Realist, not conformist analysis of the latest financial, business and political news

The Madness Of Green Bonds

A Richard Murphy

As we all know the Sage of Ely has been insisting upon the mass issuance of green bonds for many years now. As is less understood the man hasn’t understood the subject under discussion in the slightest. But here’s his own explanation of the idea in a nutshell:

There is an alternative, of course. Colin Hines and I outlined it in December 2019. Caroline Lucas welcomed it. This was the plan.

The answer is easy.

Fist, commit to a Green New Deal.

Second, change ISA and pension rules to only allow green bonds in the former and to require them as a condition of tax relief in the latter.

Make these bonds fund a Green New Deal – no iffing and butting, but the radical transformation our society needs.

What is the Green New Deal? Well, it’s that radical transformation that society requires. More detail is that it’s building windmills, insulating buildings, triple glazing them, sticking battery powereruppers on the streets and so on.

There being two rather grand economic problems with the suggestion. The first is the Underpants Gnomes problem

1) Collect underpants.

2) ??

3) Profit!

There’s an entire step left out of the calculation. How does triple glazing a house make money that then gets paid as interest to the bond holders? What is the income stream from the action?

Now, we can think of various ways of doing this. Those who have the triple glazed put in have to pay for it having been done. Or an addition to rent. Or, like certain solar cells schemes, they’re an asset that get traded separately from the underlying house – not that that has worked out all that well.

But d’ye see? We need to identify what is the income stream that pays the interest. Even, if we’re lucky, what is the income stream that pays off the capital value of the bonds at some point. On the grounds that people might like to get their money back. We can say that it’s government borrowing so it’s future tax revenues that pay them. OK, that has its own interests and problems but at least we will have done that identification. Murphy and Hines simply haven’t done that at all.

Who pays what money to pay off the bonds?

This being the bit that hasn’t been done.

One reason, I suspect, that they haven’t done this is that once that identification is made then there’s no need for Green Bonds to pay for the transformation. Because once we’ve set up a manner of people making a profit by funding the transformation then people will line up to make a profit by funding the transformation. This has actually happened with the provision of rental housing. Now that the law’s all nicely sorted out and all that – tenancy agreements, evictions for non-payment etc, no government determination of rents and all that – the institutions are lining up to build long term rental housing in large estates.

Sort out the revenue stream to be had from doing the work and the work will get done. Arguing about where you’re going to get the capital from in order to fund the work without sorting the revenue doesn’t work. They’re still in underpants territory.

The second problem is risk. This comes in two forms.

The first is that in order to save for your pension you do need to be taking some risk. Because a 1 or 2% – pre-inflation – return on your savings doesn’t cut it. Think about this for a moment. The aim it sot use the income from 40 years of work to fund 20 years of retirement (roughly enough). This is lifetime income smoothing.

The next bit isn’t exact but it’s a useful illustration. Say that these bonds pay inflation and inflation only – 2% bonds in a 2% inflation world would do that. So, to pay for that 20 year retirement at an income equal to the working years (that’s the bit that’s not right but useful) we have to save one quarter of our annual income. We have to have a savings rate of 25% that is. As opposed to the pre-covid what was it, 7%?

The way out of this is to gain a higher return from those investments. 5%, 7% (around what a decent equities portfolio might provide). This means that we have to save less in any one year in order to gain that equality of income in retirement.

Risk is a necessary part of pensions savings simply because without the returns to risk the numbers don’t work.

The other side of risk is also important. All these projects – triple glazing, windmills – who is taking the risk of their completion? Think on what the insistence is – savings must be only into bonds. Are bondholders to take the risk of non-completion? Of cost overruns?

That’s an interesting – in the Yes Minister sense of “brave” – idea. Bondholders on 2% must carry construction and completion risk?

Doesn’t anyone recall how PFI was set up? There was some actual capital, real equity, which was at risk. Then the building phase was further funded by quite expensive debt. 5% and up in fact. Once the project was completed, turned on and handed over then that expensive debt was refinanced at 2 and 3%. Because that’s the right price for debt on operating a completed project and the wrong price for the construction and completion risk.

So, the Hines and Murphy plan to finance the reconstruction of society through pensions savings. It betrays no knowledge of construction nor pensions and thereby will entirely cock up both.

Now, who was it who said that politicians should be held responsible for the damage their policies do? Ah, yes, wasn’t it the Sage of Ely?

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john77
john77
7 months ago

Minor quibble.
Absent any real return on investment, spreading your 40 years of earnings over an adult lifetime of 60 years requires a pension contribution of one-third, not one-quarter of earnings. Your 25% seems to reflect the target of two-thirds of net earnings in retirement beloved of Consulting Actuaries designing pension schemes.
Otherwise I agree.

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