MATHS 5 ILS RESCUE of Banks

Ongoing re-writes, updates and additional material are noted on the LATEST UPDATES page.

The INGRAM SCHOOL is a new school of thought - it provides a refreshingly practical and down to earth new theory of business cycles and how to manage them.
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THE ILS RESCUE MODEL

AMERICAN RESCUE BY ILS HYBRID

FOREWORD

WHY AMERICA CRASHED
The real difference between the ILS HYBRID and the ILS RESCUE is the value of P% when the mortgage is set up.

In MATHS 4 we have already seen an illustration of the ILS Rescue but what readers may not appreciate is that this model was offered to the American Authorities in September 2008. In the words of an Actuarial Analyst at the time and sent to the USA:
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To Whom It may Concern

I have met with Mr. Edward Ingram on several occasions and discussed his theoretical proposals regarding models to solve numerous financial crises that the global economy [has] been faced with.

I can conclude without doubt that these models are credible and academically sound. The logic behind the construct of the results of these models is clear and comprehensive.

I fully support and pledge my assistance in the venture put forward by Mr. Ingram.

Best Regards,

(Name withheld) 

Actuarial Analyst

Actuarial & Insurance Solutions

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ADDED TO THAT, a bevy of professors and senior bankers and actuaries willingly endorse this work, and taking their comments together as a whole, they rate it as some of the most important work in banking and economics for decades, maybe a century. Click on these pages:

SOME ENDORSEMENTS

IngramSure Board

Press Cuttings and More

ZERO RESPONSE

Certainly there were some sub-prime mortgages that were beyond rescue but not all. And it was necessary to prop up the value of those homes until the distortions that inflated them got sorted out.

The response to the above offer, (and hundreds more like it sent by email and telephone calls), of every government and Central Bank official can be typified by the following private message sent to me by a senior economist in a world body to explain why governments and their advisers refuse to read or listen to this ground breaking work.

 “Again, I repeat. Don't be fooled into thinking that the current state of economics is so deeply flawed as to require a reinvention of the wheel. Even if such re-invention is required, it will come from hard-core economists rather than those not connected to macroeconomics. Outsiders cannot come up with fundamental shifts in the paradigm in any field. An economist cannot come up with a fundamental redesign of say a rocket engine. Economics is no exception.”

Date: 13 05 2013

This is of course an insult to all those that have agreed with the analysis and a terrible price for the world to pay for arrogance at the highest level.

Economists are not trained in banking, yet banking lies at the heart of economics. I am saying that the banking sector is unstable, it makes the whole economy unstable, and it can be put right. Bankers agree with me, as seen in the links above.

The same goes for wealth locked into government debt – that wealth is unstable and that creates instability in the economy as well.

In summary, wealth in housing is unstable, wealth in savings and in bonds is unstable, the cost of servicing all of this debt is unstable, and all of this instability works together at the same time in the same direction. This, together with the ‘wealth effect’ creates alternate asset price bubbles and financial crises.

Is that too difficult for a senior economist to understand? They say the economy is very complex. So why not simplify it? Take out the distortions instead of adding more....

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MAIN TEXT

The ILS Hybrid model starts like an ordinary variable rate or adjustable rate mortgage. The ILS  model clicks in to rescue the lenders and the borrowers when the 'experts' at the central banks, the regulators, and the lenders all get it entirely wrong like they did in the USA.

WHAT TO AVOID

It is NOT recommended that lenders get it wrong but then they did didn't they? They lent far too much and lowered the entry cost of first year mortgage payments far too low as interest rates reduced. The mathematics of risk management says that is not the way to do things. Mortgage sizes and costs should not be greatly influenced by the nominal rate of interest. Property prices would not then over-inflate by much - the estimate is less than 10% even in extremely low interest rate conditions.

FULL ILLUSTRATION

MAKING UP THE TEST FIGURES

The figures made up for this illustration show incomes rising at 4.5% p.a. (on an upward trend) in the pre-crisis period while interest rates on 30 year mortgages were fixed for three years at 3.5%. In the fourth year they leap up to 8% which is about 1% above my projected level needed to rein in inflation in a balanced economy (the mid-cycle rate of interest) and was about the same as the Fed had eventually estimated, by trial and error, (or was it the Taylor method), was needed.

In this illustration, when making up the test data, only the first years were deemed to be a problem so economic undulations in incomes growth and interest rates after the early years have not been included in the later years' data. They have been set at long term average rates for a stable economy, based on past data averages.

FIG R1 below - Here the ILS Model intervenes to rescue the American Banks from arrears due to a rise in interest rates from 3.5% to 8% all in one jump at the end of their third year fixed rate term (this is called an Adjustable Rate Mortgage). 

Notice that despite the cost of the payments not rising much at all at first after the fourth year jump in interest rates and slowly thereafter  (see FIG R2 below) this does not lead to the mortgages increasing above the original amount of 100,000. See Orange year-end balances.

FIG R2 below - Here are the figures used for the above bar chart. 

FIG R3 below - These are the same interest rate and AEG figures as seen in FIG 2 above and applied to the traditional US Adjustable Rate Model for comparison. This is what brought the banks down.

The outcome for the payments is very different. They become unaffordable in year 4 for prime borrowers after a 58% jump from 5,437 p.a. to 8595 p.a., never mind sub-prime. Many prime borrowers had no capacity to increase payments as they had credit cards to repay.

FIG R4 below - shows the Money costs for the traditional US Adjustable Mortgage Model year by year. Figures sourced from the above table.

FIG R5 below - Shows the Money Cost for the ILS Hybrid (Rescue) Model. It follows the Adjustable Model until the payments become unaffordable in year 4. There is zero jump up in the payments. Source: the above table FIG R2.

FIG R6 below - Compares the two models on the '% of income' needed basis for each year's repayments. Source the two spreadsheet tables above.

The mortgage is so large at 5.22 years' income that there is little room left for payments depreciation, now set at 0.5% p.a. for the ILS Rescue Model, as shown. The ILS Model normally aims to repay in 25 years, whereas the Americans like to offer 30 year terms. A 30 year term allows more to be lent but it raises the cost of all properties and reduces margins of safety. It increases the total cost-to wealth disproportionately as interest has to be paid on high value debt for an extra 5 years at the start. The alternative ILS Rescue Model here could extend the repayment period by a few years which actually gives a lot of relief allowing the downwards slope (payments depreciation to reach 2% p.a.).

FIG R7 below - shows how all of the % of income figures may have compared if rentals had cost 70% of the first year mortgage cost and then risen as fast as average incomes (AEG% p.a.). Normally, the ILS Model is cheaper than rentals after around 12 years, but that is when the mortgage size is set correctly to allow 4% p.a. payments depreciation. 

FOR SALE: If you buy these spreadsheets all of these bar charts are generated automatically and you can insert whatever assumptions you wish. Rental can start at any figure, not only 70% as here, for example. Contact me at eingram@ingramsure.com

TOOL TO ESTIMATE THE LENDER'S ACCOUNTS

For sale: There is also a set of spreadsheets for estimating profits and cash flows under various models and several different tax regimes, all of the tax and inflation and interest rates can be set for the tests.

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