Immigration-Backed Bonds

[First off, since this is my first post here: I am in it for the real deal: open borders. But I also think that the best way to get there would be to first accommodate concerns and offer keyhole solutions that could then expand to open borders. So in this sense, the following is only meant as a keyhole solution.]

Nathan Smith has proposed a scheme: DRITI, that has as its main features return deposits, surtaxes, and savings accounts.  While I found it interesting, I also found it complicated and prone to a lot of bureaucracy. In a similar vein, Anu Bradford proposes that a bond be posted by companies for the immigrants they hire. While I liked the idea, I share David Henderson’s reservations over the exact scheme.

Now, let me make my own proposal. For full disclosure I would like to make clear that I work in the financial sector, but am not involved in what is called financial engineering in a narrow sense. I manage corporate bond funds. So I have no professional stake in what I suggest. And I am certainly not speaking for my employer. However, I have seen some financial products that try to achieve similar things, and so that got me thinking.

The main points that I would change from the above proposals are these:

– The proposals all are some kind of individual contracts where you have a lot of transaction costs. It would be much better if you were able to exploit economies of scale and created a tradeable financial product that allowed for a better division of labor with specialized parties for origination and operation, and that creates a market with price information that’s publicly available.

– For a product to attract a lot of capital, it has to be reasonably simple. In the run-up to the financial crisis many complicated products were peddled. In my view, this was to a large extent to confuse investors. I never had these products in the funds I manage. I am in corporate bonds, i. e. bonds where you have to deal mostly with just default and liquidity risks. And believe me, this is already incredibly hard. Having many features with opaque interactions does not help.

– There is a concern from those who are wary of immigration that those who are in favor of open borders just live in some nice neighborhood and would only reap the benefits from more immigrants. Risks end up with other people. So I guess it would be a good idea that if risks are incurred, someone bears them voluntarily and they are not socialized. Let pro-open border activists (or whoever wants to) put their money where their mouth is.

– To make something feasible, it is a good idea to exploit what works, and self-interest in making a profit has been a reliable motivation for ages. Markets may not be perfect, but they do a reasonable job evaluating risks. As for political feasibility, getting as many groups to join because they have a material interest is a good idea, and that applies above all to politicians and the government.

Now here is my proposal. For want of a better name, let me call it an “immigration-backed bond” (unfortunately, “immigration bond”, which would be a better term, already refers to bonds that immigrants have to post to get out of detention). It may sound complicated, too, but it is not so fancy if you compare it to other such products.

– First a special legal entity is set up (that’s usually called a Special Purpose Vehicle) that pools a certain amount of money, let’s say, 500 million dollars for ten years. There are some other parties involved who take care of origination and operations and who are paid a fee from the pool for their services.

– The money could come from a single party, or from a private offering, or there could be a public offering where you can buy bonds that are collateralized by the pool.

– Since I am thinking of the latter case, an “immigration-backed bond” would be almost like any other bond, with a principal amount that is paid back at maturity plus regular coupons.

– Now the main feature would be that there can be claims against the pool. If these occur, coupons or in excess of that also principal amount can be lowered.

How does this relate to immigrants?

– For a certain amount, let’s say for every 20,000 dollars, the pool insures the risks of one specific immigrant (all numbers here and in the following are arbitrary, just to check that things do not get unrealistic). For 500 million dollars that would be 25,000 immigrants. In well-defined cases (e. g. a criminal verdict, deportation), the pool is on the hook for costs incurred by the government, damages to third parties and maybe also something like additional punitive damages. The pool would probably have a right to get the money back from the immigrant, but that’s the problem of the pool.

– Visa for immigrants in the pool are “shall issue.” They can only be denied for good reason, e. g. the results of a criminal background check. This “shall issue” provision is not exactly open borders, but it is in line with a prima facie right to immigrate, unlike a “may issue” provision as it is now.

– Immigrants who pass the test and do not cause any claims (or stay below some low threshold) are granted permanent residency after the ten years.

What happens with the money in the pool?

– Obviously, it would be stupid to leave it in a bank account at money market rates, so it should be invested in something. And here is where I rely on the greed of the government: the pool is invested in government bonds.

– Now to make this even more attractive for the government, you could give them better than market conditions, e. g. no coupons or even negative coupons that are paid and not received by the pool.

Up to this point, this looks like a money-losing operation. Holders of “immigration-backed bonds” would only have government bonds with lower or even negative coupons minus additional costs.

That’s why:

– The pool has a claim on the immigrants for regular payments that are higher than all costs so far (market interest rates as an opportunity cost, expenses for origination and operation, discount for the government). It may be the business of the pool to collect those payments. Alternatively, they could be tacked onto tax payments as a surtax that is routed to the pool (minus some compensation to the government for supplying the infrastructure and costs for collecting the surtaxes).

– The payments by the immigrants (or whoever wants to take over for them) or the surtax are set so high, that investors can obtain a coupon that compensates interest rates plus a premium for taking on risks (losses from claims on the pool, defaults on payments by the immigrants).

– Since immigrants might leave the country before the ten years are over, there would have to be a so-called “callable” provision, i. e. early payback of part of the principal, either by lot or pro rata.

– The originator of the pool negotiates rates with the immigrants. Probably they would use some scoring method to evaluate risks and charge premiums based on the scores. If there are many high risks in the pool, rates have to be high, so investors get a high enough premium. Or else they can be lower.

So how would that look in the real world? Just a back-of-an-envelope derivation: If the pool were pretty risky, e. g. on a par with a junk bond with a rating of BB, you would want a premium of perhaps 5% per year to compensate for this. You would also want a market rate for a riskless security over ten years. Now those are very low at the moment. A realistic long-term level would perhaps be something like 4%. Then there may be additional costs for origination and operation of 2% and a further 2% to get the government interested. This adds up to 13%. Now 13% of 20,000 dollars would translate to 2,600 dollars a year per immigrant or somewhat more than 200 dollars a month. My guess would be that this is more of an upper bound.

The government would get 10 million per year and half a billion in capital for ten years. The originator and operator would get 10 million per year together. They could split it as 50 million for orgination upfront or 2,000 dollars per immigrant, and 5 million per year for operation. Again this is only meant as a rough estimate and more of an upper bound to see whether something like this could work.

You can build in other features, e. g. a life insurance company insuring risks from deaths or invalidity, or a reinsurance company taking over losses above a certain threshold. Just for fun: You could even go through all the exercises for asset-backed products, and pool “immigration-backed bonds” themselves and slice and dice them into tranches to get things like “immigration-backed bonds squared”. But then I guess that might not be a good idea. 😉

Obviously, there could be problems that the originator of the pool does not have skin in the game. As usual you can make them hold an equity tranche that absorbs first losses. You could get rating agencies to supply a rating for the bond (I am not overwhelmed by what they can do with non-standard risks, but then it may not be useless either). There might be additional parties that would supply scores for individual immigrants and so make the pool more transparent. But then there could also be limits to that because of asymmetric information and adverse selection of immigrants in the pool.

There might also be destructive incentives from a public choice perspective. The government has a monopoly for granting access, so they might try to exploit this. However, this would probably only result in a higher surtax or equivalent for the immigrant. This may not be optimal, but better than nothing. International competiton might help to mitigate such effects. Another problem could be an incentive to close down other venues to the country because “immigration-backed bonds” are more lucrative. I can’t say I have understood all the ramifications of this, so that’s why I would like to debate my proposal.

The extra money the government receives (e. g. through lower or even negative coupons) ends up only in the general coffers. However, I’d find it even more attractive if you could tie it directly to other payments. For one million immigrants, with the above assumptions, there would be 400 million dollars per year. You could send a check of 400 dollars to the one million poorest households in the country. In this way, there would be an incentive from unexpected quarters to expand the program.

As I said, I do not have a stake in “immigration-backed bonds”. I am also not an expert on structuring such products, so there might be major improvements or arguments why they would not work. However, if they came to pass, I would certainly be interested in investing my own money in them, just to show that I put my money where my mouth is – and to make a profit from a great opportunity to increase wealth.

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