When Harold Macmillan, the wonderfully urbane former UK prime minister, was asked what he considered the biggest threat to a politician, he replied: "Events, my dear boy, events." Welcome to my world. Since this column was last penned, half of the mortgage stock of the US has been moved onto the government’s balance sheet and the world’s largest insurer has been nationalized. Investment banking as we came to know it has disappeared.
Now there is a proposal before Congress to get credit and interbank markets functioning again by injecting up to $700 billion into Tarp (Troubled Assets Relief Programme). It is not the time to debate its merits or otherwise in detail. As this is being written the future of the plan is uncertain after Congress rejected it on September 29. Your columnist is at the mercy of those wretched events.
The fevered atmosphere of the past few weeks has spawned a lot of hot air from the financially illiterate. The fear of big numbers is but one example – $700 billion is by no means loose change. But it is a cap. Japanese banks actually requested only 13% of the money that was earmarked by the FSA in 1998.
Perhaps the US is less fortunate and the full $700 billion will be needed. But $700 billion still needs to be put into context. US GDP is $14 trillion. A bail-out that costs 5% of GDP has an historical precedent. It cost Sweden and Norway 4.5% and 4% of GDP, respectively, to rescue their banks in the early 1990s. There is also a crumb of comfort for US taxpayers from the Nordic banking crisis. According to a study by Norges Bank in 2004, the Norwegian public sector made a profit from its support of the banks (Thorvald Mole, Jon Solheim and Bent Vale,"The Norwegian banking crisis", Norges Banks Skriftserie, No. 33, 2004).
Again, assume the Norwegians, like the Japanese, were lucky and the US is not. Not only is there no profit, not a single cent is returned. The whole $700 billion goes up in smoke. Governments have a more sustainable financing model than the former investment banks. They borrow long. If the $700 billion is funded by Treasury bonds but never gets repaid and needs to be refinanced, the interest cost is perhaps $30 billion a year for the next 30 years. If this averts the disaster feared by many, it is small beer.
No comparison
What about the national debt? Again, we will ignore the lessons of history and assume that the whole $700 billion is on the line and the return is zero. National debt as a percentage of GDP will rise from 37% to 47%. That is lower than the level at the start of the Clinton era. Besides, the glib comparison that is made by the ignorant (or anti-American) between the US and an emerging market because of its debt is plain stupid.
The reason why it is fiscally irresponsible for developing countries to run huge deficits is that they do not have $14 trillion economies. They do not issue bonds in the world’s reserve currency. They do not house some of the world’s pre-eminent corporations and best universities. These huge comparative advantages do not disappear because of the travails of some in the financial sector.
Can anything positive come out of this crisis? I have one modest proposal. In recent years, pension funds around the world have been forced by new accounting and solvency rules to match their assets and liabilities better. Interest rate and inflation risk are two of the main concerns. However, pension fund liabilities are very long-term and there is a paucity of duration-matching assets.
Many pension funds have used swaps. But there remains a desperate need for ultra-long issuance, both of nominal and inflation-linked bonds. In 2005, the French government issued a 50-year nominal bond. The planned size was between €3 billion and €5 billion – €19.5 billion was bid. The UK followed suit with a 50-year inflation-linked bond. £1 billion ($1.84 billion) was offered and £2 billion bid for a bond that paid a real yield of just 1.112%.
The US should follow suit to fund its new liabilities. Given the choice between the US government and a financial counterparty, and a bond traded on cash markets versus an OTC derivative, it is not hard to guess where pension funds would rather put their money. The US would get cheap funding because it would be meeting demand. It would cut its annual interest costs by amortizing its debt over a longer time horizon. It would anchor the long end of the curve and it would win the eternal gratitude of many pension fund managers grappling with asset-liability matching. This modest proposal is that rarest of things: a win-win.
Andrew Capon is editor-in-chief at State Street Global Markets, the research and trading business of State Street Corp. He was formerly senior editor at Institutional Investor and has won numerous awards for journalism on fund management and investment issues. The views expressed are the author’s own