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Markets for the Digital Generation

Although I must say I’m not a fan of Microsoft products (or the company), you have to admire Bill Gates’ optimism and drive to build on his business and financial successes and advance the human condition. For obvious reasons, Bill Gates on a podium in Davos can deliver a far more powerful ‘call to action’ than I can mumbling on here at the Park Paradigm; and so I was very happy to read of him using his star power to deliver a message that I mostly agree with and who’s conclusions I wholeheartedly endorse (see by way of example here or here:)

Bill Gates has challenged companies to engage in “creative capitalism” that delivers profits and helps the poor.

This “capitalism for the 21st Century” had to improve the lives of those who did not benefit from market forces.

The Microsoft founder said capitalism only worked for those who could pay, so firms had to find out “how the power of the marketplace can help the poor.”

Here is the link to the Davos webcast (requires Windows MP or Real Player so I couldn’t read it…not very smart), but found an excerpt posted on YouTube:

The key to my mind is finding a way to help individuals in less fortunate situations, particularly in developing nations, get access to markets and (economic) freedom. My suspicion is that the technological advances (and concurrent cultural change) of the 21st century will hold the key to unlocking this vast human potential. I’m sure it won’t be easy, and I certainly don’t pretend to even have the start of an answer yet, but I am optimistic that at least the path towards the seeds of some of the solutions is slowly starting to emerge from the fog. For those seeking enlightenment in this respect, at the risk of making a premature recommendation (I’m about a third of the way through), I suggest picking up a copy of John Kay’s “The Truth About Markets” and suggest you add his RSS feed to your news reader:

…The stark differences in economic lives around the world are not the result of differences in the availability of resources, or education, or capital, or skills. They are the product of differences in the structure of economic institutions. These latter differences in turn determine the availability of resources, education, capital and skills…

…Economic institutions function only as a part of a social, political and cultural context. This is what I describe as the embedded market.

And it is worth keeping in mind, a couple other observations from Kay:

• Market economies require disinterested government.
• The combination of moral rigour and free enquiry is the basis of disciplined pluralism - the defining characteristic of the successful market economy.

I highlight these because I fear that sometimes - when trying to help the world’s poor and developing countries - successful emissaries of the market economies of the west tend to cautiously avoid giving advice or passing judgement on anything that is seen as a political or cultural issue. I suppose this is a reasonable counter-reaction to some of the more egregious excesses of the imperial past. But well-meaning and understandable as this stance may be, it is most often directly at odds with achieving the economic success sought in the first place. We need to stop being afraid of engaging in criticism of political or cultural artifacts that are clearly impediments to economic growth and improvements in human welfare. At the same time, the technological tools of the 21st century will give individuals and communities in these countries an unprecedented opportunity to dismantle corrosive political and cultural legacies that act as giant impediments to economic growth and freedom. While I remain long term optimistic, one doesn’t have to look far (for example the recent post-election turmoil in Kenya) to see that the path will be a difficult one, strewn with powerful men who have no interest in fostering greater growth, wealth and welfare, but whose only interest lies in controlling such (limited) wealth as already exists.

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A couple days ago I was travelling and so had time to read the FT in some detail, including the extended reporting on the ongoing Northern Rock saga and in particular the government guaranteed refinancing scheme floated by GS/the Chancellor. Basically, the idea is to refinance a big chunk of Northern Rock’s assets via a bond issue secured on these assets, enhanced with an explicit government guarantee. Many commentators have questioned this solution as a (bad-for-the-taxpayer) compromise between nationalization (politically embarrassing to Brown) and an entirely private solution (highly risky, with failure a real possibility and so equally politically embarrassing.) The quick-and-dirty analysis is that in this scenario, the government keeps all the (financial) downside, but gives up the upside if the rescue/restructuring is successful. The fact that the plan seems to include warrants (or some similar provision) for the government tacitly endorses this view (while hardly mitigating the potential outcome.)

Rather than dwell on the overall pros & cons of the proposed plan (which has been amply and eloquently done in many other places,) I just wanted to take a moment to take issue with the likely details of how such a structure would be executed. As it stands, it would seem a bond (or series of bonds) maturing in 3 or 4 years would be issued with a government guarantee. I’m not in the market anymore, but read that such securities would likely be sold at around Libor flat, which sounds reasonable and that the issuer would pay the government for it’s guarantee (ie the government is acting like a monoline insurer in this instance.) When the UK Treasury issues bonds directly - ie Gilts - at these maturies, they would be priced at around Libor -70 bps.) S0 for the Treasury to be equally well off, the issuer would need to pay an insurance premium of 70 bps on the amount guaranteed to the Treasury, or in this case c. £600mn. Of course this does not take into consideration whether or not the assets (Northern Rock mortgages, etc.) being financed are ‘good’ risks nor what it would cost to finance them without the government guarantee. Even if you accept the premise that the market is temporarily irrational and that the whole point of this government sponsored refinancing is to bridge this market dislocation, the ‘historical’ market cost of refinancing these assets would be signficantly above Libor flat. This difference should also be factored in to the insurance premium paid to the Treasury.

I hope I am wrong and that the winning package chosen by the Treasury includes a premium that is commensurate with the risks and the extra costs of using the Government’s balance sheet in this way, but my fear is that politics trumps economics and that UK taxpayers will end up taking on a substantial liability without being fairly compensated. Exactly the kind of thing that happens when you start confusing other people’s money (entrusted to you to manage) as being your own.

I hope I am wrong and the bid the Treasury ultimately accepts includes a commercially adequate insurance premium

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