What a debt jubilee could do for Britain

Here's an idea for rebooting Britain's consumer economy.

First, you set up a fund to help restructure household debt. Let's say it's a $1.35bn fund (you'll see why in a minute). You use this fund to buy up bad debt from banks at a serious discount. Borrowers will be asked to pay back only part of the principal on favourable terms, offering the same low interest rates that are available to banks.

To be eligible for the programme you have to have been delinquent for six months and owe $90,000 per person to a financial institution. That way you get around the problem of moral hazard. And it has the bonus of forcing banks to clear out a great deal of debt that they continue to sit on.

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This is exactly the plan that is now being undertaken by the new South Korean government. They are calling this plan the Kookmin Hangbok Giguem', or National Happiness Fund. The fund will buy the bad debts at a deep discount, around 10% of the nominal value, and at the outset will aim to expunge $19.8bn of bad debts from 430,000 borrowers.

This is a very interesting development. I think the concept behindthe National Happiness Fund will eventually find its way to the political debate in the indebted UK and rest of Europe. Itcould change how we think about debt, banks and the equity risk premium.

And there are some very interesting investment opportunities here that I want to tell you about today

The Korean debt binge

The debt situation in South Korean is pretty grim. According to The Economist, the debt to GDP ratio, once you include household debt, is about 300% of gross domestic product (GDP). But in Britain, it's nearly 500%. Have a look at this Economist chart of global indebtedness to see what I mean.

We can make a direct comparison with the UK here. Korea belongs to the rich but old' club among G20 countries, with an average age of just below 40, and GDP per capita exceeding $20,000. Other notable members in that club include France, Germany, Italy, Spain and the UK.

The background to South Korea's high personal debt level is the property boom that took place between 2000 and 2005. Households were enticed to buy fast-appreciating homes in the expectation that they would continue to rise. The debt then became untenable when Korea was affected by the global downturn.

The combination of widening inequality, stagnant incomes, unemployment and rising debt levels meant many low-income earners had to borrow to finance their monthly living costs. And it is under a promise to correct these problems that South Korean President Park Geun-hye swept to power on 25 February this year.

What can a National Happiness Fund do?

Park, 61, the first female president in the country, won her mandate thanks to her promise to focus on national security and economic revival.

North Korea and its unpredictable regime worries her. So does the domestic economy, Asia's fourth largest, whichgrew only by 2.0% in 2012, the lowest level in three years. So Park promised during her campaign to tackle the debt of some 3.2 million people by setting up a W18.0trn ($16.7bn) fund.

The National Happiness Fund is set to be launched at the end of this month, acting as a restructuring body for low-income earners with debt problems. The fund will buy bad debt (non-performing loans) from all kinds of financial institutions (banks, credit unions, private moneylenders and savings banks) and then write them down. There are already one million borrowers more than six months in arrears (as of February) who are eligible.

Now, there are still some unanswered questions, according to Bank of America Merrill Lynch. For instance, what incentive does the financial firm have to sell the debt at such a big discount? Will it mean that they could profit if the proceeds from bad loans exceeded the cost? Most of the financial institutions have already written-off or provided for most of these loans, meaning there's little chance of any sizeable losses.

There are also many sceptics who see moral hazard questioning whether the fund will be able to break even, or will need to be bailed out by taxpayers. But there is a compelling upside to this plan that makes it well worth considering.

Time for a historical debt jubilee

The Korean National Happiness Fund is closely tied to the concept of a debt jubilee. In the book In Debt: The First 5,000 Years, the anthropologist David Graeber shows that debt and debt forgiveness has been at the core of political debates from Europe to Asia since ancient times.

I don't want to give you too potted a summary of this great book here. You can read a nice run through of the ideas in the book here.But what is really interesting is that Graeber stresses that when debt becomes too large, it must be forgiven to maintain social order and protect the sustainability of economic life.

For instance, in Mesopotamia, leaders periodically supported debtors by wiping the tablets clean. In the Old Testament, a biblical-style jubilee' was declared every 50 years, to cancel outstanding consumer and government loans.

These acts prevent credit systems from degenerating into the enslavement of debtors, and prevent debt from become a serious long-term burden for a struggling economy.

Could a debt jubilee happen in Britain? We don't know.

What we do know is that in Britain and Europe today the consensus view is to support creditors, mainly financial institutions, rather than debtors.

A good example of this is the current banking crisis in Cyprus, which appears to fully side with the banks, at the behest of German creditors.

What it means for you, the investor

I think the initiative in South Korea could reverberate through global financial markets over the next few years and become a hot election issue, particularly in the UK in 2015.

One implication is that, given the similarities between Korea and the UK, skyrocketing housing prices and high consumer debt could cause serious money flight. Affluent depositors could decide to transfer their money offshore or increase their holdings of alternative assets (mainly gold). Hong Kong and Singapore have sizeable private banking facilities and could benefit, raising the prospect of further asset price inflation in these city-states. You could read my recent New World story on this to find out how you could play this theme.

The other implication is selection of banks. If there is any kind of debt jubilee in Britain or the EU it could mean that banks that are domiciled in those jurisdictions would be affected, including some well-known banks with strong emerging market presence. In other words,investors might choose to bank with local banks. A precursor of this is the trend among many European banks to sell off non-core' assets in emerging Asia, which is allowing local competitors to increase market share and pursue regional expansion plans.

A third implication is investing in banks. Until now the mantra has been to favour international banks against local banks. That could change. The best banks to buy are those located in economies with low banking penetration, low consumer debt and robust structural economic outlook. It is the ability to leverage up that decides asset prices in the long term. We have strong views on where to look for the best banking ideas. And you can certainly find out how to play this theme in the recent report I wrote for Profit Hunter.

A final implication is a convergence of political risk. With the likelihood of some sort of debt jubilee, I think the political risk for Britain and the EU will increase. This may have already started as the credit rating agencies have indicated they aim to downgrade the sovereign debt outlook for EU countries.

Asia, having recovered from its own historic debt crisis in the late nineties, has many countries with sound government balance sheets and fast-growing economies. Over time, I believe that political risk will narrow between the New and the Old Worlds, suggesting a similar tightening in the equity risk premium. That simply means that it will be more difficult to justify any valuation premium for stocks with similar characteristics based on where they are listed.

That's why I've been so busy recommending Asian stocks to my Profit Hunter readers over the last year. I'm determined to convince British people that they can enjoy growing economies and great investment opportunities by investing in Asia and especially Southeast Asia.

I'm certainly not alone in thinking that. In fact, a new report just published by Hak Bin Chua, an economist at Bank of America Merrill Lynch, reveals that foreign direct investment (FDI) into Asean countries has risen so strongly in the past few years that it is now on a par with FDI into China! One of the main factors that he picks out is a change in strategy: "US FDI into ASEAN has been increasing over the past year, despite uncertainties at home. US FDI to ASEAN rose to $19.9bn in the first 9 months of 2012, up +126% from the same period a year ago. Stronger percentage increases in US FDI were seen in Singapore (+177%), Thailand (+126%) and Indonesia (+53%)."

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