work has been greeted with a swarm of new initiatives. The NIH also remains a big investor. And David Brennan was not fired from AstraZeneca ($AZN) because investors wanted him to curb R&D--that was already under way--but because the company's R&D strategy had performed so poorly.

Still, most observers would agree that R&D financing remains an issue. If enough investors felt that CDOs offered a relatively low risk way to invest in new drugs, the added cash could make a big difference for drug developers.

- here's the column from the Financial Times