"Direct Connect – a Flight to Simplicity?" – Chris Cook – Financial Expert

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.

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.

Outcomes
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.

http://claverton-energy.com/discussion-of-banks-right-to-invent-money-seigneurage-discussed-on-bbc-today-programme.html

http://claverton-energy.com/carbon-pools-financing-energy-after-peak-credit.html

1 Comment

  1. Reply

    Hugh

    This is not an alternative to the existing system to be fought against: it is complementary to the existing system.

    The Swiss WIR credit clearing system is a great example. When times were hard (as in 1934 when it was introduced) businesses used it. When it was more convenient to use bank credit, then they use that – at the moment businesses are, I understand, swinging back to the WIR.

    I am simply proposing to extend the WIR business to business credit clearing model to include individuals as well. The software exists: all it needs is an agreement between consenting Businesses and Adults….

    Because the model is based upon consensual “two way” protocols there is nothing whatever to stop consenting adults just going ahead and doing it.

    In my view, this revolution has already started and there is nothing “they” could do even if it were in their interests to stop it. In fact, it is in their interests to adapt their business model to it, because their capital requirement tends to zero if they do.

    This revolution began with online music sharing – which continues to revolutionise the music industry – and in my view it is about to revolutionise the finance industry through online risk sharing and revenue sharing.

    And we will shortly find, as the productive sector falls down the chasm opening up before it, that in fact, as Maggie Thatcher said….. “There Is No Alternative”

    Best Regards

    Chris Cook

    ——————————————————————————–
    Date: Thu, 5 Feb 2009 13:55:28 +0100

    Chris,

    Thanks.

    I entirely agree that we might well be in “a once in a thousand years transition” and that we will almost certainly never return to the apparently “benign” if actually treacherous conditions as they were pre-crash. I am therefore intrigued and sceptically encouraged by what you write but find it hard to get my head around it. It is hard to imagine such a transformation. Even harder to see the existing political and financial systems accepting it without a giant and damaging death struggle.

    This is revolution! A complete “game-changer”. Quite seriously, how does one actually go about it at a personal level? In simple words please.

    best regards,

    Hugh

    At 10:59 AM 2/5/2009 +0000, chris cook wrote:

    Hugh

    I think you underestimate what is going on. We are going through a once in a thousand years transition, not a cyclical blip.

    The Hilton group did not create a >£1bn “Capital Partnership” because Chris Cook said so: they did it because it works. The City of Glasgow did not implement three municipal partnerships (LLP’s) (albeit conventionally financed) because Chris Cook suggested it either – they did it because it works.

    We are seeing the emergence of collaborative working and business models simply because they work better than others. LLP’s and LLC’s (for instance) are becoming pervasive in use, and moreover are being used for purposes never intended.

    More importantly, however, is the way that partnership frameworks enable the direct connections of the Internet. What I advocate is in fact a business model for the Internet Age, and that indeed is how I stumbled across it in the aftermath of a “Dot Com” I set up some 10 years ago – unfortunately for me and my fellow shareholders – 10 years too early (albeit the architecture I proposed then will be used in the global gas market project, if that goes ahead).

    It was here

    http://www.exchange-handbook.co.uk/index.cfm?section=articles&action=detail&id=38754

    8 years ago, that I wrote down the lessons I had learned, and it is only now that these ideas are being picked up and becoming “mainstream” in the tech world at least (in fact the FT just gave away a £10k prize to someone who convinced the judges that “Peer to Peer finance” is the “Next Big Thing”).

    I believe that “Peer to Peer Finance” will be introduced virally in the next few years (one to three) – as with Napster and Hotmail – because the proposition is a “killer” application.
    Interest-free unsecured credit (aka “time to pay”) – which is unobtainable from Banks – to finance yourself and your business (albeit not cost-free…) ; and
    Interest-free investment in productive assets (but carrying a return in production or revenues) to replace secured debt and conventional equity at a fraction of the cost.

    I am proposing practical solutions to practical problems. The Banks have nothing to fear, and everything to gain: in a service provider model they no longer need to put their capital at risk by creating credit based upon it….which is just as well in the current climate…

    The fact is that this “collaborative “Open” capital model is emerging because it is SUPERIOR to the existing model, and those enterprises which do not use it will be at a disadvantage to those who do. Conventional capitalism will eat itself because to pay returns to rentiers (people who make money from money) – whether shareholders in Corporations, or bank manufacturers of credit – is simply inefficient, when you can fund yourself simply by selling production forward (unitisation) or by mutually sharing the risks of credit with the rest of the market (credit clearing).

    Finally, Hugh, there simply is no alternative. The deficit-based system is finished: brought down by a terminal shortage of capital.

    Within a few years you’ll be wondering – like the rest of us – why we were taken in for so long.

    The attached is about to be published by a pretty influential US think tank btw.

    Best Regards

    Chris Cook

    ——————————————————————————–
    Date: Thu, 5 Feb 2009 10:03:55 +0100
    RE: State nationalisation, state large-scale investment in pet projects like wind, and so on : a personal response : equitable carbon pricing is all that’s needed, and a bit of a general “ramble”

    Chris,

    Thank you for copying me. This is intriguing stuff. And very convincing if humanity were starting from scratch, which we may well be doing after this crash. But you are taking on the whole political and financial establishment. And ordinary folk like me find it hard to get our heads around it. So I hope the Iranians are paying you well in MUNNY.

    I hope you can make some headway in “reinventing government from the ground up”!! You might get some traction in Iceland right now!! I fear it is only a matter time before the UK goes the same way!

    Best wishes and keep me copied in please.

    Hugh

    At 04:42 PM 2/4/2009 +0000, you wrote:
    Interesting post, Paul.

    > I take the rather old-fashioned view that “the best government, is less
    > government”. I believe that spending vast sums of taxpayers’ money on
    > almost anything, is a grave error.

    I see the future in reinventing government from the ground up.

    As currently configured, neither the “Private” sector – read “owned by a Limited Liability Company” – nor the Public Sector – read “owned by the State” – are fit for purpose. We need something else – a new, non-hierarchical and networked synthesis which operates “Not for Loss”, and I believe not only that new partnership-based legal frameworks will enable this, but that the process of transition to them has already begun.

    >The government does not seem to
    > understand that money is not free, there is interest to be paid, and is
    > putting our nation in debt with all these bailouts to banks that don’t
    > even then lend on to small businesses (as a cousin has just discovered
    > in a nasty way – they lent him money on a 2 year term, he spent it on
    > the agreed project, a lease on a new shop [the rent to be paid up-front
    > – a common condition now], a week later they said they’d reviewed their
    > lending policy and wanted it back at once, nearly crashing his perfectly
    > successful business where he runs a chain of high class furniture
    > shops).

    You are basing your thinking on the conventional assumption that Money must necessarily be interest-bearing credit issued by Banks. This is a fallacy.

    Money has no cost.

    Credit has a cost, consisting of the cost of system operation (including obscene salaries); the cost of defaults; and (usually) excessive profits.

    Capital (ie property in productive assets, such as land, machinery, and now IP) has a market price, which has declined over the centuries from 25% pa in Babylonian times; through 10% pa in medieval times; 5% pa at the dawn of the industrial revolution, and it is now probably between 0.5% and 1.0% – all of these in real terms.

    See Gregory Clarke’s book in respect of this ….

    http://books.global-investor.com/books/258486/G.-Clark/A-Farewell-to-Alms/

    A good book, albeit he draws a couple of wrong conclusions from his research IMHO.

    I digress.

    While credit is implicit in a monetary relationship, it need not actually be money. You only have to look at the Swiss WIR credit clearing system, where billions of Swiss Francs’ worth of goods and services change hands each year by reference to Swiss Francs – as opposed to in exchange for Swiss Francs – to see that there are perfectly workable and complementary solutions available which could involve Banks as service providers, as opposed to credit middlemen.

    That is what my presentation in Teheran last week was about – and I met several ministers, and their OPEC rep while there.

    http://www.slideshare.net/ChrisJCook/petro-clearing-january-2009-farsi-4-presentation

    This follows my earlier presentation re “Unitisation” of energy last October.

    http://www.slideshare.net/ChrisJCook/introducing-the-petrotrust-presentation

    > Enough about wasting money in the broader picture : now to energy. The
    > best way to encourage low-carbon generation is just to price carbon
    > equitably in my opinion, over the longest possible time frame, and the
    > market will provide. How else can anything be rationed, other than on
    > price, in a free society ??

    I agree with this. I am proposing a “Petro” energy “Value Standard” by reference to which Units redeemable in energy will circulate in an “International Energy Clearing Union” . Not only is this feasible, but I believe the first steps towards doing so have already been made, through a proposal for a global market in “unitised” natural gas.

    Once energy is “unitised” in this way it may be and used as the basis for transactions, then it turns the conventional assumptions of our deficit-based economy on their heads. Investment in energy efficiency (Negawatts) – which is the cheapest energy there is – and in renewable energy (where fuel costs are zero, and operating and decommissioning costs known) may be financed simply by selling Units redeemable in energy to investors and using the proceeds for investment in energy savings and renewables.

    We may apply a carbon levy to fund a “Pool” and then use this pool to invest in “Unitised” renewables and energy savings, and in infrastructure such as Supergrids to transcend any local anticylonic difficulties. Taxpayers may then be allocated an “Energy Dividend” in Units, which they may use, or exchange for something else.

    Nuclear energy may well stack up using this variant of energy accounting as well, but I think that it is much more problematic than renewables and energy savings which are a no-brainer, since we are exchanging for value now something that will cost us nothing to redeem in the future.

    As for your other opinions, I think that drugs should be legalised and use regulated. Prohibition is the biggest problem, and one would have thought the Yanks had learned this. As for crime and punishment, I don’t agree with violence in any form, state sponsored or otherwise, but that’s just my view.

    Best Regards

    Chris Cook

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