100 year bonds: Method behind the madness

14th March 2012

One broker recalled some 25 years later that he had stormed up the back stairs – no one bothered with "security" in those days – and literally threw a pile of forms in the air, ensuring they landed on the bank officials or their desks.

So will there be a fight to fill investor boots with the proposed Osborne Bond or will potential bond buyers ensure it is still-born? 

Waiting till 2112 for your cash could be a bad idea

The idea is that the government issues a loan which will pay interest each year but which will only be redeemed by paying back the initial principal in one hundred years' time (in 2112)  or possibly never – it could be a perpetual issue like War Loan or the less well known Consols. These can in theory be repaid at par (£100 for each £100 of face value) but there is no incentive to do so as the annual servicing costs are low  – 3.5% for War Loan and as little as 2.5% for the lesser known Consolidated Stock. The latter could, in theory, have been repaid ever since 1923.

Initial reaction to the 100 year gilt plan has been negative.  And predictable. To summarise why it is a "bad idea":

A positive spin is tough

Knocking the concept is the easy bit. The next is hard.  Given the almost unrelentingly negative reception, just why did the Treasury come up with the idea and then leak it?

Several possibilities arise:

Many will think the first option is the most likely. But at least for the sake of our economic sanity, it needs to be put aside.  The second choice is a runner but it will take time to work through.

That leaves the third possibility – that the Treasury knows what it is doing. The advantage is saving money on debt repayment and coupons each year – it could be as much as £5bn if this idea catches on.

So who will pick up the losses?

How much is lost will depend on the coupon. Currently the yield curve is normally shaped – it's pointing upwards to reflect the greater risk further out of the unknown. The 10 year benchmark gilt yields 2.1% (down from 3.6% a year ago), the over 15 year gilt offers 3.15% and going out to a 2049 maturity pushes the return up to 3.25%. 

But the "irredeemables" such as War Loan offer 3.8%. conventional gilts then level off  – a 2055 maturity pays 3.24%. This suggests there is an appetite for long dated UK government paper, none of which beats current inflation.

The buyers are those who need certainty such as pension and long term insurance funds.  And with greater longevity – as well as the growing possibility of liabilities occurring after substantial time periods (think recent asbestos claims resulting from buildings constructed in the 1950s), these firms have to think very long term even if that means a loss.

And they have to invest in as near to "risk-free" as possible to fit in with solvency and other regulations even if, again, that means losing money.  Those of a conspiracy frame of mind might consider that the rules are invented to sell government paper.

There is no such "loss" to the pensions and insurance companies in reality – they simply adjust premiums to compensate.

Shorter term investors such as hedge funds could be interested – very long dated or irredeemable paper is a bet on deflation as well as a strengthening currency.

There may be no physical battle – but the arguments have only just started.


More on Mindful Money

Budget 2012 may include 100-year 'super gilts'

The UK's refinancing crisis

The UK's great depression

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