The mechanics of a bond security are not easily understood.

A bond is a securitised loan. Securitisation is a process that enables the bond (dresses it up) to be bought and sold easily in an open electronic securities exchange, similar to the manner in which public company stocks are traded. The bond securitisation structure is a sharp distinctive difference when compared to a situation where you, as an individual, loan money to your brother-in-law (BIL). Your loan agreement, even in legal form, is a contract only between the two of you, probably unsecured and reliant upon a promise to repay in good faith. You hope that your BIL still has good credit and the discipline to perform on your informal agreement. However, if you, the lender, needed your cash back in a hurry, you cannot sell the loan on to someone else. Possibly assign, yes, but that is another topic entirely. And, if BIL defaults on the loan payments, you could be in dire cash straits yourself.

Enter the bond market. Bonds are used for investing as much, possibly even more than stocks. Bonds

• Come with a stated rate of interest (coupon rate),

• a principal amount to purchase (and be repaid),

• a certain maturity date often considered a shelf-life,

• a credit-quality designation — the higher the credit rating, generally, the more sought-after bond,

• high grade (credit quality) bonds tend to have the lowest rate of interest because of their perceived safety factor,

• are a cheaper, faster method of raising cash for a company,

• are used by central banks and the US Federal Reserve to control monetary funds flows within an economy,

• are an easy way to store cash — when using high grade very short term government bonds,

• provide diversification for management of investments and related items.

The safety factor is quite simple, and can be answered in two questions. Which interest rate is the best, and which bond is the safest? Try a simple comparison between United States Treasury bonds — 10-year Government bonds — interest coupon rate of 2.23 per cent, and a Greece government-issued 10-year bond with interest rate of 7.36 per cent. Safety or a salivating rate — which will you choose? I think you know the answer to the best choice when you ask yourself: ‘Will I get my money (principal) — any of it back? The safest bond has the lowest interest rate.

Governments love bonds. When the US Federal Reserve talks about QE -quantitative easing, the Fed does not just throw money out there. They accomplish that policy task of putting cash in the money flow system by buying US treasury bonds from individual and institutional investors — on the open market.

Our Bermuda Government has done the opposite. The Bermuda Government did not buy bonds from local investors to own them, thereby increasing the local money supply by putting more cash into local circulation. Instead, Government procured cash by selling millions of dollars of bonds, primarily to foreign investors, incurring massive debt liabilities composed of both principal and interest repayments. Our government is more like your BIL, making a solemn promise to pay this money back to those foreign and a few domestic investors — with interest at a certain point in time — not very far into the future.

Personally, I feel that more Bermuda bonds should be offered — only to Bermuda residents. This allows us all to participate in the “promise to be paid back,” and gives us an incentive to produce our very best work in encouraging additional foreign investment into the country. The faster that Government is able to rebuild its ‘treasure chest,” the faster our horrific debt load will be reduced.

It is a challenge for you, the reader, if you want the facts — to understand what bonds are, how they work, who is responsible for paying the interest on them, what happens if the interest is not forthcoming to the investors owning bonds? They are part and parcel of the operating economy of this country.

Your thought process may also be that you don’t own any bonds, personally! BUT, yes you do — own bonds: Directly — if you have a Bermuda National Pension Scheme account. Even the most conservative choice in a pension asset allocation is probably partly invested in high quality bonds.

Indirectly, you, as a Bermuda taxpayer, are secondarily (some might argue, primarily) responsible for paying the annual interest cost (and the eventual principal at maturity date of the bonds) on all of the Bermuda Government sovereign debt. If you think I’m kidding or exaggerating, I am extremely serious. Our esteemed Bermudian journalist, Larry Burchall, has written extensively on the staggering amount of debt that our government, our country, and yes, we (us) owe to foreign investors. The repayment of these debts can only be made in foreign currency, too — thank you very much.

How will Bermuda pay back our mountain of bond debt in the time frame of bond maturity dates allotted? Hopefully, by generating increased revenue from outside foreign sources, as well as our own internal taxes. More foreign revenue means more money to spend domestically with concomitant increases in payroll, consumption and other taxes.

It will not be easy; it will not be quick, but I firmly believe that Bermuda can eventually pull its financial state out of a net deficit position. However, if the foreign investment revenue results are not sufficient, we may see additional cost-cutting measures and taxes of some sort levied on the domestic population and businesses. Most of the Caribbean islands have revamped their tax structures to include VAT (value-added taxes) and other means — to meet back-to-solvency goals.

Sources and references

Understanding bonds: Bond Basics: Yield, Price and Other Confusion

http://www.investopedia.com/university/bonds/bonds3.asp

A closer look at Government’s bond offering

Martha Myron

Published Jul 7, 2012 at 7:00am (Updated Jul 6, 2012 at 4:58pm)

http://www.royalgazette.com/article/20120707/COLUMN07/707079997

Government bond offering is a snapshot of state of Bermuda’s finances

Martha Myron

Published Jul 14, 2012 at 7:00am (Updated Jul 14, 2012 at 7:38am)

http://www.royalgazette.com/article/20120714/column07/707149948

Larry Burchall: When The Money Runs Out

August 12, 2014 |

http://bernews.com/2014/08/larry-burchall-when-the-money-runs-out/

Disclosure: Martha Myron is an independent OECD-approved financial journalist. She does not receive or pay referral fees for discussing security products. She does not own any funds mentioned in this article. The investment information contained in this article is general in nature and not intended for, nor can it be used for specific personal financial planning advice. Individuals are advised to work with qualified international investment / planning professionals for their personal financial situations.

Martha Harris Myron CPA CFP JSM Masters of Law: International Tax and Financial Services,

Appointed to the Professional Tax Advisory Council, American Citizens Abroad, Geneva, Switzerland

President: The Pondstraddler* Life™ Consultancy: international financial planning, publications, presentations for the challenging lifestyles of multinational individuals and their families residing, working, crossing borders, and straddling ponds in the North Atlantic Quadrangle. Specific focus for residents of Bermuda, the premier international finance centre. Contact: martha@pondstraddler.com

* Pondstraddler. A person with one foot on each shore whose heart resides in both countries*