Opinion

Felix Salmon

Ireland’s dastardly new savings product

By Felix Salmon
June 23, 2010

A standard trick in the consumer-facing financial services industry is to appeal to people who are sure they’re going to have no liquidity or cashflow problems in the future, and then make lots of money off them when the inevitable crunches happen. Free checking, for instance, becomes extremely expensive checking when you overdraw your account; and people regularly buy items on their credit card intending to pay the statement off in full, but then fail to do so, incurring substantial interest payments not only on that one item but on everything else they bought that month as well.

In the U.S., some kind of consumer financial protection agency is going to be created to crack down on the worst excesses along these lines. In Ireland, however, the government seems to be interested in taking a leaf out of the predators’ book with its new savings product, the National Solidarity Bond. You can download the brochure for these things here, but the basic structure is quite simple and dastardly: the bonds pay a coupon of 1% per year, and then pay out a massive final tax-free coupon of 40% of the initial investment at maturity in 10 years’ time. And then there’s the clever twist: you can pull your money out at any time, with just 7 days’ notice.

It’s trivially true that this product makes very little sense as an investment product unless you’re going to hold it to maturity. And it’s also trivially true that the number of people who end up needing to get at their money at some point in the next ten years is going to be substantial. It’s a bit like the life insurance industry, which is profitable only because of the people who stop paying their premiums and therefore never get any payout at all.

So while this is a clever way for the Irish government to raise some much-needed long-term funding, I also think it’s a little bit evil. And it’s very hard indeed to recommend this product to anybody.

(Many thanks to Alex Rolfe for the tip.)

Comments
10 comments so far | RSS Comments RSS

Felix, wouldn’t the markets just calculate the net rate of return and buy and sell the product according to the actual maturity value? It’s really no different then buying any other bond…you just calculate interest payment and final payment, and work out the net interest rate. In effect, you reprice it according to normal schemantics.
The only way this wouldn’t work is if selling the bonds through a third party NULLIFIED the final payment. Now that would truly be evil.

Posted by REDruin | Report as abusive
 

REDruin: It’s not a tradable security. It’s a long term savings product being offered through the Post Office.

The *best* part of this is that it’s not even tax free (for the interest part). So your real rate of return is minimal. Less than 2% pa, assuming inflation of 2%. That may not be too bad right now, although you can get better rates, especially if you waive the 7 day access requirement. But interest rates aren’t going to stay this low for 10 years. Or even one year. Meanwhile, the yield on a 10 year Irish government bond is 5.6%.

Posted by GingerYellow | Report as abusive
 

yeah, I’m coming up with two things:
The 1% over 9 years is basically .91ish % return.
The 40% in last year is basically a 3.425% or so discount bond (buying $1400 for $1000 up front).
So, your combined return on these is about 4.3%, and it should be traded in the secondary market accordingly vs other bonds.

Posted by REDruin | Report as abusive
 

Not a tradable security? Feh.

Posted by REDruin | Report as abusive
 

It’s Irish for savings.

Posted by HBC | Report as abusive
 

Thanks to GingerYellow for the ten-year Irish bond rate, which is obviously key here.

I have money that has been in US savings bonds for nearly ten years. A tradable instrument might be better — i.e., buy the 5.6% bond — but the put option is worth more than nothing. Felix may have a point that people are likely to overvalue this product, but I think he exaggerates its uselessness, especially if the sweetener is tax-free. I wouldn’t put my first tier of just-in-case money in this product, but I might put my second tier in it.

Posted by dWj | Report as abusive
 

To be fair, I don’t think this scheme is as bad as the UK government’s “premium bond” savings product, which uses lottery style jackpots to persuade naive people to finance the government (to the tune of £40bn!) at an average expected return of 1.5%. They are at least tax free, though, including the jackpots.

Posted by GingerYellow | Report as abusive
 

Shouldn’t the coupon rather be compared to 7-day Irish government bills? The kicker at the end is a nice sweetener if you reinvest for 10y in a row but this seems more like a 7-day bill with automatic reinvestment.

Posted by niveditas | Report as abusive
 

Hm, and you get a 10% kicker if you leave your money in there for at least 5y (22% after 7y).

Last bill auction for 7m maturity was at an average yield of 1.32%.

I honestly don’t see what’s wrong with this scheme? Wouldn’t you like to have what’s pretty close to ready cash in case you need the money or find a better investment, earning guaranteed at least 1%, with a nice bonus if you happen not to need to touch the money?

Posted by niveditas | Report as abusive
 

When we hear of anything, either a service or a product which would help us enjoy some savings, we usually go for it but just be very careful on what you go for. for some the best way to have their money on safe hands is through bonds. Now with Ireland’s new financial scheme, it still is something to find out whether it is something worth trying.

Posted by easybucks | Report as abusive
 

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