David Bowie, among his many other creative achievements, was an innovator in finance, with the first ever intellectual property rights securitisation.
Nearly everyone seems to have been affected by the death of David Bowie, a uniquely creative and influential musical artist. I’ll add my own personal memories to the list. I think the first ever song I really loved was Life on Mars (which I still love though I’m also still not sure what it’s about). It’s impossible to categorise and shows both Bowie’s wonderful gift for melody and chord progression (with that surprising and wonderfully uplifting chorus) and his wide singing range. There is a wonderfully simple piano version of the song performed a few days ago by Rick Wakeman on BBC Radio 2 here. A second favourite is Heroes, one of the most utterly romantic songs ever made. It was recorded in his famous Berlin period and both the lyrics and the sound somehow capture the defiant mood of tragic heroism in that city then (well, West Berlin was heroically tragic – East Berlin was just tragic). The classic video of the song is here.
But Bowie also left his mark on finance. In 1997 a bond was issued and sold to an investor (the Prudential Insurance Company of America) where the payments were secured on the income from a package of 25 David Bowie albums recorded up till 1990. It paid an interest rate of 7.9%, compared with the then 10 year US Treasury bond rate of 6.4%. The bond was repaid as planned after ten years.
A special type of securitisation
A bond is a financial contract between two parties, in which one receives a payment upfront and the other receives a promise of a future stream of cashflows, with repayment of the bond at the end of the agreed term (a bond can be perpetual but this is rare). Anybody can issue a bond (unlike an equity share, which can only be issued by a corporation) if they can find a willing buyer. Bonds are usually issued by governments and by companies. They can be unsecured, meaning that the investor trusts that the issuer can find the means to honour the contract out its general financial resources, or it can be secured, in which case the cashflows are paid from a specific asset which the investor regards as reliable and perhaps can be siezed in the event of default.
Any set of reasonably reliable cashflows can be packaged as a bond. From the 1970s it became common to create bonds from bundles of loans that had been made by banks or finance companies. The biggest part of this market is mortgage-backed securities, in which the cashflows are paid by mortgage borrowers, either residential or commercial. But other sets of cashflows can be securitised too: credit card receivables, student loans and equipment lease payments are all well established categories.
Bowie bonds were an extension of this securitisation process. The cashflows were future predicted income from the royalties on Bowie’s albums. These involved some risk, mainly that Bowie would fall out of favour with record and CD buyers. That wasn’t a major risk though the buyers took another risk, that turned out to be more serious, that the sale of music in general would be threatened by free (legal and illegal) downloads. In other words, there was an unforeseen technology risk. These risks were managed in part by Bowie’s record company EMI providing a guarantee to the bond investor.
Other types of intellectual property bonds followed, but the chronic uncertainty about the commercial business model in music has become an obstacle to new issues.
Demand and supply
Any financial innovation happens only because there is a willing buyer and seller. The benefit to Bowie of issuing the bonds was to bring forward 10 years of revenues into a single lump sum of $55m (the value of the bond). There might be various reasons why that might be useful: tax efficiency, the ability to make a large payment to acquire other assets (Bowie used part of the funds to buy the rights back to some of his other songs) and estate planning.
Why would somebody buy such a bond? The investor looks at risk and return. If the bond appears to offer a better return than other more conventional bonds of equivalent risk then it’s a good investment. There might also be an argument from diversification: if the bond’s cashflows are not highly correlated with those of other investments then the bonds might boost the overall risk/return efficiency of the investor’s portfolio.
The bonds were new, and that can bring some idiosyncratic risk but also better returns than more proven and commoditised investments. In this case, the bonds did lose creditworthiness later in their life, which would have cut their value to another investor. But the bonds were repaid on schedule and proved that innovation can be, to some extent, cool.