Is Debt Really an appropriate Financial Instrument for the 21 st Century?

1. Is Debt Really an appropriate Financial Instrument for the 21st Century? Evan Schulman Tykye, LLC Summer 2012

2. Proposal • US Government Sells: • “x”% of GDP for, say, 20 or 30 years • “x”% is the amount raised / Present Value of GDP • Certificates expire worthless • There is no guarantee of principal • With no guarantee, Certificates are not debt • Gilbert v Comm’r (2d Cir. 1969) • For tax purposes Certificates are annuities

3. Beneficiaries • Legislators: • Debt ceiling goes away - temporarily • Voters: • Certificates are self-liquidating • We pay our own way; no longer saddling our progeny with our debts • Treasury: • No rollover requirement • Decreases debt service burden in recession • The debt service relief can be used for tax decreases or stimulus projects • Investors: • A marketable, no-load, no fee term annuity with growth, inflation protection, low volatility (vs equity) and no counter-party risk - that covers the economy • Buy America (GDP = f(inflation, productivity, population]) vs TIPS • Intermediaries may disaggregate, allowing tailored sector exposure Spreadsheet

4. Spreadsheet Results • Retire 10% of Treasury Debt: ($1.6 Trillion) • Assume: 3% nominal growth, 30 year maturity • Given today’s Treasury rates of 2%, Govt needs to pay 0.3% of GDP of which principal is some $20 billion • Adjust for “equity” risk • Equity risk Premium = 4%, beta = 0.1 • Investors’ required rate goes from approx 2 to some 2.5% • Value Inflation Premium • “Unexpected inflation” starts in year 5 at 1.5% • Premium approximates 13% or some $180 billion

5. Corporate Debt: Limitations • Saddles Issuerwith Fixed Costs • Exposes Investorto the risks of Inflation • Low Placement AgentFees • Net of customization expenses • IlliquidSecondary Market • Transaction costs are large relative to the small changes in credit and the value of imbedded options & seller may have information

6. Sales CertificateA contract like a bond, but …. • Payout = a function of gross revenues (sales) • Expires worthless at maturity • Standardized terms • Terms are reset in case of merger or acquisition • This instrument is currently in use • Consequences: risk shiftsfor issuer & investor • Tax on crime, non-usurious,

7. Issuer Benefit • Fixed cost becomes a variable cost • Self Adjusting costs make these a Premium Product • The “interest” equivalent is tax deductible • Ernst & Young letter • Smaller liquidity premium • Changes in revenue prospects will swamp transactions costs versus the small changes in credit ratings and valuations of imbedded options of bonds • Sales are transparent

8. Investor Benefits • In periods of inflation stocks & bonds are highly correlated • Certificates are hooked to sales & behave differently • Inflation insurance is important for both defined benefit & defined contribution plans & NOW is the time. • High Cash Flow Vehicle • No-load, no-fee, marketable Term Annuity with inflation protection • More liquidity • More transparent; higher probability of informed participation

9. Percent of Sales to Service Issue 0% Growth 5% Growth 5 6 7 8 9 10 11 12 13 14 15 % of Sales = $ Raised/PV Sales Capital raised = ¼ Current Sales 6% Discount Rate Std Dev of growth rates = 8%

10. Potential Purchasers • Those who need an Inflation Adjusted Annuity • High Cash Flow Vehicle with inflation insurance • Tailored protection • New Asset Class • Investors such as • Endowments, Casualty Insurers, Pension Funds • Institutions with 401(k) clients • Fidelity, Vanguard, Schwab • Entities under Shari’ah Law • Sovereign Wealth Funds

11. Potential Issuers • Money Managers • Other Professional Organizations • Auditors (WSJ, Mar 12th 2007 pg A8), lawyers, software firms, consultants: firms with few assets but high margins, Co-operatives • Private Firms, LBOs, Insurance Cos (AIG), Airlines • Firms under Shari’ah law • Firms financing stock repurchase programs • Chevron – Market Value / Sales = 1. So, 0.75% of sales redeems 10%+ of equity: - Self-liquidating equity • 1/3rd of listed firms have a Market Value / Sales ratio =< 1.0

12. Inflation Alphas Cohn, Polk, Vuolteenaho: NBER Working Paper 11018 2005 Plus term-structure steepness

13. Issuer Games • Move sales to out years • Indenture statement & IRS rules • Concentrate on profitability • Indenture statement as to use of funds • Buy less profitable firms? • Over-estimate sales growth of acquisitions(Under-estimate sales growth of a division sold) • Statement “…these are the material facts as we know them…” plus fair value opinion

14. Problems Mitigated: - Corporate Debt • Mitigation: • Saddles Issuer with Fixed Costs • Certificates offer self adjusting cost • Exposes Investor to the risks of Inflation • Portfolios of Certificates allow tailored coverage • Illiquid Secondary Market • Duration changes, need to trade or ladder: like bonds • Speculators attracted by sales volatility • Low Underwriter Fees • Premium product

15. Summary • Modigliani-Miller still holds • Risks are reallocated more appropriately • Premium product, broader appeal • New asset class, new types of issuers • Helps to complete the market • Liquidity: • More transparent; trades on revenue prospects, higher probability of informed participation The unfamiliar need not be implausible…