Friday, February 6, 2015

Perpetual Bonds: An Economically Viable Solution To The Big Fat Greek Debt Crisis?

Even though the last time economists heard of it was probably in their history courses back in college, are perpetual bonds an economically viable solution to the current Greek debt crisis? 

By: Ringo Bones 

When the “radical left-wing” SYRIZA Party won a majority of seats during the January 25, 2015 Greek Legislative Election, the European Union powers-that-be at Brussels got scared given that SYRIZA’s party leader Alexis Tsipras was a well-known left-leaning politician running on an anti austerity platform that got him elected with an overwhelming majority. Several days after the January 26 swearing in of Tsipras as the new Greek Prime Minister, fears of a “Greek Eurozone Exit” died down after the new Greek prime minister decided to cooperate with the EU to pay its debts but in a manner that would lessen the current austerity measures imposed on the country by Brussels, could perpetual bonds provide an economically viable – and a less austere option for Greece to pay off its debts? 

Perpetual bonds are a kind of bond with no maturity date therefore it may be treated as equity, not as debt. Perpetual bonds are not redeemable but pay a steady stream of interest forever. Some of the only notable perpetual bonds in existence are those that were issued by the British Treasury to pay off smaller issues used to finance the Napoleonic Wars back in 1814 – hence the college history class connection of when might current tenured economist had last heard of such bonds. Some top economists in the United States believe that it would be more efficient for the government to issue perpetual bonds, which may help it avoid the refinancing costs associated with bond issues that have maturity dates. A perpetual bond is also known as “consol”, “perpetual” or just “perp”. 

Since perpetual bond payments are similar to stock dividend payments – as they both offer some sort of return for an indefinite period of time – it is logical that they would be priced the same way. The price of a perpetual bond is therefore the fixed interest payment, or coupon amount, divided by some discount rate, which represents the speed at which money loses value over time – partly due to inflation. The discount rate denominator reduces the real value of the nominally fixed coupon amounts over time eventually making this value equal to zero. As such perpetual bonds, even though they pay interest forever, can be assigned a finite value, which in turn represents their price. In exchange for the loans, the issuer agrees to make interest payments to the bond buyer for a specific time period. 

A variety of risks are associated with perpetual bonds. Perhaps the most notable is that a perpetual period is a long time to carry on credit risks. As time passes, bond issuers, including both governments and corporations, can get into financial trouble and even fail. Perpetual bonds may also be subject to “call risk”, which means that the issuer can recall them. 

1 comment:

K8-LYN said...

Given the inherent risks associated with perpetual bonds, Greece will be screwed if a NAZI like organization manages to take over - or gets voted into - the European Union's Brussels headquarters.