Universal Basic Financing - Part VI | Risk | Founders' Review Editorial

Risks may get artificially higher, if the investor base is limited. How to solve that?

Equity holders can compete with similar industry risk premiums just as debt financing. Such a financing scheme is ideal for growth economies, and economies returning from recessions. More investors analyze the same project pool, but rates are kept in bay. Growth is not pulled back by the withholding standards. The result is close to the real credit money model.

If the investment opportunity is small, it can easily be addressed by existing capital. Sometimes governments take responsibility. The government limitation is that it spreads its resources across too many projects. There is a lack of focus, and risk assessment can be distorted. This is why governments have municipal, county, state, federal, and international organizations. Monetary policies choose the lowest risks and assess the right rates as opposed to fiscal policies that use the same government note interest rate.

The Basel standards and installment based debt structure is designed to protect the investments in existing industries. It raises the barrier, so that a steel mill can provide value for its lifetime preventing losses, joblessness, etc. It is not disrupted easily with cheaply financed competition.

Installment financing also gives a leverage. Proponents insist that those who already have equity will more likely pay back their debt. This is statistically correct. The Basel standard ensures that retail and investment banks stay liquid. Equity holders get more financing with better terms splitting the debt market away from less prominent debtors.

The concentration disrupts the perfect market raising the barriers. The increased margins and cash flows support appreciation of capital assets of the past. This is the mathematical model of laboratory grade capitalism, when it detaches from free markets. This kind of growth was typical to tech companies in the period of 2015-2021. They grew together with their clients in a circle.

Statistics is a good transparent measure of the efficiency of investment. Central banks and their regulatory institutions can keep inflation and investment banks at bay by enforcing the Basel standards. Too much liquidity would let them tamper with the markets too often. The Basel standards get stricter every decade or so. This brings stability and ensures revenue for large capital investments. This is why currencies of the Bretton Woods system used today are statistical money and not laboratory grade credit money.

It is also worth to mention that equity valuation bubbles are the result of an unlimited equity holding term. Higher rates reduced the gap between bond and equity return on investment ratios to par in 2023. It shows that when the security needs to be matched with face value and dividend payments of term bonds, it returns the investor mindset back to reality.

Why is that? Investment banks have an account at the central banks with risk-free rated financing. Investment banks get to their money, if they lend with a rate that reflects the actual risk premiums of the securities. The higher the premium, the less likely project managers take the money to prevent default.

A bond has a term. The market value reflects the actual cash payments. This reflects the value created in the short term.

On the contrary, equity can grow more with some or no dividend payments. An equity may be held for a long time with a valuation supported by just a few transactions. Should the entire company be sold periodically, the valuation returns to the actual bond premiums of the industry. This also suggests that mergers and acquisitions, and liquidity events set a more realistic valuation of equity. This is the reasoning behind seed, series A, B, C... funding rounds in Silicon Valley.

Successful corporations allow building up significant wealth. It is not necessarily a disadvantage. It supports motivation, liquidity, development, and stronger markets. There is a real credit money to support personal spending in society. Credit card lending fills the gap for low income businesses, if the cash outflow to the wealthy is significant.

The author thinks that the Basel standards affect price stability less than potential alternative rules. Lucrative investments for the assets of the extra wealthy & foreign holders like second homes prevent market distortions. Such schemes may have a better impact on inflation than limiting lending to small businesses.