Why wealth bonds?

Mar 26 2014 07:27
*Edward Ingram
AS PART of a team of senior representatives in both the South African and UK financial services industry, we have drafted a paper for consideration by Bank of England governor Mark Carney.

In a nutshell, my co-authors and I say there is a problem with fixed interest bonds because they have no predictable cost or value as economic conditions change. They inject significant volatility into markets and into the reserves held by lenders and many others. Wealth bonds, like bonds linked to GDP, can resolve these problems.

However, they have significant advantages over bonds linked to GDP or real economic growth. Wealth bonds are bonds in which the capital debt is index-linked to an index of national average earnings/incomes (NAE).

By introducing these bonds to both the public and the private sector, many of the most intractable problems faced by the financial services sector may be resolved and a level playing field for the entire investment, savings, lending and borrowing sector can be created.

The result will be a significant reduction in financial instability within the economy.

Significant volatility and arbitrage opportunities would disappear, as would the need for ever-increasing reserve ratios. The whole economy would benefit.

While a link to GDP may seem attractive to a government seeking to balance its borrowing liabilities, it would skew the level playing field, creating more opportunities for arbitrage, and it would not address the needs of the financial services sector in the same way or to the same extent.

By addressing these needs effectively, the cost of borrowing can be minimised not only for government, but for everyone, because the demand for them will be maximised and both investment and borrowing risks linked to changing economic conditions will be significantly reduced.

When using a wealth bond, each party to the contract removes the risk (to wealth) of the other party. In the event of GDP increasing as population grows, a wealth bond would give similar budget-matching benefits to a GDP-indexed bond, but it would also lower borrowing costs.

In the opposite scenario, with the population decreasing, GDP-linked bonds would cause a loss of confidence in the matching of liabilities in the private sector and there would be unwanted consequences.

Just as one major economic problem can cause a cascade of problems, the opposite can be true, and wealth bonds solve some fundamental problems resulting in a cascade of benefits. These include:

* Assisting stability while ending quantitative easing;
* Stabilising bonds (and house prices can be stabilised by new risk management regulations);
* Preventing asset bubbles;
* Stabilising the economy;
* Reducing costs for government, businesses, and the general population;
* Decoupling ‘already in force’ mortgages and loans from interest rate movements;
* Simplified management of interest rates for central banks; and
* Increased market and business confidence.

* Edward Ingram has a strong and growing support base. One American has started a petition asking President Barack Obama and/or his senate committees to look into these ideas. Ingram says: “Why not here in South Africa? The ideas are universal.”

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edward ingram  |  borrowing  |  money  |  investments



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