Wealth Bonds can help to create a significantly stronger and better performing economy, one that looks after the wealth of both investors and borrowers without giving unexpected surprises to either along the way. For investors, the security is unmatched and the investment return can, in a thriving economy, be significant.
Potentially huge losses may be incurred by investors in fixed interest bonds if our economies recover and if QE raises inflation rates above 2% with incomes rising above 5% p.a. - See Table 4 below.
WHAT ARE WEALTH BONDS?
There are several formats depending on their use - government debt, business debt, or Mortgages. All have an interest rate which is indexed to average incomes / earnings growth (AEG% p.a.). Plus fixed interest on top.
We defined wealth as saved income and protection of wealth as keeping pace with an index of average incomes / earnings. When Edward first started studying average incomes, looking for an index in the UK there was only one index for average earnings. Hence the terminology that he grew up with was Average Earnings Growth (AEG).
MORTGAGE BASED BONDS
A wealth bond can be used to fund a secured loan with a predefined, and reasonably affordable repayments schedule, one that gets less costly against an index of average incomes / earnings, every year. This is what normally happens with a fixed interest rate mortgage when average incomes are rising all the time.
Whereas normally the borrower does not know what the cost-to-income (or the cost to average income) will be because incomes growth rates cannot be forecast, with a Defined Cost ILS Mortgage, that question is resolved. Given a predefined rate at which payments get easier relative to the index and a predefined total repayment period, the borrower knows in advance how much the mortgage will cost for an average borrower. And he/she knows that even if income does not rise every year as fast as average, the payments will be affordable. The lender knows that the level of repossessions will be correspondingly low and that the mortgage will be secured by the property.
For the investor in wealth bonds, the rate if return is linked to AEG% p.a. plus a margin that is fixed. This fixed margin enables the lender to calculate the terms and conditions of the mortgages that can be offered. The borrower has to pay a bit more to cover all of the costs of administration including legal fees and insurances and so forth.
SUMMARY OF BORROWER BENEFITS
A wealth bond can be used to fund a secured loan with a predefined, and reasonably affordable repayments schedule, one that gets less costly against an index of average incomes / earnings, every year. This is what normally happens with a fixed interest rate mortgage when average incomes are rising all the time.
Whereas normally the borrower does not know what the cost-to-income (or the cost to average income) will be because incomes growth rates cannot be forecast, with a Defined Cost ILS Mortgage, that question is resolved. Given a predefined rate at which payments get easier relative to the index and a predefined total repayment period, the borrower knows in advance how much the mortgage will cost for an average borrower. And he/she knows that even if income does not rise every year as fast as average, the payments will be affordable. The lender knows that the level of repossessions will be correspondingly low and that the mortgage will be secured by the property.
For the investor in wealth bonds, the rate if return is linked to AEG% p.a. plus a margin that is fixed. This fixed margin enables the lender to calculate the terms and conditions of the mortgages that can be offered. The borrower has to pay a bit more to cover all of the costs of administration including legal fees and insurances and so forth.
SUMMARY OF BORROWER BENEFITS
Wealth Bonds linked to ILS Defined Cost Mortgages protect both parties, if not from vulnerable property values, then at least from repossessions and loss of wealth. If and when inflation takes off, property prices may be vulnerable but after a while property prices would rise with inflation of course. But people do not want to move house on account of property values changing. They just want their payments to be affordable.
A video presentation of this kind of mortgage can be found on U Tube here.
THE MATHEMATICS
Normally a marginal rate of interest above AEG% p.a. will be added. But if the rate of interest was equal to AEG% then the income lent, say four years' average income, will be the total amount of income that gets repaid after adding interest. Just add up the '% of income' paid every year to get the total. See the 'Average % of Income' Column in Fig 1.
Fig 1 is an amazing example of the maths in which it is possible to have the interest rate rising every year yet the payments are falling relative to the index and the interest is set to be equal to AEG%.
Check out the '% of income' used in the payments every year. The payments are pre-set to fall against the index at 4% p.a. relative to AEG. That is the pre-defined rate of easement in the contract. The contract does no know what will happen to interest rates or AEG but it says that the two will be equal.
Fig 1
 |
| The loan was 4.84 years' income and by adding up all of the 'income %' used we find that the total repayments add up to 4.84 years' income. |
Fig 2
The point is that both sides get protected by the Defined Cost ILS Mortgage Model, but the repayments under the more traditional Level Payments (LP) Model can become unaffordable at some stage. Despite the total wealth cost being a net zero figure: loan amount borrowed = total income repaid in both examples.
If the marginal rate, which I have named 'True interest' (see the GLOSSARY), is 1% above AEG% then about 10% more wealth will be repaid. But that might be consumed in costs, with less payable to the bond investor who provided the funds..
Here is a more realistic example where the two parties agree on a 2% true rate of interest and conditions are variable:
Now the lender is getting 23.7% more than was lent or invested in the bond.
INVESTOR RETURNS ARE HIGHER
Let us forget costs for a moment and look at what this means for an investor in wealth bonds.
If income is re-invested as it probably would be, then below in Fig 4 is a table of returns from a 25 year fixed true rate Wealth Bond. This is a simple compound interest table. The first and last columns show the investor's data and the middle columns show the borrower's data. The net total cost to the borrower is the excess income repaid compared to the income originally borrowed, including all interest payments.
Note that the nominal interest rate r% is not shown. r% = AEG% (which is variable) PLUS I% (true interest which is fixed. Thus the system can provide relative stability to all parties in almost any economic conditions. Market rates for bonds are determined by matching the supply with the demand.
Fig 4
INVESTOR RETURNS ARE HIGHER
Let us forget costs for a moment and look at what this means for an investor in wealth bonds.
If income is re-invested as it probably would be, then below in Fig 4 is a table of returns from a 25 year fixed true rate Wealth Bond. This is a simple compound interest table. The first and last columns show the investor's data and the middle columns show the borrower's data. The net total cost to the borrower is the excess income repaid compared to the income originally borrowed, including all interest payments.
Note that the nominal interest rate r% is not shown. r% = AEG% (which is variable) PLUS I% (true interest which is fixed. Thus the system can provide relative stability to all parties in almost any economic conditions. Market rates for bonds are determined by matching the supply with the demand.
Fig 4
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| Source: Edward C D Ingram spreadsheets |
Now we see that although the borrower repays 22% more at 2% true interest, if the bond holder re-invests those repayments, by the end of 25 years he/she gets 64% more wealth, than the income (wealth) lent, less costs. The lender has to pay the costs and collect them from the borrower. So the borrower will be quoted one true interest rate and the investor will offer another. The difference is the lenders' costs and profits.
What borrowers using other mortgage models, such as fixed interest bonds do not know is:
- How much wealth in terms of the AEG index will be needed to repay the mortgage.
- How fast their payments will ease if they are using a fixed interest bond. So they do not know what the cost will be as a '% of income' even for an average borrower.
If they use a variable rate Bond then they do not know:
- What their payments level in money or any other terms will do over the period.
The ILS Defined Cost Mortgage answers all of those uncertainties. The figures are guaranteed by the contract.
MANAGING REDEMPTIONS
With a wealth bond the true rate is fixed for the duration of the contract. The only problem is that the term of the bond may be cut short when a borrower moves home or sells up. Then consideration will need to be given to re-investing in a new wealth bond at the new current market rate for wealth bonds invested in mortgages. Lenders and investors will need to have an agreement on what is and what is not guaranteed in that respect.
IN SUMMARY
An ILS Defined Cost Mortgage protects the wealth of both parties to the contract, as well as removing both the interest rate risk to the monthly payments and the inflation risk to the lender. And there is another risk that the borrower escapes from: the risk that incomes will not rise for many years leaving them with very high costs for a long time. If incomes are falling then the borrower is still protected with payments that fall faster.
In such a case drawn to my attention in Ireland, some incomes are falling at 5% p.a. and interest rates can be as high as 4.5% so the true rate is 9.5% for that sector of the community. Imagine having to fund their pensions and you get this 9.5% p.a. true return on your Bond! Well lenders cannot lend at a fixed true rate at that cost, but there is a variable rate option which I have illustrated for the Irishman who asked.
See this page: http://ingram-school-illustrations.blogspot.com/p/g-owens.html
In such a case drawn to my attention in Ireland, some incomes are falling at 5% p.a. and interest rates can be as high as 4.5% so the true rate is 9.5% for that sector of the community. Imagine having to fund their pensions and you get this 9.5% p.a. true return on your Bond! Well lenders cannot lend at a fixed true rate at that cost, but there is a variable rate option which I have illustrated for the Irishman who asked.
See this page: http://ingram-school-illustrations.blogspot.com/p/g-owens.html
FALLING INCOMES
Mortgages in places like Japan where incomes are not rising or in other places where average incomes are falling can still offer a pension fund a good return because money may be rising in value.
Mortgages in places like Japan where incomes are not rising or in other places where average incomes are falling can still offer a pension fund a good return because money may be rising in value.
COMPARATIVE RETURNS ON WEALTH BONDS
Siegel's constant suggests that an equity investment may provide a true interest rate equivalent of 3% - 4% p.a. over the long term. You can look this up with a Google Search.
But there is some debate over the applicability of the data:
Property values usually offer a lower long term average. You can check that out too either at the same time or by looking at the Fidelity website www.fidelity.com
The long term true rate of interest on mortgage finance will be above zero because that costs nothing for the borrower and my researches of past data for the UK found that the true rate of interest on prime mortgages was around 3% p.a. But the rate varies from year to year.
Fig 5
The true rate is the difference between the two lines shown for AEG and interest rates. It is shown as a just visible line in yellow.
I gave more information on estimating the mid-cycle rate of true interest on this page:
And the dangers to an economy of getting nominal interest rates down too far on this page:
In the latter discussion on the low inflation trap the wealth bond scenario opens the escape hatch enabling the economy to grow past that scenario of long term low growth. Thus ILS Mortgages and wealth bonds are a part of the new model for our economies that I am proposing in my Research ABSTRACT.
A NEW CLEARING HOUSE
I want to establish a clearing house which sets the current market rate by matching borrowers and lenders / investors. I am seeking a business partner to do that. Contact me on
eingram@ingramsure.com
and look at my co-directors here:
and my personal passion and ability here:
OTHER FORMATS FOR WEALTH BONDS
BUSINESS LOANS
Wealth Bonds can also be designed with a variety of repayment structures to suit different business models / projects.
CAPITAL WEALTH BONDS
Some businesses may want to defer all payments in the first year or two but the wealth bond will still protect the wealth of the investor and it may attract a higher rate of true interest. The lender has to ensure that the bond is well secured. Because the rate of increase in average turnover has a relationship to average earnings growth (spending levels) the borrower has some protection from the indexation of the debt AND is better able to determine how much capital needs to be borrowed. The early cash flows can be mnaaged better and more can be borrowed if the collateral security is in place. To get an equivalent size and cost of a loan a business needs tax relief on the interest, yet when the bushiness is in most need of that there are no profits with which to obtain that tax relief.
A QUESTION OF TAXATION
Will these wealth bonds obtain any tax relief? That depends on how they are constructed (index-linked and tax free by negotiation with the revenue people) or all interest and getting too much tax relief when profits are coming in and not enough when profits are not coming in. Tax authorities need to level this playing field by taxing only the true rate of interest and giving tax relief on the same.
A QUESTION OF TAXATION
Will these wealth bonds obtain any tax relief? That depends on how they are constructed (index-linked and tax free by negotiation with the revenue people) or all interest and getting too much tax relief when profits are coming in and not enough when profits are not coming in. Tax authorities need to level this playing field by taxing only the true rate of interest and giving tax relief on the same.
MATURITY WEALTH BONDS
A bond where only the true interest is paid, may also be a suitable way of funding the early years of a new enterprise as long as, in both cases, (Capital Bond or Maturity Bond), the loan is well secured or the company is a blue chip company. The maturity date may be fixed or negotiable when profits roll in.
When profits roll in, then the repayments can get started on an agreed repayments schedule by negotiation between the lender and the borrower. There are a variety of possible constructions for repayments including the Defined Cost Mortgage Model already explained above.
A zero rate of payments easement might work well for a business loan with the cost rising as fast as AEG% p.a. But that is negotiable. A higher start would ease the cost of the payments over time and provide a greater degree of security with more flexibility if the business gets into difficult times going forward.
A zero rate of payments easement might work well for a business loan with the cost rising as fast as AEG% p.a. But that is negotiable. A higher start would ease the cost of the payments over time and provide a greater degree of security with more flexibility if the business gets into difficult times going forward.
Business loans of this kind may well attract a true rate of interest that is greater than the return obtainable from equities over the long term which according to the page on Explaining Siegel's Constant is not a high rate of return. Maybe only 4% true. Investors and fund managers may also be wide to brush up on ways to estimate the mid-cycle rate of interest.
RESEARCH OPTIONS
Some research papers are needed to explain how this knowledge can be adapted for some of the more volatile developing economies. Let me know if you are interested in doing that. You will need to know about or learn about control systems and management of the business cycle.
LENDERS AND BUSINESSES
It may be wise to offer a lower true rate in the early years so as to safeguard the wealth and the collateral cover, but by agreement at outset, that low initial true rate could be increased once the business became profitable and repayments began.
LENDING MORE THAN IS USUALLY POSSIBLE
In developing nations and nations where interest rates and inflation rates are BOTH high, these wealth bond structures come into their own enabling investors to find a better way to earn money from lending and enabling lenders to lend much more than usual and enabling businesses to lend much more than usual.
RESEARCH OPTIONS
Some research papers are needed to explain how this knowledge can be adapted for some of the more volatile developing economies. Let me know if you are interested in doing that. You will need to know about or learn about control systems and management of the business cycle.
LENDERS AND BUSINESSES
It may be wise to offer a lower true rate in the early years so as to safeguard the wealth and the collateral cover, but by agreement at outset, that low initial true rate could be increased once the business became profitable and repayments began.
LENDING MORE THAN IS USUALLY POSSIBLE
In developing nations and nations where interest rates and inflation rates are BOTH high, these wealth bond structures come into their own enabling investors to find a better way to earn money from lending and enabling lenders to lend much more than usual and enabling businesses to lend much more than usual.
GOVERNMENT / SOVEREIGN DEBT
If governments were to replace all of their fixed interest bonds with wealth bonds it would remove significant amounts of risk to the wealth of investors and risk to the future and even the present cost of borrowing.
The increased wealth protection would also help to reduce volatility in the value of the currency.
People say that an index-linked bond linked to the prices index will do the same job. It will not do the same job. The prices index tries to protect people from shortages of oil and food and doing that does not increase the supply of those things. It is a dangerous guarantee to give that is unfair to those uninvested and unfair to tax payers.
For investors, these bonds do not guarantee to protect wealth. the prices index lags behind the AEG index by about the rate of real economic growth so look at Fig 4 above and see how big the investment losses may be when real economic growth clicks in and the marginal rate of interest added to the index-linked bond does not increase to cover the gap.
A wealth guarantee will sell. All meaningful guarantees sell - it is a matter of explaining them.
FUND MANAGERS AND PRIVATE INVESTORS
USES OF WEALTH BONDS
It would be wide to read all of the above and then read this summary of how you may be able to protect your hard earned wealth and your pension from risk and from inflation of other people's incomes leaving you with a gap in your wealth.
Wealth Bonds can be included in annuity contracts and in pension funds where the clients wish to see their exposure to equities and property reduced. Wealth bonds are on the same platform )playing field) as equities and property investments because they are linked to rising income and rising spending in the economy. And they lack the volatility and risk over the short and medium term up to ten years.
A CAUTION
The main difficulty is regulations and taxes. You need to know how these may affect your investment in your particular economy. And as for investing in mortgages, and business loans, be aware that in some nations laws to protect the borrower can be very much against your best interests. For example, in America Home buyers can walk away from their mortgages and be protected from further liabilities. And there are Chapter 11 Bankruptcies and just bankruptcies to cope with.
You need to be careful or you need to insure these risks with an insurer that you trust. Today I would not be sure that any insurer can be trusted because the derivatives market is all pervasive and it is said that one insurer is buying insurance for another and the process is repeated so many times that maybe the first insurer ends up insuring itself or if any part of the chain breaks they will be exposed. To an extent, the degree of caution needed here depends upon in which country or state you are located. Some nations like states in the USA have guarantees for policyholders with insurance companies that go bankrupt, but even so I would query whether those funds are good enough in these days.
To get our Badge of Safety any financial institution, investor or lender will have to reach an agreement and n understanding with us on such issues.
Wealth Bonds can be included in annuity contracts and in pension funds where the clients wish to see their exposure to equities and property reduced. Wealth bonds are on the same platform )playing field) as equities and property investments because they are linked to rising income and rising spending in the economy. And they lack the volatility and risk over the short and medium term up to ten years.
A CAUTION
The main difficulty is regulations and taxes. You need to know how these may affect your investment in your particular economy. And as for investing in mortgages, and business loans, be aware that in some nations laws to protect the borrower can be very much against your best interests. For example, in America Home buyers can walk away from their mortgages and be protected from further liabilities. And there are Chapter 11 Bankruptcies and just bankruptcies to cope with.
You need to be careful or you need to insure these risks with an insurer that you trust. Today I would not be sure that any insurer can be trusted because the derivatives market is all pervasive and it is said that one insurer is buying insurance for another and the process is repeated so many times that maybe the first insurer ends up insuring itself or if any part of the chain breaks they will be exposed. To an extent, the degree of caution needed here depends upon in which country or state you are located. Some nations like states in the USA have guarantees for policyholders with insurance companies that go bankrupt, but even so I would query whether those funds are good enough in these days.
To get our Badge of Safety any financial institution, investor or lender will have to reach an agreement and n understanding with us on such issues.
REDUCING VOLATILITY RISK FROM A FUND
Wealth Bonds, especially those that are safe government under-written Wealth Bonds and those lenders who issue them and are covered by our Badge of Safety, can be included in the asset mix of ANY fund where a lower wealth risk level is needed, without compromising the long term safety of the wealth invested in the fund.
REDUCING BETA - MAYBE
It must be pointed out that the investment industry is used to the term 'Beta' which is not wealth related as defined, so a new term may be needed, and a new sales pitch can be opened for the selling of wealth protected funds.
A measure is needed to replace Beta Value in this case with 'Wealth Risk Value'.
MARKET RESEARCHES NEEDED
Ask your market research people this: "What does the public really want? Do they want their wealth protected and enhanced or do they want money guarantees not knowing what money may be worth? And do they really want that much risk to go with pure equities or property funds? Fixed interest bonds can be disastrous, if AEG% p.a. rises with the next economic recovery leaving fixed interest bondholders holding a near-worthless investment, as a look at Fig 4 will show - you can easily get into a negative true rate scenario that way. Advertise this information and make friends with your clients that way.
A measure is needed to replace Beta Value in this case with 'Wealth Risk Value'.
FINANCIAL ADVISERS AND FINANCIAL INSTITUTIONS
MARKET RESEARCHES NEEDED
Ask your market research people this: "What does the public really want? Do they want their wealth protected and enhanced or do they want money guarantees not knowing what money may be worth? And do they really want that much risk to go with pure equities or property funds? Fixed interest bonds can be disastrous, if AEG% p.a. rises with the next economic recovery leaving fixed interest bondholders holding a near-worthless investment, as a look at Fig 4 will show - you can easily get into a negative true rate scenario that way. Advertise this information and make friends with your clients that way.
When I take my pension I want it to be at least partly invested in wealth bonds,with the rest invested in property or equities since I am expecting these to rise faster than AEG after the world economic recovery. But at least 60% in wealth bonds would be about right for me I think, having retired many years ago at age 52 to pursue these researches funded by my own savings.
I am fortunate to have a significant retirement fund already. Otherwise I would go for at least 80% in Wealth Bonds.
FURTHER READING
Why these kinds of mortgages hold the key to future economic prosperity.
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