John Gilmore famously said that;
“The Internet interprets Censorship as Damage and routes around it”
Perhaps one of the key events in the development of the Internet age was the invention by a 19 year old of direct on-line music sharing – Napster – which destroyed for good the existing business model of the global music industry.
This capability of the Internet to route around, or dis-intermediate, middlemen is becoming daily more apparent, to the extent that a reader of the Financial Times recently won £10,000 for identifying “Peer to Peer” finance as the “Next Big Thing” in the financial world.
How such a directly connected financial system could work is a question that has interested me, from a starting point as a former Director of a global energy futures exchange, throughout almost 10 years work in the area where markets and Internet converge
At a conference last week in Teheran addressing the challenges of the current financial crisis, one of my fellow speakers observed that;
“… it is not possible to solve 21st Century problems with 20th Century solutions…”
I agree wholeheartedly, and the partnership-based enterprise model – or legal and financial structure – which I observe emerging has evolved in response to the challenges of this direct Internet connectivity.
Finance consists of credit, which facilitates trade and enables productive assets to be created; and investment, which consists of financial claims over productive assets such as secured debt (eg mortgage loans), and Equity (eg shares in a Corporation).
Both credit and investment may in fact be achieved without the intermediation of Banks. Since Bank capital will be further eroded as the Credit Crunch spreads into the productive economy, I believe that “Peer to Peer” finance offers a solution form an entirely unexpected direction.
Direct (P2P) Credit
Trade sellers have routinely extended credit – or “time to pay” – to trade buyers for thousands of years. As trade has developed nationally, regionally and globally, one of the key economic functions of a bank has been to support trade credit by stepping between sellers and buyers to provide, for a fee, an implicit guarantee of the buyer’s credit.
However, it is possible to dispense with a credit intermediary and to provide such a framework of trust through the use of an agreement – a “Guarantee Society” – whereby sellers and buyers collectively provide a mutual guarantee. This mutual guarantee may then be supported by provisions made by both seller and buyer into a default fund in the hands of a neutral Custodian.
A Service-Provider-Formerly-Known-as-a-Bank could then set guarantee limits, operate the accounting system, and deal with defaults in return for a fee. The crucial advantage for Banks of such a Guarantee Society credit enterprise model is that they no longer have to put Capital at risk by creating credit based upon it.
Direct (P2P) Investment
When we distinguish the Public Sector from the Private Sector we are actually distinguishing between enterprises and assets which are owned by the State and those which are owned by that specific enterprise model known as the Joint Stock Limited Liability Corporation.
In recent years, media attention has focused almost exclusively upon developments and events in the field of credit. The emergence of new generations of alternative investment vehicles such as Income Trusts (in Canada); Real Estate Investment Trusts; Exchange Traded Funds; hedge funds constituted as Limited Partnerships…it’s a long list…has passed by relatively un-remarked.
In particular there has been an explosion in the US of the use of the simple and flexible new partnership-based Limited Liability Company. In the UK and elsewhere an even simpler form – the Limited Liability Partnership (no relation to the US version) – is emerging at a phenomenal rate for purposes never intended by legislation introduced with the intention of limiting the liability of partners in professional partnerships.
Such partnership-based entities may be used as framework agreements – not organisations – which bring together investors with users of investment in a “Capital Partnership”. In this way, it is possible to create new revenue and production-sharing mechanisms for direct investment in productive assets of all types, and particularly in real property and in energy assets through what I call Unitisation.
By way of example, let’s consider how a Pool of distressed mortgages may be refinanced by Unitisation.
? Stage One: transfer the properties to a neutral Custodian.
? Stage Two: agree affordable rentals and index link them to an agreed measure of inflation;
? Stage Three: divide the resulting Pool of rentals into proportional Units (or n’ths);
? Stage Four: allocate a proportion of rentals for maintenance/ management and sell the balance of Units to Investors.
For the “Co-owner” Occupier, this is a new form of Rent to Buy – since any amount paid in excess of rental will buy Units.
For the “Co-owner” Investor, Units provide a reasonable, index-linked, secure (because affordability = certainty) revenue stream, ideal for risk averse long term investors such as pension funds.
For Banks holding portfolios of distressed mortgage loans Unitisation enables what may be described as a new form of Debt/Equity swap. Moreover, it will be seen that the proceeds from selling such Units will far exceed the proceeds of a conventional debt restructuring into new debt which simply leaves intact the obligation to repay un-repayable capital.
By way of another example, imagine a cluster of wind turbines, producing a Pool of energy for perhaps the next 20 years. We create Units redeemable in (say) 10 Kilo Watt Hours of electricity and sell these to investors at a suitable price. In the UK at least, it is necessary only to sell between 30and 40% of production in order to finance the turbines. After allocating a few per cent to an operating partner, the balance is pure surplus.
So Direct P2P Investment gives rise to “Shares…but not as we know them, Jim”. Once again, we see a role for Banks as service providers, appraising investments, advising investors, and providing liquidity – all classic investment banking roles. As with Direct P2P Credit there is again no need for banks to risk capital by creating credit based upon it.
The enabling factor for a new generation of Direct P2P Finance is a new generation of networked partnership-based framework agreements and entities. The work of visionaries like Professors David Johnson of New York Law School and Oliver Goodenough at the Vermont Law School in creating the new Vermont “Virtual LLC” is a major advance in this direction.
A generic Clearing Union network of direct financing will enable a simple but radical new approach to global economies. It could enable systemic fiscal reform based upon taxation of privilege rather than earned income and also offers new solutions for financing public assets. Most exciting of all, it enables a new networked generation of global markets, and even the potential for a “New Settlement” – a Bretton Woods II – establishing a new global architecture for world trade.