Equity Shares Chris Cook FEASTA Annual Lecture 2008 5 November 2008 A Debt Free Solution to the Property Crash
Equity Shares - A Solution to the Credit Crash
Dec 22, 2014
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Equity Shares
Chris Cook
FEASTA Annual Lecture 2008
5 November 2008
A Debt Free Solution to the Property Crash
We live in Interesting Times…..
10/04/23 2
….some say, “the end of the financial system as we know it”
10/04/23 3
Most people have now heard of Peak Oil....
10/04/23 4
….but last year we reached the point of Peak Credit....
10/04/23 5
...when the Irresistible Force of economic growth….
10/04/23 6
...met the Immovable Object of finite resources...
10/04/23 7
...and Peak Oil
10/04/23 8
Where did it all go wrong?
10/04/23 9
To find out, we need to understand what banks actually do....
10/04/23 10
A Bank is a Credit Institution which creates credit as interest-bearing loans....
10/04/23 11
... a Pyramid of Credit, on a base of “Regulatory Capital”...
Bank Credit
BankEquity
10/04/23 12
...and this Credit constitutes >97% of the money we use....
£
10/04/23 13
..but a Bank does not lend pre-existing money….
10/04/23 14
….it creates new money as interest–bearing credit….
10/04/23 15
….which is then deposited back into the system
10/04/23 16
But a Bank’s true economic function….
10/04/23 17
...is as a Credit intermediary or middleman...
Borrower LenderLender£
10/04/23 18
...stepping between borrower and lender...
BankBankBorrower Lender(Depositor)Lender
(Depositor)£ £
10/04/23 19
…and guaranteeing that the borrowers’ credit is good…
10/04/23 20
Interest is charged for the use of the guarantee
BankBank
Interest
BorrowersBorrowers
10/04/23 21
..from which Interest is paid to Depositors..
BankBank
Interest
BorrowersBorrowers
DepositorsDepositors
Interest
10/04/23 22
..Default and Operating costs deducted...
BankBank
Interest
BorrowersBorrowers
DepositorsDepositors
InterestCosts
10/04/23 23
..and a profit to Investors normally results
BankBank
Interest
BorrowersBorrowers
DepositorsDepositors
InterestCosts
InvestorsInvestors
10/04/23 24
Demand for Credit has been so high…
10/04/23 25
….that Banks began to “outsource” their guarantee to rid themselves of risk.
10/04/23 26
…and thus allow Equity to support more credit creation
10/04/23 27
Banks outsourced risk totally – through “securitising” debt and sale to
investors….
10/04/23 28
…temporarily – with “Credit Derivatives” (a time-limited guarantee)….
10/04/23 29
…and partially – using credit insurance from insurers such as AIG
10/04/23 30
The Result is a bigger Credit Pyramid than Banks alone could sustain…
Investor Equity
Credit
BankEquity
10/04/23 31
…and a “shadow banking system” of Investors with “sliced and diced” risk…
Investor Equity
Credit
BankEquity
10/04/23 32
This extended Pyramid of Credit funded the “Mother of all Bubbles” in US
property prices….
10/04/23 33
…and servicing this credit finally exceeded the financial capacity of the
US population...
10/04/23 34
…to the point of Peak Credit ....
10/04/23 35
In August 2007, the Bubble started to deflate and attention turned at last to
defaults …
10/04/23 36
..but by now no-one knew where the Risk lay…
Investor Equity
Credit
BankEquity
10/04/23 37
Banks started to think, “if this is what our balance sheet looks like…..”
10/04/23 38
“…what does everyone else’s look like…..?”
10/04/23 39
...and Banks stopped lending to each other ...
10/04/23 40
The problem is not shortage of money - liquidity – Central Banks can handle that
10/04/23 41
…..it is shortage of Equity - Solvency – which Central Banks cannot handle…..
10/04/23 42
Bank Equity is being eaten away by defaults….
10/04/23 43
…and Investors will not recapitalise the shadow banking system...
10/04/23 44
The Result?
Equity
Credit
10/04/23 45
So, Credit is becoming both scarce and expensive….
10/04/23 46
…Central Banks are irrelevant….
10/04/23 47
…and further defaults in the shadow banking system…..
10/04/23 48
….continue to drain money out of the system in a “deflationary spiral”....
10/04/23 49
….leading inevitably to a Depression....
10/04/23 50
So much for the Credit Crunch problem
10/04/23 51
Clearly the solution cannot lie in creating more credit
10/04/23 52
So why not take a new approach to “Equity” investment instead?
10/04/23 53
Conventional Equity consists of shares in a Limited Company or
“Corporation”….
10/04/23 54
Ownership by a Corporation is what makes the “Private Sector” Private
10/04/23 55
While the Corporation may be conventional, it is not the only enterprise model there is
10/04/23 56
While all eyes have been on Credit innovation…
10/04/23 57
…”Asset-based” finance has been developing “under the radar”….
10/04/23 58
Canadian “Income Trusts” use a Trust law framework to “unitise” gross Corporate
revenues….
10/04/23 59
Income Trust
Income Trust
CorporationCorporation
GrossRevenues
UnitInvestors
UnitInvestors
%
%
Units
Costs
Dividends?
10/04/23 60
Units are sold to risk averse investors such as pension funds…
10/04/23 61
…who consider investment less risky if they access corporate revenues…
10/04/23 62
….before the management does….
10/04/23 63
We are also seeing new asset classes such as Exchange Traded Funds (“ETF’s”)….
10/04/23 64
…Real Estate Investment Trusts (“REIT’s”)…
10/04/23 65
…Hedge Funds using Limited Partnerships…
10/04/23 66
…and Islamic finance ”Sukuks”
10/04/23 67
In 2001 the UK introduced the Limited Liability Partnership (“LLP”)......
10/04/23 68
....confusingly, an LLP is not legally a partnership...
10/04/23 69
…but a corporate entity with a legal personality independent of its members.....
10/04/23 70
…and limited liability, so members cannot lose more than they put in.....
10/04/23 71
…and...errr...that’s it ...there isn’t even a requirement for a written LLP agreement...
10/04/23 72
…which is why I call it an “Open” Corporate..
10/04/23 73
…and it is being put to some very interesting uses...
10/04/23 74
Capital Partnership - Hilton Deal 2002
Capital Partnership LLP10 UK Hotels
Gross Revenues
Hilton GroupCapital User
Hilton GroupCapital User
Consortium LLP Capital Provider
Consortium LLP Capital Provider
BankBank PropertyDeveloperProperty
DeveloperHotel
Specialist
% %
%%%
10/04/23 75
The Hilton Deal was the first example I have seen of a “Capital Partnership”...
10/04/23 76
...which I believe may perhaps be an optimal enterprise model - as follows..
10/04/23 77
Firstly, ownership of productive assets is transferred to a “Custodian”....
AssetsAssets CustodianCustodianOwnership
10/04/23 78
…then Investors put in Financial Capital in money, or “money’s worth”…
10/04/23 79
AssetsAssets
Investors
CustodianCustodianOwnership
Financial Capital
…Managers put in Human Capital of time, expertise and experience....
AssetsAssets
Investors ManagersManagers
CustodianCustodianOwnership
HumanCapital
Financial Capital
10/04/23 80
…and Users pay for the use of this Capital…
AssetsAssets
Investors
UsersUsers
Payment
ManagersManagers
% %
CustodianCustodian
Use
10/04/23 81
…resulting in a “Capital Partnership”
AssetsAssets
Investors
UsersUsers
ManagersManagers
CustodianCustodian
10/04/23 82
A “Capital Partnership” enables new forms of Equity…
10/04/23 83
(a) Equity Shares - proportional (%age) ”n’ths” such as billionths.....
10/04/23 84
…..which may be bought and sold, but never redeemed, because there must
always be 100%
10/04/23 85
(b) Redeemable Units – eg Kilo Watt Hours;
10/04/23 86
...with a value in exchange, but with no continuing rights to production
10/04/23 87
Units hold their value because they are asset-based on value provided by the
issuer …
10/04/23 88
….rather than being deficit-based upon a claim over value issued by a Bank
10/04/23 89
€nergy investment is for another time...
10/04/23 90
..today we are looking at the potential of Land Partnerships....
10/04/23 91
...to solve the current Credit Crash.
10/04/23 92
Imagine a developer has unsold homes....
10/04/23 93
....and a Bank on his tail ....
10/04/23 94
...who in turn has a Central Bank on their tail....
10/04/23 95
First, we transfer the houses to a Custodian
HousesHouses CustodianCustodian
10/04/23 96
Then we rent the houses affordably but at an index-linked rental....
HousesHouses
OccupiersOccupiers
CustodianCustodian
Rental
10/04/23 97
....noting that because rents are affordable, failure to pay is by definition unlikely...
10/04/23 98
Then we appoint a Manager and give him a proportional share in the rentals....
HousesHouses
OccupiersOccupiers
Manager
CustodianCustodian
%
Rental
10/04/23 99
....so that with a stake in the outcome he has an interest in doing a good job...
10/04/23 100
....and the Investors complete the picture
HousesHouses
InvestorsInvestors
OccupiersOccupiers
Managers
CustodianCustodian
% %
Rental
10/04/23 101
Occupiers may “Rent to Buy” - simply by paying rent early, they become Investors...
10/04/23 102
...and end mortgage slavery as rental may then be paid in Equity Shares, not cash...
10/04/23 103
...while maintaining the property themselves will give them “Sweat Equity”....
10/04/23 104
For Investors it’s an index-linked, property-based investment...
10/04/23 105
..with low risk, since affordability=certainty..
10/04/23 106
...giving a perfect match for the liabilities of the pension funds...
10/04/23 107
...who will buy from distressed developers their Equity Shares in the
Rental Pool....
10/04/23 108
...so that they can repay distressed Banks...
10/04/23 109
...and make the Central Bank happy
10/04/23 110
Lets have a quick look at the numbers
10/04/23 111
Imagine a Pool of a thousand homes with outstanding debt of €200 million
• Conventional Mortgage Finance– 25 year loan at 6% gives repayments of €15,600
pa per home and €15.6m pa in total
10/04/23 112
Imagine a Pool of 1,000 homes with outstanding debt of €200 million
• Land Partnership– Step 1 - Create the Pool
• Set an affordable rent (say) €6000 in the first year• Rental Pool is then €6m in the first year
– Step 2 – Unitise• One million Equity Shares each with the right to €6
initially
– Step 3 – Sell Equity Shares to Investors• @ 3% initially €200 million is raised– repaying all debt• @ 4% we raise €150m – and repay 75% of debt • And so on
10/04/23 113
Let’s have a look at undeveloped land...
10/04/23 114
Conventional development is based on transactions – the “Four B’s”.....
10/04/23 115
Borrow, Buy, Build and B...er Off...
10/04/23 116
First, the land is transferred to a Custodian
LandLand CustodianCustodian
10/04/23 117
...and the Land Owner becomes an Investor
LandLand
Land OwnerLand Owner
CustodianCustodian
Land Value
10/04/23 118
...as does the Council, in return for planning permission...
LandLand
CouncilCouncil
CustodianCustodian
Value of Planning permission
10/04/23 119
...and so do the Contractors at least for their profit margin...
LandLand
ContractorsContractors
CustodianCustodian
Profit Margin
10/04/23 120
...and Risk-Takers provide € to pay Contractors’ agreed costs...
LandLand
Risk-TakersRisk-Takers
CustodianCustodian
€
10/04/23 121
....while the Developer invests “Intellectual Capital” of concept and services...
LandLand
InvestorsLand-owner, Council,
Contractors, Risk Takers
InvestorsLand-owner, Council,
Contractors, Risk TakersDeveloperDeveloper
CustodianCustodian
Value Value
10/04/23 122
When the development is occupied...
HousesHouses
InvestorsInvestors
OccupiersOccupiers
Managers
CustodianCustodian
% %
Rental
10/04/23 123
...the Development Investors have a choice of selling their Equity Shares....
10/04/23 124
...or keeping them for their pension
10/04/23 125
Everyone has a stake in the outcome....
10/04/23 126
....with an interest in high quality, energy efficient housing ....
10/04/23 127
....because this lowers the cost of occupation over time ....
10/04/23 128
....which makes the Rental value higher and makes Equity Shares more valuable
10/04/23 129
So we go from a transaction model...
DeveloperDeveloperLand
OwnerProperty
BuyerProperty
Buyer
£ £
PropertyBuyer
PropertyBuyer
£
10/04/23 130
...to a service provider model where property is never sold again...
10/04/23 131
...but service providers bring together Occupiers with properties...
10/04/23 132
...and property Investors with property investment
10/04/23 133
A Land Partnership is not an Organisation...
10/04/23 134
...it does not own anything, do anything, employ anyone, or contract with anyone...
10/04/23 135
...it is simply a framework within which the stakeholders self organise ...
10/04/23 136
...with a mutual interest in developing land sustainably.
10/04/23 137
So let’s replace conventional secured debt with a new form of Community Equity...
10/04/23 138
...simply by Unitising pools of Rentals
10/04/23 139
…and turn the Risk Pyramid the right way up!
Management Equity
Investor Units
Community Equity
10/04/23 140
It’s not Rocket Science
10/04/23 141
Thank You
10/04/23 142
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