4 THE ILS MORTGAGE MODELS

COMMISSION OF ENQUIRY

World-wide

A new structure for financial stability

Proposed Agenda 2013

Drafted in Collaboration with

Graham D Hollick FCIS FIBSA CeMAP and others

By The Proposer And Chief Researcher

Edward C D Ingram

DISCUSSION TOPIC 1

1.1. The Ingram Lending and Savings (ILS) Models for Housing Finance should be examined. 

Here is a good outline of how they will work. 

NOTE TO VISITORS
Visitors to this page please Click on that above link and read it because the rest of this page is an agenda for a study group or a commission of enquiry of what they need to verify after reading the book. 

Better still Try Chapter 5 of the Book which explains ILS in easy-to-read depth as does the mathematics on This Blog.
END OF NOTE

It is claimed that the ILS model, when properly regulated, will be able to merge seamlessly with existing mortgage models as a Hybrid Solution or as a stand-alone Defined Cost Model, (more details) and/or the Basic ILS model which manages the repayments as interest rates change. The advantages of all ILS Models are: 

1.2. Interest rate risk will diminish almost to vanishing point, allowing lenders to raise the funds needed to match their assets and their liabilities at almost all times; in the event of a mismatch on a temporary basis the lender can suspend lending new mortgages or in the worst case scenario, a lender can look for some form of assistance, merger, or take-over. 

1.3. The ILS model has been shown to be more competitive and better able to cope with all economic conditions within reason compared to all current alternatives. 

1.4. Some currently worrisomely uncovered BASEL III concerns arising from inherent instabilities in the current debt structures and regulations get to be covered, something that is impossible with current mortgage models. 

1.5. The safe amount that can be lent depends critically upon there being a new managed feature called Payments Depreciation whereby the cost of the mortgage in terms of value paid (or % of income paid) reduces every year, fast enough to minimise any arrears problem. This is well illustrated in the report in this interview on the GlobalRisk Community Website’s 2012 Almanac where it tops the list of contributions. No other mortgage model has this feature.

1.5.1. This means (mathematically) that it is unsafe to lend more just because the nominal rate of interest is lowered: that nominal interest rate will increase later. In fact, what matters is how much wealth is lent and how much wealth is taken in the repayments, which is not a function of current interest rates so much as of the average ‘true’ interest rates, (see below). 

1.5.2. The true rate is the rate at which wealth is transferred by the interest rate from the borrower to the lender. 

1.5.3. It is unsafe to lend more just because the true rate of interest has reduced below median value because by definition, that true rate of interest will increase later. 

1.5.4. DEFINITION: The true rate of interest I% is the nominal rate r% minus the rate of average incomes / earnings growth (AEG% p.a.); it is the marginal rate of interest above AEG% p.a. I% = r% - AEG%. It should be noted that when AEG% is negative (incomes are falling) then if the nominal interest rate is fixed positive, the true rate of interest and the cost-to-wealth of borrowing increases. 

1.5.5. If the true rate is zero it means that average incomes are rising as fast as the interest rate is adding interest. This true interest rate is too low: it is inflationary. No wealth gets transferred from the borrower because incomes are rising as fast as the interest is added. The amount of income borrowed is the amount of income repaid. This is a key part of the studies for the committee to learn and to understand clearly. 

1.5.6. If the true rate of interest is very high, say 5% p.a. (nominal rate 5% above AEG% p.a.), then lenders are getting a better return on their lending than they can get from a long term investment in some economically developed countries’ equities. The commission will look at the arguments herein which claim that lenders should set the income multiple that they use for lending at a multiple which is affordable (with low arrears from a high enough rate of payments depreciation) and which, given that, can also cope with the estimated median rate of true interest. Both the rate of Payments Depreciation and the rate of true interest are critical factors in the calculation of the monthly cost of the repayments. 

1.5.6.1. All Edward’s spreadsheet testing and back-testing will be examined. It is claimed that these tests clearly show that this formula will work; and this finding is also supported by the mathematics. 

1.5.6.2. Not every expert on the commission of enquiry is expected to follow the mathematics. Some members of the commission will need to rely on the opinion of others, and vice versa on various topics. That is why a commission is needed. 

1.5.6.3. The commission will be made aware of the fact that all of the actuaries as well as Graham Hollick, a past president of the International Union for Housing Finance and co-author of this script, and Andrew Pampallis, retired head of banking at the University of Johannesburg, and others like them, have already reached these conclusions.

CLAIMED OUTCOMES

1.6.   The claimed outcomes of the ILS Models which the commission will be asked to endorse, are as follows: 

1.6.1. Wealth held in property will be relatively safe, because mortgage multiples (sizes) will have to stabilise so as to manage arrears and collateral risk. Collateral security for lenders will then be significantly safer than in the past. Property price bubbles will not form but maybe bulges will. We can live with that. A BASEL III rethink may be indicated. 

1.6.2. On account of this, lower deposits will be needed. 

1.6.3. Lenders have been caught out in the past, when interest rates rise, by the lack of spare capacity of the borrowers with which to increase their payments. This capacity would have been taken up by credit cards and personal loans or just by other increased family commitments. With payments depreciation firmly in place under the ILS regime, this hazard will no longer exist. 

1.6.4. There will not be any significant alternate shortages and surpluses of funds for Housing. 

1.6.5. The arrears rate will not distort interest rates, nor interfere with monetary policy, as has happened in the past. 

1.6.6. Bank balance sheets and reserves will be significantly less vulnerable and asset values placed in their annual accounts will be reliable. 

1.6.7. The whole housing sector will stabilise as will the wealth of savers, lenders, and home owners, as will the budgets of home buyers using mortgage finance. 

ALL READERS AND COLLABORATORS

Your feedback is important. You may email Edward Ingram with suggestions on the anything...whatever comes to mind.
eingram@ingramsure.com

You may also like to join the LinkedIn Group named MACRO-ECONOMIC DESIGN where you can discuss issues with other interested persons.