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A modest proposal
Jul. 19th, 2009 09:11 pmAn interesting point made by David Smith in today's "Economic Outlook" in the Murdoch ST. Smith observed that there has been a wholesale loss of lending capacity (and a loss of wholesale lending capacity), and that the >i>message du jour if not month or year, is deleveraging.
I concluded, therefore, that one way in which I could help out the banks would be to let them deleverage my mortgage.
In the insurance business there's an apparently complex, but in reality quite simple, mechanism called commutation. This invariably involves long-tail business whereby a reinsurer offer to pay the insurer x million dollars now rather than an uncertain number of dollars between now and armageddon. Suppose the actuaries think that the amount likely to be owed over the next 30 years is $50m, but the reinsurer offers you a "certain" $25m today.
Now, although the principle is simple, the calculations on whether the insurer should take the "certain money now" are complex. They depend on assessments on future interest rate movements, inflation and, most importantly, counterparty risk -- the chance that reinsurer might not be around for the next 30 years.
This leads to the odd business situation wherein the company offering teh fixed amount tries to convince the counterparty that it is in a worse state than it actually is. "Take the money now, 'cos we might be broke tomorrow". The more the offerer can convince the recipient of the truth of this, the smaller "certain" amount the recipient is likely to accept, because of the "bird in the hand" argument.
So, I thought, I'll phone up Lloyds TSB and offer them an opportunity to deleverage their loan with me for a mere 90p in the £. I.E, I'll pay them £220,000 now for the £245,000 debt, no questions asked. Everyone wins. They get ready cash and deleverage. I clear my debt for 90% of the principle.
Of course, if I can convince them that the likely alternative is that I will default on the loan and they will end up with a flat that they can't sell, I might even get them to accept 80p in the £. On the other hand, unlike in the insurance world, I won't be able to reappear tomorrow in another guise, writing reinsurance again.
I eagerly await the lender's enthusiastic response.
I concluded, therefore, that one way in which I could help out the banks would be to let them deleverage my mortgage.
In the insurance business there's an apparently complex, but in reality quite simple, mechanism called commutation. This invariably involves long-tail business whereby a reinsurer offer to pay the insurer x million dollars now rather than an uncertain number of dollars between now and armageddon. Suppose the actuaries think that the amount likely to be owed over the next 30 years is $50m, but the reinsurer offers you a "certain" $25m today.
Now, although the principle is simple, the calculations on whether the insurer should take the "certain money now" are complex. They depend on assessments on future interest rate movements, inflation and, most importantly, counterparty risk -- the chance that reinsurer might not be around for the next 30 years.
This leads to the odd business situation wherein the company offering teh fixed amount tries to convince the counterparty that it is in a worse state than it actually is. "Take the money now, 'cos we might be broke tomorrow". The more the offerer can convince the recipient of the truth of this, the smaller "certain" amount the recipient is likely to accept, because of the "bird in the hand" argument.
So, I thought, I'll phone up Lloyds TSB and offer them an opportunity to deleverage their loan with me for a mere 90p in the £. I.E, I'll pay them £220,000 now for the £245,000 debt, no questions asked. Everyone wins. They get ready cash and deleverage. I clear my debt for 90% of the principle.
Of course, if I can convince them that the likely alternative is that I will default on the loan and they will end up with a flat that they can't sell, I might even get them to accept 80p in the £. On the other hand, unlike in the insurance world, I won't be able to reappear tomorrow in another guise, writing reinsurance again.
I eagerly await the lender's enthusiastic response.
