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I’ve heard of this before, but I’m still puzzled by the logic of a loan that never gets paid off. Was this just a bad idea, or does this still happen and there’

I’ve heard of this before, but I’m still puzzled by the logic of a loan that never gets paid off. Was this just a bad idea, or does this still happen and there’s a good reason for it? Could the water authority pay the loan back to close it out? Just asking questions to the air, but if anyone knows the answer I’d love to know!

RobRivera 6y ago
NPVs tend to converge even on a perpetuity. simple measure of whether the seller will underwrite it, and will there be a market for purchase.
pjdemers 6y ago
The UK government used to issue consols, which are perpetual bonds. Over the centuries, they bought them all back. https://en.wikipedia.org/wiki/Consol_(bond) https://en.wikipedia.org/wiki/Consol_(bond)
- PLenz 6y ago
  Whenever you read in Regency to Victorian books that so-and-so has an income some pounds per year it is usually referring to these.
  - compiler-guy 6y ago
    They often refer to rents paid by tenants on the estate.
CapriciousCptl 6y ago
These sorts of bonds used to be more common and in the US. The closest more common semi-equivalent thing today is perpetual preferred stock. Most of it is callable, meaning the issuer can pay it off after a designated period. As for what is used for— it’s cheap capital to run your business with.
lostlogin 6y ago
I know nothing about finance but kept thinking in this. There is a wiki on it which says “ Perpetual bond, which is also known as a perpetual or just a perp, is a bond with no maturity date. Therefore, it may be treated as equity, not as debt.” However the wiki notes that they have no voting rights so aren’t as good as equity. https://en.m.wikipedia.org/wiki/Perpetual_bond https://en.m.wikipedia.org/wiki/Perpetual_bond
- Scoundreller 6y ago
  Aka « preferred shares », but they often have rules about being redeemed for par value. But in bankruptcy, they get paid after other creditors. The payments are dividends which may have tax advantages/disadvantages.
IkmoIkmo 6y ago
> I’ve heard of this before, but I’m still puzzled by the logic of a loan that never gets paid off. Was this just a bad idea, or does this still happen It sounds weird but it's not a bad idea, no. In essence an infinite set of future payments has a finite present value, due to inflation. i.e., suppose inflation is 100%, this means prices will double every year, and the real value of a nominal amount will halven every year. So $100 today, will be worth $50 (in today's money) in a year from now. A year later (2 years), a $100 then will be worth $25 in today's money. Another year later (3 years) it'd be worth $12.5. And so on. As you can see, a nominal future payment, say $100 in 300 years, will start to approach zero. Of course interest rates aren't quite that high, but it's just to get the point across. The interest rate is essentially a discount rate, which lets you value a future amount of money, in today's prices. In the above example, $100 in 3 years would be worth 100 / 2^3 = 12.5 This means that an infinite series of payments (perpetuity) can be calculated as well by simply taking the payment divided by the interest rate to discount it with. So at an interest rate of say 5%, a $100 per year infinitely, would be worth $2000 today. In other words, in a world with 5% interest rates, you'd be indifferent to receive $2000 today, or $100 ad infinitum. They have the same present value.
- bawolff 6y ago
  Well we have a constant rate of inflation in modern times, how true was that 300 years ago?
  - boltzmann_ 6y ago
    > constant Yeah about that..
- tantalor 6y ago
  Do you know what website you're on? You should have used $128 or $256.
  - WJW 6y ago
    Real hackers are not limited to numbers that are powers of two.
howeyc 6y ago
I believe the water authority could offer to purchase the bond (and then write it off once they own it). It would be up to the current owner to decide if they are willing to sell.
- gotsa 6y ago
  The price of the bond itself is at least 100x the value it would have to pay for eternity
  - mminer237 6y ago
    100x the annual yield would be assuming a 1% interest rate, so I'm guessing it's worth quite a bit less than that. Long-term government bonds give 2+% returns and fixed term annuities/MYGAs are giving ~4% returns, as far as I know. So I would expect a value more like 30–50 times its eternal annual payments. Heck, inflation is around 2%, so eventually this will be worthless.
    - maclockard 6y ago
      I think they were referring to the historical value of the bond itself makes it worth far more than its strict monetary value over time. So even if its 'worth' 30-50 times more when you do the math, a collector maybe be willing to pay 500 time more due to its rarity.
ijidak 6y ago
Conceptually, it seems similar to a royalty. I give you money to be a part of something, and collect a royalty into perpetuity. Or, it's even more like buying land under a building. I sell the land under my building to get some quick cash. And in turn agree to lease the land back from the new owner permanently. Depending on how badly I need the money, it may be my best and only choice...
Aperocky 6y ago
Inflation. As long as the perpetual interest are lower than the inflation, then it make sense. I'd imagine all debt so marked in German marks before the German hyperinflation in 1920s gets essentially wiped this way.
dougmany 6y ago
I bought some shares in our local coop when they were building a new store to move into. Each share gives 3% interest with no expiration and I can sell it back if I want.
ArnoVW 6y ago
If they expire you have to manage the rolling over (creating debt to pay off other debt). If the interest rates have gone up since the original loan, you pay more. This is often forgotten when people say 'but the state can get 0.01% interest loans!'. Sure, true, but if the rate goes to 5%, that 3xGNP loan becomes quite cumbersome to service. At 2.5% fixed forever perhaps it's interesting to keep. Also, I suppose that there are not many bonds that survive 367 year. So a lot of the debt 'disappears' as time goes on.
- kennywinker 6y ago
  My mortgage does not need to be re-financed in 25 years, since it’s designed to be paid off by then. Since that’s been my main interaction with debt to date, I assumed that’s how it always works. I’m starting to suspect from the comments here that was a bad assumption
  - djbebs 6y ago
    Most debt at this level works with coupons. The debtor simply pays the interest every year and at the end returns the principal
golergka 6y ago
Isn't it practically investment?
wahern 6y ago
In addition to what others have said, from a historical perspective such bonds were the functional equivalent of stock. That is, these particular bonds effectively represented equity, not debt. Joint-stock, limited liability corporations are relatively recent, especially in terms of market liquidity and legal norms. Whereas the laws regarding bonds and bond payments are much older and were (and in many ways remain) much more consistent across all of Europe and, today, the world. A bond is a type of negotiable instrument, and laws regarding negotiable instruments--which also include checks, letters of credit, mortgages, etc--go back to at least the Medieval period in their literal terms, and in general terms to the Lex Mercatoria (i.e. merchant laws of the Mediterranean trading nations, including the Roman Empire, that were organically preserved through the Medieval period and even up to today). Other commercialized civilizations also had substantially similar laws. Bonds are a relatively safe investment for more than the reasons commonly recited today--e.g. hedging market volatility, etc.
- deleted 6y ago
  [deleted]
mywittyname 6y ago
There are some practical and legal difference between the two, but this "water bond" is more akin to a modern stock certificate. The interest payments are derived from an ownership stake in the a series of dykes and canals, which are managed by a water board. Replace water board with board of directors and interest payment with dividend and nobody would bat an eye at the perpetual aspect. The big difference is that stock certificates usually don't have dividend entitlements outlined on them, while bonds do. However, historically, stock certificates could have either face values or distribution entitlements listed directly. Especially stocks in railways.
garmaine 6y ago
The 2nd mortgage on my house is a perpetual loan, so it very much is still a thing. Some context: I could only go 5% down but wanted to avoid PMI, so the other 15% for 20% down on the first mortgage was taken from a 2nd mortgage, which had the perpetual terms. It's more commonly known as an interest-only payment loan. The interest rate is adjustable and I only pay the monthly accumulated interest.
ThrustVectoring 6y ago
So a perpetual bond has both major advantages and disadvantages. The advantage is liquidity - all the different issuances are interchangeable like common stock, so instead of N different markets for each of N times the company raised money via selling bonds, there's one market. The disadvantage is that bonds do not just entitle you to periodic coupon payments, but also give you rights according to the face value of the bond in bankruptcy proceedings. Selling bonds far from the "par" you are theoretically owed in bankruptcy has big problems - either the bond is trading above par and you risk not being made "whole", or it is below par and the company is selling bankruptcy liabilities on their assets for pennies on the dollar. The movement of interest rates over time guarantees that one of these situations will eventually hold, so either issuers or buyers will want to adjust the nominal yield (and thus par value), resulting in the loss of interchangeability. Notably, the US government has zero risk of being able to pay its nominal obligations, so is a prime candidate for issuing perpetuals in a way that corporations cannot. Currently, if you buy a new 20-year treasury bond and wait 2 years, you end up with an off-the-run bond that is difficult to efficiently trade. It'd be much better if these instruments did not "expire" as such, and the increased usefulness to investors would wind up reflected in lower financing costs for the government. Theoretically, the entire US treasury bond structure could be replaced with a zero-duration overnight interest account, a perpetual that pays a $1 coupon per day, and an inflation-linked perpetual that pays the CPI as coupon.
Lazare 6y ago
Here's one way of thinking about it: Let's say I need $1000 now. I'd like to borrow it, and I'm willing to pay some amount of money back over time to obtain it. Money now is more valuable than money later, so I know the payments will sum to more than $1000. You have some cash on hand right now, and you'd like it to be larger; you're willing to lose access to it for a while in order to get more money later. Let's say I'm a SUPER trustworthy borrower, and that SUPER trustworthy borrowers generally borrow at 2% per year right now. Here are some options that we would expect I (as the borrower) and you (as the lender) would find fairly equivalent: 1. You give me $1000 now, I give you $1,040.78 in 2 years. 2. You give me $1000 now, I give you $20 every month, and $551.46 in 2 years. 3. You give me $1000 now, I give you $17.53 every month for 5 years. 4. You give me $1000 now, I give you $9.20 every month for 10 years. 5. You give me $1000 now, I give you $1.67 every month for 10 years, and $1000 in 10 years. 6. You give me $1000 now, I give you $5.06 every month for 20 years. 7. You give me $1000 now, I give you $1.93 every month for 100 years. Excel has all these functions build in; provide all but one of the rate, the number of periods, the present value (aka PV, here, $1000), the future value (aka FV, the final payment at the end), and the periodic payment size, and it's simple math to calculate the missing value. Note that these all have, at least in theory, an equivalent value. Less money sooner, versus more money later, with the tradeoff defined by the rate (here 2%). If you, as a borrower, look that that and go "I'd really prefer a shorter term" that means the correct rate (for you) should be higher, but if 2% is the right rate, all 7 options will seem about the same. Modern bonds often have the same value for PV and FV (that is, you pay the face value back at the end), but every combination you can imagine exists in the real world, and much financial activity involves people with a payment stream structured one way getting it transformed into one structured another way. One thing you might have noticed: As the period gets longer, the amount you'd need to pay each period gets smaller and smaller, but it's asymptotic to a value. If $1000 now is "worth" $1.93 a month for 100 years, it'd be "worth" $1.67 a month over 500 years. Or indeed, over 1000 years. Turns out, the payment per period works out to the PV times the interest rate. 12% APR is ~0.1667% per month, and $1000 * 0.1667% = ~$1.67 per month. That's the finance 101 calculation, at any rate. In the real world, there's always risk in various forms. One other point: Did you notice that the interest payment on the perpetuity was $1.67, same as for the "standard" 10 year bond? (And note, bond term doesn't matter here; it's the same for 1 year, 5 years, or 20 years.) That's not a coincidence, because they're economically equivalent (ignoring risk, liquidity, etc.). In fact, consider that as practical matter, most bonds issued by national governments will never, ever really be paid off. Instead, as they come due, they are "rolled". The principle for one lot of bonds is paid off by the issuing a new lot. But consider the math: Today I get $1000 by selling you a 5 year bond. Then every month for 5 years I pay $1.67 in interest. Then at the end of 5 years I issue a new bond for $1000 (which, let's say, you ALSO buy), and I use the proceeds to pay off the first bond. Then for 5 years I pay $1.67 in monthly interest, before we do it again. Ignoring the $1000 payments every 5 years, since they cancel out to $0, this borrowing deal is "I get $1000 now, then I pay $1.67 forever", which is...a perpetuity. Conversely, if I did sell you a perpetuity, you could just sell it in 5 years. You'd expect to get $1000 when you sell a perpetuity on those terms, if interest rates haven't changed, so the cash flows for you buying and later selling a perpetuity is identical to buying a bond and holding it to maturity. So in short: Not a bad idea, still happens ALL THE TIME, we just package it differently for various practical reasons.

RobRivera 6y ago

NPVs tend to converge even on a perpetuity. simple measure of whether the seller will underwrite it, and will there be a market for purchase.

pjdemers 6y ago

The UK government used to issue consols, which are perpetual bonds. Over the centuries, they bought them all back. https://en.wikipedia.org/wiki/Consol_(bond) https://en.wikipedia.org/wiki/Consol_(bond)

PLenz 6y ago
Whenever you read in Regency to Victorian books that so-and-so has an income some pounds per year it is usually referring to these.
- compiler-guy 6y ago
  They often refer to rents paid by tenants on the estate.

CapriciousCptl 6y ago

These sorts of bonds used to be more common and in the US. The closest more common semi-equivalent thing today is perpetual preferred stock. Most of it is callable, meaning the issuer can pay it off after a designated period. As for what is used for— it’s cheap capital to run your business with.

lostlogin 6y ago

I know nothing about finance but kept thinking in this. There is a wiki on it which says “ Perpetual bond, which is also known as a perpetual or just a perp, is a bond with no maturity date. Therefore, it may be treated as equity, not as debt.” However the wiki notes that they have no voting rights so aren’t as good as equity. https://en.m.wikipedia.org/wiki/Perpetual_bond https://en.m.wikipedia.org/wiki/Perpetual_bond

Scoundreller 6y ago
Aka « preferred shares », but they often have rules about being redeemed for par value. But in bankruptcy, they get paid after other creditors. The payments are dividends which may have tax advantages/disadvantages.

IkmoIkmo 6y ago

> I’ve heard of this before, but I’m still puzzled by the logic of a loan that never gets paid off. Was this just a bad idea, or does this still happen It sounds weird but it's not a bad idea, no. In essence an infinite set of future payments has a finite present value, due to inflation. i.e., suppose inflation is 100%, this means prices will double every year, and the real value of a nominal amount will halven every year. So $100 today, will be worth $50 (in today's money) in a year from now. A year later (2 years), a $100 then will be worth $25 in today's money. Another year later (3 years) it'd be worth $12.5. And so on. As you can see, a nominal future payment, say $100 in 300 years, will start to approach zero. Of course interest rates aren't quite that high, but it's just to get the point across. The interest rate is essentially a discount rate, which lets you value a future amount of money, in today's prices. In the above example, $100 in 3 years would be worth 100 / 2^3 = 12.5 This means that an infinite series of payments (perpetuity) can be calculated as well by simply taking the payment divided by the interest rate to discount it with. So at an interest rate of say 5%, a $100 per year infinitely, would be worth $2000 today. In other words, in a world with 5% interest rates, you'd be indifferent to receive $2000 today, or $100 ad infinitum. They have the same present value.

bawolff 6y ago
Well we have a constant rate of inflation in modern times, how true was that 300 years ago?
- boltzmann_ 6y ago
  > constant Yeah about that..
tantalor 6y ago
Do you know what website you're on? You should have used $128 or $256.
- WJW 6y ago
  Real hackers are not limited to numbers that are powers of two.

howeyc 6y ago

I believe the water authority could offer to purchase the bond (and then write it off once they own it). It would be up to the current owner to decide if they are willing to sell.

gotsa 6y ago
The price of the bond itself is at least 100x the value it would have to pay for eternity
- mminer237 6y ago
  100x the annual yield would be assuming a 1% interest rate, so I'm guessing it's worth quite a bit less than that. Long-term government bonds give 2+% returns and fixed term annuities/MYGAs are giving ~4% returns, as far as I know. So I would expect a value more like 30–50 times its eternal annual payments. Heck, inflation is around 2%, so eventually this will be worthless.
  - maclockard 6y ago
    I think they were referring to the historical value of the bond itself makes it worth far more than its strict monetary value over time. So even if its 'worth' 30-50 times more when you do the math, a collector maybe be willing to pay 500 time more due to its rarity.

ijidak 6y ago

Conceptually, it seems similar to a royalty. I give you money to be a part of something, and collect a royalty into perpetuity. Or, it's even more like buying land under a building. I sell the land under my building to get some quick cash. And in turn agree to lease the land back from the new owner permanently. Depending on how badly I need the money, it may be my best and only choice...

Aperocky 6y ago

Inflation. As long as the perpetual interest are lower than the inflation, then it make sense. I'd imagine all debt so marked in German marks before the German hyperinflation in 1920s gets essentially wiped this way.

dougmany 6y ago

I bought some shares in our local coop when they were building a new store to move into. Each share gives 3% interest with no expiration and I can sell it back if I want.

ArnoVW 6y ago

If they expire you have to manage the rolling over (creating debt to pay off other debt). If the interest rates have gone up since the original loan, you pay more. This is often forgotten when people say 'but the state can get 0.01% interest loans!'. Sure, true, but if the rate goes to 5%, that 3xGNP loan becomes quite cumbersome to service. At 2.5% fixed forever perhaps it's interesting to keep. Also, I suppose that there are not many bonds that survive 367 year. So a lot of the debt 'disappears' as time goes on.

kennywinker 6y ago
My mortgage does not need to be re-financed in 25 years, since it’s designed to be paid off by then. Since that’s been my main interaction with debt to date, I assumed that’s how it always works. I’m starting to suspect from the comments here that was a bad assumption
- djbebs 6y ago
  Most debt at this level works with coupons. The debtor simply pays the interest every year and at the end returns the principal

golergka 6y ago

Isn't it practically investment?

wahern 6y ago

In addition to what others have said, from a historical perspective such bonds were the functional equivalent of stock. That is, these particular bonds effectively represented equity, not debt. Joint-stock, limited liability corporations are relatively recent, especially in terms of market liquidity and legal norms. Whereas the laws regarding bonds and bond payments are much older and were (and in many ways remain) much more consistent across all of Europe and, today, the world. A bond is a type of negotiable instrument, and laws regarding negotiable instruments--which also include checks, letters of credit, mortgages, etc--go back to at least the Medieval period in their literal terms, and in general terms to the Lex Mercatoria (i.e. merchant laws of the Mediterranean trading nations, including the Roman Empire, that were organically preserved through the Medieval period and even up to today). Other commercialized civilizations also had substantially similar laws. Bonds are a relatively safe investment for more than the reasons commonly recited today--e.g. hedging market volatility, etc.

deleted 6y ago
[deleted]

mywittyname 6y ago

There are some practical and legal difference between the two, but this "water bond" is more akin to a modern stock certificate. The interest payments are derived from an ownership stake in the a series of dykes and canals, which are managed by a water board. Replace water board with board of directors and interest payment with dividend and nobody would bat an eye at the perpetual aspect. The big difference is that stock certificates usually don't have dividend entitlements outlined on them, while bonds do. However, historically, stock certificates could have either face values or distribution entitlements listed directly. Especially stocks in railways.

garmaine 6y ago

The 2nd mortgage on my house is a perpetual loan, so it very much is still a thing. Some context: I could only go 5% down but wanted to avoid PMI, so the other 15% for 20% down on the first mortgage was taken from a 2nd mortgage, which had the perpetual terms. It's more commonly known as an interest-only payment loan. The interest rate is adjustable and I only pay the monthly accumulated interest.

ThrustVectoring 6y ago

So a perpetual bond has both major advantages and disadvantages. The advantage is liquidity - all the different issuances are interchangeable like common stock, so instead of N different markets for each of N times the company raised money via selling bonds, there's one market. The disadvantage is that bonds do not just entitle you to periodic coupon payments, but also give you rights according to the face value of the bond in bankruptcy proceedings. Selling bonds far from the "par" you are theoretically owed in bankruptcy has big problems - either the bond is trading above par and you risk not being made "whole", or it is below par and the company is selling bankruptcy liabilities on their assets for pennies on the dollar. The movement of interest rates over time guarantees that one of these situations will eventually hold, so either issuers or buyers will want to adjust the nominal yield (and thus par value), resulting in the loss of interchangeability. Notably, the US government has zero risk of being able to pay its nominal obligations, so is a prime candidate for issuing perpetuals in a way that corporations cannot. Currently, if you buy a new 20-year treasury bond and wait 2 years, you end up with an off-the-run bond that is difficult to efficiently trade. It'd be much better if these instruments did not "expire" as such, and the increased usefulness to investors would wind up reflected in lower financing costs for the government. Theoretically, the entire US treasury bond structure could be replaced with a zero-duration overnight interest account, a perpetual that pays a $1 coupon per day, and an inflation-linked perpetual that pays the CPI as coupon.

Lazare 6y ago

Here's one way of thinking about it: Let's say I need $1000 now. I'd like to borrow it, and I'm willing to pay some amount of money back over time to obtain it. Money now is more valuable than money later, so I know the payments will sum to more than $1000. You have some cash on hand right now, and you'd like it to be larger; you're willing to lose access to it for a while in order to get more money later. Let's say I'm a SUPER trustworthy borrower, and that SUPER trustworthy borrowers generally borrow at 2% per year right now. Here are some options that we would expect I (as the borrower) and you (as the lender) would find fairly equivalent: 1. You give me $1000 now, I give you $1,040.78 in 2 years. 2. You give me $1000 now, I give you $20 every month, and $551.46 in 2 years. 3. You give me $1000 now, I give you $17.53 every month for 5 years. 4. You give me $1000 now, I give you $9.20 every month for 10 years. 5. You give me $1000 now, I give you $1.67 every month for 10 years, and $1000 in 10 years. 6. You give me $1000 now, I give you $5.06 every month for 20 years. 7. You give me $1000 now, I give you $1.93 every month for 100 years. Excel has all these functions build in; provide all but one of the rate, the number of periods, the present value (aka PV, here, $1000), the future value (aka FV, the final payment at the end), and the periodic payment size, and it's simple math to calculate the missing value. Note that these all have, at least in theory, an equivalent value. Less money sooner, versus more money later, with the tradeoff defined by the rate (here 2%). If you, as a borrower, look that that and go "I'd really prefer a shorter term" that means the correct rate (for you) should be higher, but if 2% is the right rate, all 7 options will seem about the same. Modern bonds often have the same value for PV and FV (that is, you pay the face value back at the end), but every combination you can imagine exists in the real world, and much financial activity involves people with a payment stream structured one way getting it transformed into one structured another way. One thing you might have noticed: As the period gets longer, the amount you'd need to pay each period gets smaller and smaller, but it's asymptotic to a value. If $1000 now is "worth" $1.93 a month for 100 years, it'd be "worth" $1.67 a month over 500 years. Or indeed, over 1000 years. Turns out, the payment per period works out to the PV times the interest rate. 12% APR is ~0.1667% per month, and $1000 * 0.1667% = ~$1.67 per month. That's the finance 101 calculation, at any rate. In the real world, there's always risk in various forms. One other point: Did you notice that the interest payment on the perpetuity was $1.67, same as for the "standard" 10 year bond? (And note, bond term doesn't matter here; it's the same for 1 year, 5 years, or 20 years.) That's not a coincidence, because they're economically equivalent (ignoring risk, liquidity, etc.). In fact, consider that as practical matter, most bonds issued by national governments will never, ever really be paid off. Instead, as they come due, they are "rolled". The principle for one lot of bonds is paid off by the issuing a new lot. But consider the math: Today I get $1000 by selling you a 5 year bond. Then every month for 5 years I pay $1.67 in interest. Then at the end of 5 years I issue a new bond for $1000 (which, let's say, you ALSO buy), and I use the proceeds to pay off the first bond. Then for 5 years I pay $1.67 in monthly interest, before we do it again. Ignoring the $1000 payments every 5 years, since they cancel out to $0, this borrowing deal is "I get $1000 now, then I pay $1.67 forever", which is...a perpetuity. Conversely, if I did sell you a perpetuity, you could just sell it in 5 years. You'd expect to get $1000 when you sell a perpetuity on those terms, if interest rates haven't changed, so the cash flows for you buying and later selling a perpetuity is identical to buying a bond and holding it to maturity. So in short: Not a bad idea, still happens ALL THE TIME, we just package it differently for various practical reasons.