By Chris Cook
It was pleasing to see that the editorial in the Financial Times today - which is entitled "Sovereign Equity" - suggests that perhaps financial instruments other than debt may be appropriate for governments. It is becoming daily more evident that UK Plc not only has no equity, but shows the debt on its balance sheet while ommitting the assets against which the debt is secured.
I have been promoting the concept of a National Equity, and a legal and financial infrastructure enabling it, for several years now. But merely floating the idea on LabourList elicited a mixture of incomprehension and derision.
In fact, as I pointed out, a National Equity has to all intents and purposes existed since the mid 18th century in the form of the UK Treasury's undated, but redeemable Consolidated Loan, and the more recent undated, redeemable War Loan, both of which are interest-bearing government debt or 'gilts'
In addition to this apparently anachronistic undated debt, the UK's notes and coin, which are undated instruments of 'sovereign credit', are to all intents and purposes also a non-interest-bearing form of equity, and we have Mr Darling to thank for the fact that this stock of cash has now been boosted by £200bn of sovereign credit in the form of the much maligned and widely misunderstood 'Quantitative Easing'. The fact that the Bank of England chooses to pay 0.5% in respect of the bank reserve balances which were pumped up by QE has essentially created a form of UK Plc redeemable equity costing the public 0.5% a year. Cheap at the price.
I believe that it is possible for the public and private sectors to combine to create new forms of equity instruments within the framework of corporate partnerships, rather than archaic company and trust law vehicles. Such Public Equity is capable of revolutionising the long term financing of UK productive assets - such as affordable housing, renewable energy, new transport infrastructure, and the re-skilling of our workforce. As I have pointed out, such massive government investment can and should be funded by QE provided it is managed professionally under the supervision of a monetary authority.
It may not be conventional - but I agree with the FT that it is about time the UK issued some National Equity - just not the toxic form of equity comprised in a Plc.
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((First, let me tell you that I work in the pensions and investments industry, and have done so for a decade. I would like to think I know what I am talking about))
1. Pension are structured very much like bonds. They have fixed cashflows per annum, dependent on the current "face" value, and even (over an entire fund) an assumed maturity. They are only undated in so far as an individual persons lifespan is hard to gauge - on average over thousands of people it is pretty well known.
2. OK, markets worked before CDS, but you clearly know not the first thing about CDS. Sovereign CDS could not be used to try and "bankrupt" a country - only poor fiscal governance can do that, leading the underlying bonds themselves to sell off.
Without CDS rates would be a lot higher, put it that way.
3. You taking an outlying example and trying to debase my argument on it. Shame that won't really work.
Truly, you can sell the production, but it makes absolutely no difference to my argument. How do you value the "production" of many public services? It is hard, nay, impossible to sell "equity" of any kind without some kind of cash positive flow to the investor.
For example, what value is the police's "production"? It is simply unquantifiable, until they start charging for their service. Or, a motorway? The asset itself is worthless, unless you own the land and can sell/develop it, or charge people for using it.
As for you, you seem to be living in some happy clappy fantasy land where you can effectively print money and shower it down on the nation with absolutely no consequences. Your article is just a re-hash of the one you did (and was completely wrong about) regarding extending QE for investment. You clearly don't understand the difference between investment and spending, and I get the impression you don't really understand what investing is either - much like the current governemnt.
I might have known you were a pensions intermediary. That probably explains your patronising tone throughout your visits to this list.
I have spent 25 years in market development and regulation - for many years at top level, and I have probably forgotten more about how markets work than you will ever know.
So much for the pissing contest.
Point 1.
The new types of quasi-equity I am observing emerging (eg Income Trusts, Master Limited Partnerships, and the innovation I was seed funded by the Norwegian government to develop) offer new tools for liability driven investment.
I have also developed a new approach to address longevity risk, using legal tools which are also, interestingly enough, the basis of Islamic insurance known as 'Takaful'.
Point Two
I know perfectly well how CDS work and have never said that CDS could be used to bankrupt a country.
Without CDS rates would be a lot higher, put it that way.
Which just goes to show either how lacking you are in your appreciation of risk, or how willing you are to privatise profit and socialise losses. In other words, whether you and your colleagues are Fools or Knaves.
Point 3.
You taking an outlying example and trying to debase my argument on it. Shame that won't really work.
This takes the biscuit.
The forms of Public Equity I advocate are based on a new approach to ownership of productive assets, particularly land/location and energy assets.
The provision and financing of public services such as policing is a different question, and concerns credit in circulation.
Your article is just a re-hash of the one you did (and was completely wrong about) regarding extending QE for investment. You clearly don't understand the difference between investment and spending, and I get the impression you don't really understand what investing is either - much like the current governemnt.
Classic - pure bluster.
You have not produced a scintilla of argument which addresses why the use of privately created credit for investment - professionally managed and supervised -is superior to publicly created credit aka QE, when also so managed and supervised.
Why should not banking professionals manage public credit under supervision of a Monetary Authority? If offered the chance they would probably queue up to do so since they would not need to deploy their own capital to support it.
I might take you seriously if you had an answer to that question, rather than simply resorting to pathetic and unfounded bluster.
But as the man said, it's not easy to get someone to understand something when their salary depends on them not understanding, and as a pension intermediary you are a classic case of an endangered species.
* Allowed where there is no 'insurable interest'
* No necessity to have the capital to redeem the insurable loss
* Unregulated (except some restrictions in NY State)
* AIG got into the shit with them
The main problems, quite apart from the valuation aspect mentioned below, are to my mind twofold: (i) if there is no objective reward (i.e. cash dividends) in this structure then what is the incentive for anyone to take the "shared risk"? and (ii) even if the shared asset class he proposes were created, how could we possibly migrate the vested interests from the current position to the new structure without causing absolute chaos...
Always a pleasure to engage with someone who knows his stuff, and avoids the polemic.
Your Point One.
There is a difference between fiat money 'cash' and 'money's worth'. I suggest that many would prefer a return in land rental value or energy value to a return in fiat money.
For instance there are literally $ tens of billions now invested in energy and commodities through ETFs which will see no cash income from the investment, and are essentially 'hedging inflation'.
Your Point Two.
I believe that the 'Unitisation' of property rentals, and of energy flows, using Units redeemable in underlying use value, offers a compelling value proposition to all stakeholders.
For existing 'for shareholder profit' intermediaries the proposition is a transition to service provision, and a dramatic shrinkage in the need for capital, which would therefore be returned.
For existing owners and investors the Debt/Equity swap proposition is:
(a) Debt - such as bonds - a better outcome than any debt-based solution;
(b) Equity - for owners/shareholders, a better 'exit' than any other solution.
For the users of capital the cost is drastically reduced because it comes directly from stakeholders, and there is no compound interest.
If and when you were to get your head around what I am actually proposing, eg Pages 8 and 9 here....
Co-ownership
...or concerning Energy Pools
...you may even agree with me.
Regarding the first point: I'm trying to relate this back to real life, assuming a structure like this were to be implemented, but am still struggling to understand where the risk/reward balance lies. For the sake of argument, let's pretend I represented a family with a modest amount of savings - clearly I recognise the value of long term investment for my family, and if I were to invest into this structure then if I understand correctly my capital could give my family an energy or land rental "credit" (depending, presumably, on where I chose to invest?). Thus if the UK performs well, relatively, then I will, for instance, receive money off my energy bill or other such reduced living costs, but if the UK underperforms then does the opposite happen: does my bill increase? How do I get my investment back out? Is this done in the same way as buying shares? Are foreign investors permitted?
Re Point 2: I don't think I can disagree with the principle of the endgame you outline, but my concern comes again from the transition - at the moment the vast majority of the invested cash is tied up in pension funds: to get from the current position to the future you outline do we give everyone their pension investment, in cash, to allow them then to choose the form of re-investment? Or do we move people across without consultation? Put simply, I don't see how the inherent imbalance of wealth would not be carried over into any new structure without an extreme wealth redistribution scheme - a politically impossible task, short of enacting a French-style revolution...
For example, what value is the police's "production"? It is simply unquantifiable, until they start charging for their service. Or, a motorway? The asset itself is worthless, unless you own the land and can sell/develop it, or charge people for using it.'
Well, that's interesting to hear amongst all the claims about a decline in productivity in the public sector.
it makes no difference. my point still stands - they are not in themselves profit making, and until they are (privatised) no-one will buy equity stakes in them.
you can't "soverign equity"/privatise the whole UK as that in effect privatises the tax system (I suppose actually you could, but that would be the end of the welfare state, which not even I would advocate).
Equity is a share in the ownership and profits of a business.
Currently, roads, hospitals, education etc are NOT businesses. They are amenities. Whilst they are undoubtably necessary, and needed to create business and wealth, they have no profits of their own, and they are paid for by taxation.
So you can either tackle "sovereign equity" one of two ways. Either, you can either turn those individual ammenities into businesses (otherwise known as privatisation) or you can do it on a country wide basis - people buy UK PLc equity, and get paid dividends on the basis of the total tax take of the country.
The former i'm sure the left wouldn't want, and the latter won't work as either the government would not pay out enough in dividends (leading no-one to buy the investment), have to raise taxes too hard, or simply, the wealthy will use this equity to hedge their own tax exposure (which the less well off will not be able to do).
The last thing I advocate is the uniquely toxic public variant of the Joint Stock Limited Liability Company. ie the Plc. You would know - if you could bring yourself to actually read what I have many times written - that I advocate a partnership framework for investment rather than the pathological Plc form.
There is no profit and no loss within a partnership - merely shared risk and reward.
So in fact it's not the either/or choice you think it is, at all.
It's quite possible to conceive of a networked participative State in which citizens are members - and indeed, I think that will be the outcome from the current trend of dis-intermediation.
In this model there are no taxes, although there is revenue sharing. Hong Kong's approach - which is an accident of history - has seen up to 35% of government revenue raised from a Crown Rental.
This means that the entrepreneurial Hong Kong population does not have the rentier landlord monkey on their shoulder the way that their competitors do.
"They are amenities"
No, they aren't. They are utilities, or, more precisely, facilities that provide a utility.
"OK let me spell this out as simply as I can;" Don't patronise me.
1. Public sector pensions are DEBT claims on a balance sheet - they are nothing like equity.
2. CDS banned? Sure - do it. If you want to crush both sovereign and corporate lending. You clearly have no idea about how those markets work.
3. As for sovereign equity - it will never work, and thank god it won't. Why would we ever want our governments to have a way to raise money against assets which are hard if not impossible to value, impossible to sell and create no hard value (i.e. no cashflows or profits), then give that same government the right not to pay any cost for that (dividends are not enforecable, coupon payments are) and make the chance of default even higher.
It's debt for a reason.
1. In what sense is an undated ownership claim over revenues unlike equity?
2. The markets worked fine before CDS.
3. In what sense is an energy flow or a flow of land rentals hard to value?
You seem to think that equity necessarily means a Plc.
Wrong. You don't have to sell the asset to sell the production. Ever heard of Trusts? Master Limited Partnerships. REITs?
You don't appear to understand much of anything other than debt and shares in companies.
That's a bit limiting.
" .... and create no hard value (i.e. no cashflows or profits) .... "
Perhaps not.
However, the next time that you or your spouse, whatever, visit Tesco (or Sainsbury's, Asda or Wm Morrison), I suggest that you look at the goods stacked on the shelves, scratch your head and think for a moment about how those goods got there.
This is all very well until the people overseas that have been buying our debt want their money back.
I think you are under a misapprehension as to the effects of this.
At the moment we have God knows how many different classes of Treasury debt, both by date and by rate of interest, not to mention index-linking.
If an overseas investor wants his money back now for such debt, he must either wait until expiry or he must find a buyer, in which case he will find that liquidity is pretty fragmented.
A pool of quasi-National Equity is different. If all conventional gilts are consolidated into one Pool, and index-linked gilts are consolidated into another - or maybe if we just created one big pool of index-linked Consols - then the liquidity would be massively increased, I suggest?
You may have to put on some economic tutorials for me! I don't mind owning up to the fact that I do not have a clue about all of this. Perhaps I should get my old GCSE Economics books out......!
Steph
Maybe you're finally getting over the incomprehension barrier ;)
Actually, it would be interesting to know what the credit side of the UK Plc balance sheet looks like.
Given the hoo ha from the Tories about debt at the moment it would be good to see how assets aquired by the government over the decades and centuries rank against the short term borrowing used to aquire them.
For instance, the value of the education, health, and road infrastructures. Not to mention the MOD's huge property portfolio.
My image is that the governments assets dwarf the short term debts and would clearly indicate that we're operating well within our capacity to appear credit worthy.
Of course it doesn't help when governments flog off these assets at knock down prices.
I'm afraid that our Public Sector Net Worth (which includes our publicly-owned infrastructure of transport and buildings) is forecast to turn negative in 2012/13 ....
In 1987/88, it was estimated at 74.0 per cent of GDP, steadily decreased until 1998/99 to 14.4 per cent of GDP, then increased to 28.9 per cent of GDP in 2007/08, and is forecast to reach minus 6.2 per cent of GDP in 2013/14.
Table A8 in Public Finances Databank (from HM Treasury) refers.
That's rather sad. I don't doubt the source of your figures, but I have to say I'm rather surprised at their volatility. I'd be looking to see if what is considered to be a public sector asset, is the same as a state owned asset.
I don't expect the assets of the state to be that volatile.
You see I'd include not just direct government organisations but also those 'owned' by the state in a non-governmental capacity as well. So that includes Network Rails, Forestry Commission's, National Trust's, Crown Estates, etc, etc, assets as well.
Admittedly it's mainly property. But with the MOD includes the largest property owners in the country.
"That's rather sad."
Indeed, it is.
As I understand the glossary of "Public Finance Terms", well, I'll write it out :
Net worth : "The difference between total assets and liabilities (including debt) held by the Government. It represents a more comprehensive measure of the overall worth position of the Government than debt, as it includes non-financial assets (such as roads)."
I take "non-financial assets" to include all the buildings - offices, hospitals, schools, for example, and equipment - medical scanners, computers from PC/laptop level to "super computer" (I once worked for a company that owned two Cray's ; beat that!), vehicles and, I guess, military hardware, all within the public ambit, whether direct or indirect eg Met Office, VOSA (was DVLC)
I am almost certain that land is not included - it isn't included in the ONS "annual wealth" measure. It all belongs to the State, anyway ; constitutionally, to 'er in Buck House.
Don't forget, especially during the Great Privatisation Period, all that happened was that assets changed hands so that what belonged to all taxpayers publicly, afterwards belonged to a reduced number of taxpayers, but privately. The assets, ie things that hurt when they drop on your foot, remained more or less intact and the total stock of assets was, more or less, unchanged come "privatisation day."
Apologies for taking a while to get back to you on this.
Highly informative as usual. A republican (i.e. me) might conclude we'd be better off without a monarchy if all the government land holdings are deemed to be crown lands.
Chris Cook might know whether even freehold ownership still means that it doesn't belong to the freehold owner in the final analysis, but the Crown.
I know I don't remember any historical renunciation of the Feudal rights of the monarchy in that retrospect. Just the abolition of the right to confiscation without redress.
Re : land ownership
I think you'll find "in the final analysis" that all land does indeed belong to the Crown.
Your comparison with a republic invites me to wonder who actually owns the land in, say, France or the US?
Is it the state?
Now, there's a nice little project for you ....
http://www.bloomberg.com/apps/news?pid=20601009&sid=a8c_1vtVGzD8
BTW countries don't have balance sheets - otherwise the 1.2 trillion of public sector pension debt (unfunded, and to be paid for out of current taxation, by me and others) would have to be shown.
I gree a state can't show much in the way of COP, but free cash flow, and assets, whether productive, or unproductive, are rather important for business and states as well.
After all governments get cash based on thier percieved ability to pay. It would be a strange business that leant money without considering the ability to pay and existing assets.
Doh!. Of course that's what those prats in the banking sector did to get us into this mess in the first place.
Well, that's how they borrow money and how the interest rate is set. The majority of their cash comes from taxation, which is the state raising money from their people by consent (i.e. laws passed) but with no specific service provided. i.e. if I don't uses the NHS I still have to pay for it. That's not business.
This government has borrowed money without considering the ability to repay as it doesn't have to sell anything else or make any more profit, it just raises more tax.
Prats are fairly common?
(i) the immediate liability of any government regarding public sector debt is the interest payable each year. At present, this amount is well within government's (ie the taxpayer's) ability to pay, based on the historical record.
(ii) the future liability is redemption, perhaps 5, 10, 15 or more years hence, of the principal itself. £10 billion in 15 years time - should government decide to "roll-over" the debt is a different kettle of fish to £10 billion today, because of the combined effect of a steadily growing economy and modest inflation. A compound 5 per cent (equally split between real growth and inflation) has the effect of halving the effective debt over 15 years.
Easy-peasy.
Banks don't borrow pre-existing money - they create it as credit, and either spend it (on costs or dividends) or lend it at interest. They then borrow the resulting deposits from retail, wholesale and Central bank depositors at a lower rate of interest to that charged to borrowers.
That's the magic of banking.
'Governments get cash on their perceived ability to repay'
There's no reason at all why the government cannot do exactly what private banks do, and create credit to spend or lend into circulation.
Provided the process is professionally managed and sensibly overseen, then the creation and issue of Public credit 'at cost' is in fact LESS inflationary than private bank credit to the tune of fat-cat salaries and dividends to shareholders on the private capital supporting private credit creation.
Indeed, prats are fairly common and too many of them are voodoo economists and their political cheerleaders.
Indeed it should be on the balance sheet, but why as debt, when there's no date on it?
The claim of Public Sector pensioners is an equity claim on the balance sheet if ever there were one.
Agreed. I can see no other way forward for this country. We need to counter the continuing decline in jobs and manufacturing by finding another methodology to grow and develop our economy for the long term.
Since there is no obligation to repay capital, a Credit Default Swap - which essentially acts as time limited insurance against non-repayment - will largely become irrelevant.
"Naked" CDS which are not based upon a specific debt, but are essentially as though you and I were punting whether someone will default - should either be:
(a) Banned - on the grounds that they are against public policy, in the same way that insurance requires an Insurable Interest; or
(b) Unenforceable - like a gambling debt owed to a bookie.