The long and the short of Britain's debt issues

No surprise there you might think. We all know that the public finances are in deficit and government has to borrow to pay its bills.

We know too that the nation's pension funds and insurance companies have a need to invest in long-term securities to match their long-term liabilities — their obligation to pay a pension or redeem an insurance policy in perhaps 20 years.

They are what is called natural buyers because they want an investment they can lock away as securely as possible which, when they open the cupboard 20 years on, will still be worth what it's meant to be worth.

Inflation-linked government bonds are just what they want. So you would expect this latest long-dated issue to be one of many — but you would be wrong.

The great mystery in the markets is that in spite of pleas from the pensions industry that they want more of this type of stock, and in spite of the fact that government needs to borrow as much as it cheaply can, and finally in spite of the fact that long-term interest rates are as low as they have been in living memory, the Government issues comparatively little of it and is far more likely to issue debt with a maturity of five to seven years.

Selling long-dated linkers, as they are known, ought to be a win for everybody — including the taxpayer, and no one can understand why it is not happening.

Interestingly, the Debt Management Office (DMO) has a different take on things. It says it has issued much more long-dated stuff than it has done in the past.

Now this is true, but it is also the case that it is issuing far more debt of all kinds than it has in the past — for obvious reasons.

The fact is that though the quantum of long-dated gilts has increased, the proportion it makes up of the overall debt issuance is falling.

The DMO's answer to this, and it is a fair one, is that it can only sell what the customers want to buy.

It says that pension funds and the like can protest all they like about the desirability of long-dated gilts but the market prefers the shorter-term stuff.

It says it is much easier to shift £5 billion of seven-year bonds than £1 billion of long-dated — so naturally it goes where the demand is.

But in spite of this it says it is doing a good job in providing longer-term maturities because the average age of the total of our debt is already much longer than is the case in other rich nations.

The average time to maturity in all the leading Continental countries is probably not much more than five or six years — much less than the average time to maturity on British debt — and in America there is almost no long-dated stuff at all any more because of the country's unshakeable belief in its own creditworthiness, which means it is convinced that it will always be able to refinance and roll over its debt mountain.

Much of it has a life of only three or four years.

Now faced with this problem you can do one of two things: first, you can assume that the market is always right and give it what it wants — which is what the DMO does; alternatively, you use the evidence of your eyes and ears which tells you that there is a huge demand out there from pension funds which is not being met and therefore the market is failing — something in the distribution of government debt is dysfunctional.

And this is where we bring in the investment banks.

Between the DMO and the investing public sit the gilt edge market makers, the desks in investment banks which act as middlemen.

They actually purchase the stock off the Government in order to sell it on at a small profit to the end investor.

All market makers set great store by liquidity, because the easier it is to buy and sell a security in the market, the less likely it is that there will be violent moves in its prices and the less likely in turn the investment banks will lose money.

Liquid markets make it easier for them to control their risks. The short-dated stock is always much more liquid than the long-dated — for the obvious reason that the longs are bought to lock away.

So the market makers prefer the shorter issues because it is easier for them to make money.

It is not the end investors who are demanding short-dated stock, it is the investment banks. Not for the first time their interest is edging out the clients' interest.

There is a straightforward solution. What we need is for the Treasury, the Bank of England and the DMO to understand that debt issuance is too important to be left to the markets and there are some things which matter more than liquidity.