I’m gonna steal your cash!

So renationalisation could be done in the same way. Issue bonds for fair value. Make them redeemable in not less than thirty years, and maybe longer. Make the interest rate the very low ones on offer now. In net terms these are likely to be negative throughout that thirty year period. And what is the net cost of renationalisation? Next to nothing. Or less.

I’ll let inflation do the expropriating.

The very slight problem with this, over and above the glee at theft here, is that those bonds will have to be rolled over. And as we’ve been told by the SnippaMeister himself government never does repay bonds because that would be to reduce the money supply. They will thus be rolled over and interest rates will rise…..the cost will be rather high then. Millennia of interest paid to feed a current political Spud.

Well done.

31 comments on “I’m gonna steal your cash!

  1. I think he means a debt for equity swap, which then means that in order to cover the annual interest due not only to existing debt holders but also the new debt holders, the company has to increase its prices.

  2. Bonds at fair value – that is the nominal value is the reciprocal of a fair price between willing buyer and willing seller, not the price at which you can dump gilts on insurance companies that are *required* (by law in the form of regulations) to hold £X billion of gilts. So the nominal value will be immense as the fair price at which anyone will voluntarily buy 30-year bonds with a coupon less than the inflation rate is around 54% of the nominal price.

    Murphy doesn’t understand the word “fair”.

  3. AlexM

    the company has to increase its prices

    But the company would not then be paying dividends? It would pay interest instead.

    Company worth £1,000 say paying a not very high dividend of £20 per annum (could be more, I’m making it up?). Swap the equity for debt at say 0.5% or less? The gov’t now has say a minimal £1 (100%) equity stake in the company.

    The gov’t doesn’t want dividends. And the company now pays out just £5 (interest) per annum instead of £20 (dividends)?

    Is that what the Murf is thinking?

  4. J77

    So perhaps swap 0.5% for whatever the current market yield is on 30 year? Or try 10 year? At the moment, with low bond yields, that may still be less than the dividend yield?

  5. ‘Murphy doesn’t understand the word “fair”.’

    But what does he understand? Words mean what he thinks he wants them to mean.

  6. @PF “Swap the equity for debt at say 0.5% or less? The gov’t now has say a minimal £1 (100%) equity stake in the company.”

    Swap the [junior] debt at a yield lower than the yield on the senior debt of the company and get sued for expropriating for less than fair value. If it was cheaper to finance with junior debt rather than equity, companies would be doing it already.

  7. Actually J77 insurance companies can buy anything they like now provide they have regard for the security, liquidity and creditworthiness of the portfolio as a whole. In practice this means buying a ton of gilts for liquidity management purposes. The majority of the money however, at least for annuity businesses, goes into higher yielding so called illiquid assets

    The Solvency II prudent person principle is the key thing to look up if you want to read more. Then branch into the matching adjustment and the joy of capital modelling. All good stuff.

    Inflation linked gilts are quite useful though…. anyway must stop now before it gets really boring.

  8. And the holders of the bonds would not be able to sell them on the market? It would certainly add quite a lot to the national debt. Does he know that there are markets for government debt? He did when he claimed last week that governments only issued debt to give pension funds something to invest in. Is there much of a market for 30 year bonds?

  9. AlexM

    If his target for renationalisation has existing debt, maybe Murf would also intend repaying it as part of the deal? Who knows..:)

    I’m presuming, and following John’s comment, that there would be no intention of not offering the shareholders fair value? Otherwise, obviously it’s simply part confiscation?

  10. The correct way to do it is to crank up OFWAT’s powers and regulate all the profits out of the sector. (“No you can’t raise prices, yes you must fix every leak everywhere.”) The companies go bust, government steps in like the saviour it is, nationalise them, roll back the regulations, job done.

    The ECJ would have put a stop to that kind of thing before, but we’re leaving the EU now.

  11. Andrew again,

    “Inflation linked gilts are quite useful though…. anyway must stop now before it gets really boring.”

    Please carry on, it’s how those of us n the outside gain an understanding of what is going on and why I’ve been reading this blog for over 10 years.

  12. @BIND
    + 1 Lots of topics I’d rather head to the comments section of a blog I know attracts a sector-knowledgeable crowd, then hope between online newspaper offerings in the hopes of finding a journalist who understood what was going on. Timmy writes some good thought-provoking stuff (though his better, fuller pieces are to be found elsewhere) but it’s below the line that this site really shines, in a hard-to-reproduce way. For example, our gracious host is – as he would be first to admit – not the most technical wizard this side of Oz, and yet venture down here, and there’s a whole community of folk who know their onions from their shallots.

    @AA
    Go on, go on, go on … you know you want to!

  13. I’m confused.

    If he thinks the effective interest rate over the bond period would be negative – then who the hell would ever buy them?

  14. Why bother with Murphy’s worthless IOUs? Just go the whole hog and Chávez the fuck out of people. To be honest, you know that’s what The Great Tuber™ would do if he thought he could get away with it.

  15. Governments love pilot studies and this is a classic policy for using one. I propose nationalising a house in somewhere like, say, Ely, and using it to house refugees. If the policy and finances are still sound in 5 years then I could rolled out to houses in Islington as a 2nd stage.

  16. Could Murphy not be prevailed upon to take over running the UK debt management office?

    Given his uber-competence in every field of human endeavour, he should be able to do the general management work during his 15 minute coffee break each Sunday afternoon and maybe need an extra 10 minute slot to deal with any actual gilts auctions?

  17. @BIND +1
    @MBE +1

    @Andrew Again
    More please, and in more detail – or failing that, links to good beginner material.

    Just remember most of us know very little about your specialist area.

  18. @Justin – what is it that you’d like to know? This is my area also (I’m guessing Andrew Again is an actuary?)

  19. @PF Most of the nationalisation targets are already heavily geared. One reason for privatisation was to allow them to borrow to invest without adding to government borrowings. I think the water companies are geared about 4:1 and the power companies not much less than that, so repaying the debt is probably a non-starter. If the government simply swaps equity for debt at fair value, then by simple arithmetic the cash interest paid on the debt must be worth as much as the dividends on the shares plus the likely value of the uplift in the shares. This requires more cash to flow through the companies to pay the interest, and they are likely to have to put up their prices or go bust. Trust me, I’m a corporate financier.

  20. And I am back,,. Thanks for the vote in favour of my favourite subject. I am categorically NOT an actuary but your guess is close as I work with many. You don’t need to be able to do the calculation to understand, and question and develop, the principles. We seem to put actuaries on a pedestal in respect of insurance related maths. A lot of actuaries are “can’t see the wood for the leaves” sort. My job is to see the trees, describe the problems with the forest and solve them.

    Anyway. Point is gilts have multiple uses in the real world. The “hang on until it matures” crowd are locking in lots of interest rate risk (present value of gilts goes up and down as rates go down and up) unless they match them up to something to does the same. This *isn’t* the liabilities of an insurance company as they are *for regulatory purposes* currently discounted at something approximating to swaps (the rate at which banks swap money over different maturities). For long term annuity business (there are three main types but the insurer is on the hook the most for this type – the others have the policyholder taking or sharing the risk) firms get a bump in the liabilities discount rate if they hold assets that are relatively illiquid. The more illiquid the asset the bigger the bump. Higher discount rates means less liability which means you need fewer assets and can pay more dividends. Gilts have no, or a negative, illiquidity premium so you don’t get the bump in discount rate so you have to hold more assets than if you hold something else.

    Some liabilities have an inflation link, think DB schemes insured to so called bulk purchase writers. For these the firms can either take the inflation risk themselves or hedge it. Hedging long term inflation risk isn’t that simple or cheap so long term inflation linked gilts become useful. The thing is… the no arbitrage condition holds so the inflation protection from gilts and inflation swaps should be the same price, but you know the state will pay you back, so counterparty risk capital can be reduced/eliminated if you hold linked gilts.

    Finally we have the fact that we know the state, who can print money, will pay us back. This means we have people who like gilts as they know they will get *something* back even if real interest rates are negative. The don’t want rates risk so they tend to be T-bills, short dated government debt, as they move less with rates movement.

    The other bucket of demand for gilts is as collateral but as EMIR comes in and collateral moves to cash we see that reducing. This is a good thing but changes the setup of the financial system plumbing.

    Pension schemes used to hold lots of gilts but those of you who followed the logic above will have realised that an insurer can value the pension liabilities at a lower value than a pension scheme. It therefore makes sense to shift liabilities from the scheme to an insurer in a so called buy-in or buy-out.

    There is more complexity on this but the Bank Of England has teams of people who monitor gilt supply and demand. They were buying the bloody things recently to reduce rates. If we start issuing tons of debt with less structural demand then rates will go up.

    Enough? I don’t do links to basic stuff as I don’t tend to need them. Sorry.

  21. AlexM

    That’s interesting and thanks. I may have misunderstood you below, in which case it should be obvious?

    Most of the nationalisation targets are already heavily geared. One reason for privatisation was to allow them to borrow to invest without adding to government borrowings. I think the water companies are geared about 4:1 and the power companies not much less than that

    Sounds reasonable, I didn’t appreciate that.

    If the government simply swaps equity for debt at fair value, then by simple arithmetic the cash interest paid on the debt must be worth as much as the dividends on the shares plus the likely value of the uplift in the shares. This requires more cash to flow through the companies to pay the interest

    Ignore the existing senior debt for a second. Assume the same before and after.

    Ultimately, if replacing equity with debt (and at fair value), the yield on debt should be lower, and especially for debt guaranteed by the government? It’s lower risk – ie, cost of equity is higher than cost of debt (hence gearing)?

    In principle, wouldn’t we be saying to the existing equity holders, “your stake (value fixed last night as the market closed + a small margin for your inconvenience) has the same value, but less risk (and hence you’ll now receive a lower return). If you want to sell it to someone who wants that lower risk profile, fine, it was swapped in principle at fair value as of yesterday close, so you shouldn’t lose any money”?

    As the current market share value of the equity (and hence new replacement debt) would be higher than the existing balance sheet shareholder funds, admittedly there would most likely be a pretty large new goodwill number (or negative funds) (Dr) on the balance sheet (!), but that’s not cash. And the government no longer cares about the shape of the balance sheet, it isn’t going to pay any dividends? In effect, I guess that Dr represents what it has given away through privatisation?

    One of the issues, that Labour might suggest here, is that there is no need to pay a yield for equity risk, when – given the nature of the sector – there is no genuine risk to equity, the risk is being borne throughout by customers?

    If I’ve got that wrong, apologies, I should probably have taken one of the energy companies (say) and its balance sheet / market cap, and run some hypothetical numbers / thought it through further?

  22. @F “Ultimately, if replacing equity with debt (and at fair value), the yield on debt should be lower,”

    Not so. Yields on debt *are* generally than total returns on equity, but that is because the equity is subordinate to the debt (i.e. in a liquidation the debt holders get paid out before the equity holders), but that is not the case here.

    If we swap equity for debt in an otherwise debt free company, the future debt holder is in exactly the same position as he was as an equity holder, and has exactly the same risk of loss – but unlike the equity holder, the debt holder does not participate in any increase in the value of the equity of the company.

    If the debt is to have the same fair value as the equity, the yield on the debt must be equal to the dividend yield on the shares plus something extra to compensate for the potential appreciation in the value of the shares (the downside risk is identical).

    It follows that the company will pay more to service the debt than it was paying as dividends.

  23. Alex

    If we swap equity for debt in an otherwise debt free company, the future debt holder is in exactly the same position as he was as an equity holder, and has exactly the same risk of loss

    These would be £ government bonds, there is no risk of loss..:)

    And, in real terms, that won’t be reflected in the current prices we are talking about. I haven’t checked numbers, but perhaps compare yields on government bonds (which is presumably what is proposed) with the current equity yields (using current market price) on Labour’s targets for renationalisation?

    I’ll happily be proven wrong, but I would bet the current equity yields are higher (P/E or div yield)?

  24. @PF et al. That would appear to be the reasoning used however the debt wouldn’t be gilts it would be some form of state guaranteed debt, which is we all know isn’t the same thing. Guarantees can be changed by law. Look at Railtrack debt if you are curious. Trades at a higher yield than gilts but is really in demand as it has a high rating due to the guarantee.

    If, a big if but an if nonetheless, Labour get into power the risk premium demanded for holding these companies will sky rocket reducing then equity value. The cost to buyout the equity could be quite low. Mind you this would have the rather nasty side effect of increasing the risk premium across the market and reducing inwards investment as no-one would trust the government not to do it elsewhere.

    Modigliani-Miller is worth a google.

  25. Andrew,

    I don’t disagree with any of that. You are right, a Labour win would change everything in that context, as no one currently expects it.

  26. @PF “These would be £ government bonds, there is no risk of loss..:)”

    Even a Corbyn government, at least one advised by the Treasury, would avoid putting this on the government balance sheet if at all possible.

  27. AlexM

    Yes, I agree. And don’t get me wrong, I’m not trying to defend the politics. Like most here, I regard “bat shit crazies” to be the polite form…

  28. @ Andrew Again
    Try telling CEOs of insurance companies that (I have tried on occasion). There is, among the notes to the Accounts, in the Annual Report an analysis of Risk and their Internal Risk Assessments have to be approved by the Regulator if they want an ICA or they are lumbered with the default risk capital formula. In one case I couldn’t even persuade him to match his investments to the expected term of his liabilities because his investments would be marked to market and show a big loss if interest rates rose while liabilities (with an average term of 7 years) would not be discounted because it was “short-term business”. Needless to say, interest rates fell, so he incurred a real loss by mismatching because he was scared of the nominal but unreal loss that could be reported if he matched.
    Many moons ago I asked one of my elder-and-betters why my then employer was buying index-linked gilts which werre lousy value-for-money (not as bad as today, but they certainly didn’t meet our investment criteria) and was told that they were required to do so to fund the expected future liability of the cost of collecting premiums on old non-profit life policies that exceeded the premiums being collected. This was a dozen years after the company had solved that problem and simultaneously looked very generous by making all the non-profit whole-of-life policies for those over 70 at the time paid-up at full value (if anyone else is still reading, that means it waived all future premiums), so we *knew* that we didn’t have to waste money to do this. I just don’t believe your optimistic view of the regulatory environment.

  29. @john77. In respect of the regulator I couldn’t possibly comment ;-). Let me just say there are bad actuaries and good ones just like there are good regulators and, err, not so good ones.

    I just tell it like the system is.

  30. @ Andrew Again
    I beg to differ – you tell the system as it claims to be, while *I* tell it as it is.

    Yes, there are bad Actuaries and good regulators but I don’t need to take off my socks and shoes to count them, in contrast to good Actuaries and bad regulators (most Actuaries are just boring but the minority are overwhelmingly good rather than bad – you only need one bad Actuary to ruin an insurance company like Equitable)

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