C73 / 14, f. 3-4 Courtesy of the Bank of England Archive
Record book showing the first of Turner’ s 1829 swaps of long annuities( LA) for terminable annuities( TA). His is transaction # 24.
jealousy employed in estimating the proportional value of old and new annuities.”
Other papers did not come out with such explicit condemnation, but instead responded with silence. There were a few comments about the need for the government to change regulations to avoid losses, and about the high level of activity involving TA. What was lacking was explicit advice to investors to treat themselves to a free lunch. Apparently, this was regarded as unseemly, not to be indulged in by well-bred gentlemen. Turner, not being“ well-bred,” seems not to have been constrained by such inhibition.
To put this in modern terms, let us recall the famous joke about an economist who believes in efficient markets walking down a street with a companion. That person interrupts their conversation to say,“ Look, there is a $ 20 bill lying on the ground!” To which the efficient market economist responds,“ Can’ t be, if it were a real $ 20 bill, somebody would have picked it up.” Would this anecdote carry the same punch if instead of a $ 20 bill, it was a dime that was lying on the ground? Might people even think it strange for somebody to bother to pick up a dirty coin? It may be that due to the cultural norms of early 19th century Britain, investors looked at swapping LA for TA similarly to affluent Americans stooping to pick up a dime.
Two Decades Later
The LA to TA swap in 1829 was one of two known cases of risk-free arbitrage by Turner. The other one occurred in 1847. During most of the 19th century, there was a persistent mispricing in the main British government securities. About half of the national debt consisted of the famed Consols, which paid 3 % per year, and were perpetual, but could be redeemed by the government. But about 1 / 6 consisted of the reduced 3 % annuities( RA). They also paid 3 % per year and were perpetual but redeemable. They differed from Consols in that they paid interest at the beginning of April and October, as opposed to the beginning of January and July for Consols.
Simple calculation shows that rational pricing would have been to have £ 100 of
par value of Consols to be priced almost exactly £ 0.75 higher than RA in April through June, and also in October through December, and £ 0.75 lower in the other six months. That was widely recognized at that time, and this relation held at various periods. But most of the time Consols were traded at higher prices than RA, occasionally as much as 2 % higher. It’ s as if a dollar bill with an even serial number would buy two cents more in candy bars than one with an odd serial number. This phenomenon was generally known to contemporaries, and the instances of British financial journalists pointing out the easy gains to their readers are well documented. But few investors did that. One who took advantage of this opportunity was Turner.
Soon after the financial crisis of October 1847, the overpricing of Consols relative to RA increased. That’ s when Turner acted. He swapped £ 10,000( par value) of Consols for the same amount of RA. His broker dealt with the same jobber for both sides of this swap, which should have minimized brokerage and markup
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