I have a dream: a world without debt, and with much more equity. It’s not just that summer holidays are a good time for fantasising. The fifth anniversary of Lehman Brothers’ bankruptcy is a month away, and regulators have recently forced both Deutsche Bank and Barclays to issue more shares.
Some regulators’ beach thoughts may drift to the magic numbers of bank capital ratios. My approach is less technical and more philosophical. I wonder why the financial system relies so much on debt. Loans and bonds are poorly designed for their primary economic purpose – investment.
This observation may sound shocking. Interest-bearing debt is considered totally normal. Financial theory unquestioningly treats risk-free debt as the standard instrument. Savers usually compare all investments to a similar standard: safe bank accounts which pay a steady interest rate.
But a little reflection on the real economy shows that the typical debt arrangement is an unfortunate holdover from a more primitive age. Loans are unnecessarily distant from economic reality. If we were starting now, we would never rely on such rigid instruments to fund investments.
To start, loans carry a maturity mismatch, because temporary debt funds permanent investments. Depositors can take money out of banks, banks can pull lines of credit and loans are supposed to be repaid or refinanced at maturity. But the factories the credit finances cannot then be unbuilt. The research cannot be undone and the people cannot be untrained.