UK Government to Pay Off Old War Debts

The Wall Street Journal has an interesting story today. Her Majesty’s government is preparing to pay off some of its debts…some of its reeeeally old debts.

In 1927, Winston Churchill, Chancellor of the Exchequer, consolidated a bunch of outstanding war debt into one big bond. The bond was a callable perpetuity, meaning it never matured but the government could call it in at any time. That’s what they’re doing now. The coupon is 4%.

A bond with infinite maturity is often referred to as a consol bond (or a perpetuity), but the name comes from consolidation, which the government did a few times with a mass of outstanding debt.

The 4% Consols includes debt dating back to the Napoleonic War. Now that interest rates have dropped, it’s in the government’s best interest to get rid of the higher-yielding bonds. The WSJ adds that the War Loan from 1932 may be next to be bought out.

The 1932 War Loan has a complicated history. That year, Neville Chamberlain announced that the government would call its 5% War Loan. Bondholders were given the option of taking cash or continuing to hold the bond, but at 3.5%. This was technically legal, but some say that it was a default by the UK government. There’s about 2 billion pounds left of this bond.

A reader writes in to say:

Sorry, but you have botched this story. Don’t worry, because almost everyone does, including Reinhard and Rogoff.

The correct story is that the 1917 War Loan was issued at 5% as a callable Bond 1929/42. In other words callable any time after 1929 and before 1942. That was specified in the Prospectus, so everyone knew they were buying callable Bond.

In 1931 the Government announced that it was calling the Bond – note, not changing the coupon – by redeeming it at full face value, and holders had a choice of being paid out in cash, or in a new 1932 War Loan at 3.5%. I sort of assume we don’t call redeeming a Bond at full face value a “default”, do we?

The reasons for calling the Bond was simple; by 1932 interest rates had fallen from 1917’s 5% to 3.5%.

When the Bond was called, 8% of the holders chose to be paid out in cash, and 92% exchanged the 1917 loan for the 1932 loan. Why? it’s simple; if they took cash, they would only be able to invest it at 3.5% anyway, so taking the new 1932 Bond was a wash.

As for the ‘some say”, well of course some say. “Some say” because they want to be able to pin a default on an otherwise perfect record. Now ask yourself why the UK would want to pin a default on its own perfect record.

I’m remind of the saying that nothing’s as surprising as the past.

Posted by on November 3rd, 2014 at 7:14 pm


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