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Peak Credit
A Flight to Simplicity
Chris Cook – BarCampBank London5th July 2008
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What is a Bank anyway?
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It is a “Credit Institution”
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It creates Interest-bearing Credit (or “Debt”)
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…which is >97% of the Money we use
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Money created as interest-bearing loans……
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…is immediately deposited into the system
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A Bank is also a Credit Intermediary – or “Middleman”
BankBorrower Lender
£ £
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….but what does a Bank really do?
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A Bank guarantees borrowers’ credit…
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......and charges “Interest” for their use of this Guarantee…
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…deducts from that the Interest paid to Depositors…
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…plus its operating costs and any defaults by borrowers..
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…and aims to make a profit…
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The Credit Pyramid
Bank Credit
Capital
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Demand for Credit has been high…
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….from property buyers and investors..
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…from hedge funds and “Private Equity”..
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….and Banks started to “outsource” their implicit Guarantee….
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….“freeing up” and making best use of their Capital….
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…totally – by “securitising” debt and selling it to investors….
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…temporarily – using “Credit Derivatives”….
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…and partially – using “Monoline” credit insurers
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Result- a Bigger Credit Pyramid
Investor Capital
Credit
Bank Capital
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…with Risk “Diced and Sliced”…
Investor Capital
Credit
Bank Capital
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…so that no one knew where the risk lay…
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What is Credit anyway?
?
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Credit is an IOU and comes in two flavours…
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….“Trade” Credit from a Seller to Buyer backed by Value….
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….and Bank-created Credit supported by their Capital….
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Credit is “Deficit-based” finance
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….essential for the creation of productive assets……
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….such as buildings, wind turbines, and software……
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The problem comes when credit is created to buy existing assets……
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….typically secured by a legal claim over the asset……
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….resulting in “deficit-based” but “asset-backed” credit….
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….such as loans secured against property (ie mortgages)….
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….which are the source of over two thirds of dollars and sterling ever created…..
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…and therefore of asset price “Bubbles”….
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John Law created the first such Bubble in 1718
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…and they have never stopped since…
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…until last year we saw the culmination in the US of the “Mother of all Bubbles”….
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…since when Banks have been asking themselves….
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…is the risk with me?
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….or with the hedge fund I dealt with?
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…and they are thinking….
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….if this is what OUR balance sheet looks like…..
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…what does everyone else’s look like…..?
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So Banks now charge more for their implicit guarantees…..
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….and are much more discriminating in relation to counterparty risk…..
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….based upon the Capital they have left…
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….so that “wholesale” lending to other banks has all but dried up…..
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…meanwhile investors have gone on strike
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…so securitisation and credit derivatives have dried up too….
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…while “monoline” credit insurers are also in deep trouble…….
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…so no Capital there either…
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The Result is that the pool of Capital supporting the credit pyramid….
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…..has shrunk…..
Capital
Credit
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…interest rates set by Central Banks are irrelevant….
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….and credit is both in short supply….
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….and increasingly expensive….
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If Peak Credit is behind us….
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…what lies ahead….?
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I believe the answer is “Peer to Peer”…..
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…direct connection….
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…and ”dis-intermediation”….
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What does “Peer to Peer” Credit look like?
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Introducing the “Guarantee Society”
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“Trade” credit is extended “peer to peer” when Seller gives Buyer “time to pay”….
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…credit is subject to a mutual guarantee….
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…through membership of a “community of interest”…….
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…which may be geographic in scope…
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…or functional, or both
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Credit is interest-free, but not cost-free…
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….since provisions are made into a “default fund”…
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….and system costs shared…
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….by both sellers and buyers, since all benefit…
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….and with the sellers agreement….
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….settlement may be in money or in “money’s worth”….
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….such as units of energy or property rental value….
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Banks no longer risk their capital….
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…creating credit based upon it…..
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….but manage “peer to peer” credit creation…
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…as credit “service providers”
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“Peer to Peer” Investment
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“Equity” consists of “ownership” of property…
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….“asset-based” rather than “deficit-based” finance
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The kind of “Equity” finance Capital we are used to…
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…is “stocks” or “shares” in a “Corporation”….
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…the “Joint Stock Limited Liability Company”….
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…which is what makes the “Private Sector” Private
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But while we have all been looking the other way….
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…at the financial revolution based upon credit innovation…
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…there have been interesting developments “under the radar”….
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…in “asset-based” finance.
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In Canada we have seen “Income Trusts”….
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….where part of the gross Corporate revenues are “unitised”….
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….and sold to long term investors…
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….such as pension funds....
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…who love Income Trusts because…
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…they are getting their hands on corporate revenues….
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….before the management does….
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…there are lots of other new ways to “invest” in assets…
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…such as “Exchange Traded Funds”…
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…“Real Estate Investment Trusts”…
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…and not forgetting Islamic finance “Sukuks”
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“You don’t know what you’ve got ‘til it’s gone”
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…and you don’t know what you haven’t got ‘til you see it
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…in 2001 the UK inadvertently made “the Corporation” redundant..
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…when they introduced the UK Limited Liability Partnership (“LLP”)
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An LLP can do anything a Corporation can do..
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…own property; enter into contracts etc….
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…and you can’t lose more than you put in..
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….and.…errr….that’s it…..
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…there need not even be an agreement in writing…
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I call it an “Open Corporate”
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….the US LLC is a close cousin…
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…and both make possible a “Capital Partnership”
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Introducing the Capital Partnership
Capital Partnership
Investors
Users
Revenues
Managers
% %
CustodianOwnership
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….property is held by a “Custodian”..…
Capital Partnership
Investors
Users
Revenues
Managers
% %
CustodianOwnership
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….and Investors put in money, or “money’s worth”
Capital Partnership
Investors
Users
Revenues
Managers
% %
CustodianOwnership
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….which Managers use to fulfil the agreed purpose…
Capital Partnership
Investors
Users
Revenues
Managers
% %
CustodianOwnership
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…and revenue or production is shared…
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…..within a consensually agreed framework
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The “Capital Partnership” enables new forms of Equity…
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….proportional (%age) ”n’ths” such as billionths..
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…..which may be bought and sold…
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…but never redeemed…
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…..because there must always be 100%
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“Units”, such as kilowatt hours
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….or barrels of oil
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….or the use of an acre for a year
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…which are redeemable..
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…and with a value in exchange…
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…but carry no rights to income…
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These hold their value…
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…because they are based on value..
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… and not a claim over value..
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….issued by a “Credit Institution”
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So the possibility is there..….
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…to affordably refinance housing debt…
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…with simple new pools of land and property rentals…
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…to keep assets in public ownership..
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…but finance development by issuing non –redeemable “units” to investors…
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….carrying a reasonable index-linked return
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The result could be a National Equity…
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…and a shrunken National Debt.
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This is not Rocket Science…
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….but it is a Flight to Simplicity…
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….which, as it happens, is Islamically sound…..
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When all is said and done
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……maybe Ethical is Optimal?