05/27/2009 A SwapRent based generic Islamic housing finance product example – A new type of housing finance products without foreclosure possibility (FARM)

The new Islamic finance application is a quite recent academic endeavor on my part and I will have a lot to learn about the intricacies of the Sharia principles. However, the more I looked into it the more I found out that ideologically the Islamic finance could be much more receptive to these newly created shared economic ownership concept because of its inherent restriction on burdening people by borrowing and lending. It would be much easier for us to introduce SwapRent based economic ownership by approaching it from letting renters gain the appreciation potential gradually in order to achieve full home ownership, rather than from the opposite end, by letting spoiled homeowners give up the appreciation opportunities. This is simply because these instant homeowners usually took it for granted to have easy access to loose credit to try to own more than what they could actually afford under the Western financial system which, by the way, had led to their current undoing in some countries.

Here below is one of many possible structures of what a new type of Islamic housing finance products could be created by using SwapRent contracts. Many other variations from this basic structure are possible, especially when accommodating some country’s or jurisdiction’s idiosyncratic operational requirements is necessary.

A home seeking person could start out as a regular renter for a residential property in a location of his choice. The bank will purchase the property into a trust or simply in a co-ownership legal structure for him. In the trust, the person could buy into a portion of the legal ownership between 0% to 100%. Either 5%, 10% or 20% could be a good starting point depending on the issuing bank’s credit standard. He could buy into more of the legal ownership vehicle now or later at the then prevalent market price. Meanwhile through these new “economic owning” or “economic renting” concepts, this new home occupier could make proper arrangements with the bank to become an “economical owner or renter” for whatever proportion of the total value of the property any time in a totally flexible and reversible manner (either buying or selling) for whatever length of time through making SwapRent transactions at REIDeX.com.

Being a renter gives a person the rights to occupy and use of a property. Being an owner will give him the right for the financial gains if there is future appreciation by the time he decides to sell, in addition to the same rights to occupy and use that a typical renter would have during his ownership. Of course he will also have to bear the risk of depreciation if he has to give up ownership at any given time pre-maturely. To put it in a very simplified way, the cost differential between the cost to rent and the cost to own will determine whether a person will be entitled to the future financial gains of the appreciation and the responsibility of bearing the risk of loss due to depreciation, meanwhile he could continue to occupy and use the property regardless what the financial value of the property is.

For simplicity reasons, let’s use the same numerical example for the $800,000 house as illustrated in the SwapRent presentation slides. Since the real physical rental rates may be higher or lower than the SwapRent rates (especially the short term rates) depending on the market conditions in each country, let’s assume a real rental rate of the property is 1.5% per annum ($1,200 per month). It could certainly be lower or higher, say 2.5% at other times as the market supply and demand forces dictate. The corresponding SwapRent for a 5 year contract may be 2% ($1,600 per month) and cost of ownership (e.g. MFC or Mortgage Funding Cost, in Western financial system) may be 5% per annum ($4,000 per month). The cost difference between economically renting and owning in this 5-year SwapRent contract example is $2,400 a month.

Therefore upon agreeing to pay $1,200 a month real rental payment the person could occupy and use the property for the next 5 year say in this 5 year contract example. He could decide to reversibly buy into the economic ownership units of between 0% to 100% of the home value with a price tag of between $0 to $2,400 more a month in additional monthly payments, on top of the rental payments ($1,200) he is already paying in his legal rental agreement, through Generic SwapRent contracts traded at REIDeX.com. He could also sell freely the number of units of economic ownership for the remaining maturity of the contracts that he already bought before for whatever reasons he may have at any time during the 5-year period before maturity. Furthermore, if he is only interested in obtaining future appreciation potential, he may pay a bit more in monthly payments to acquire that appreciation potential only with AG SwapRent contracts instead, so that he would not have to bear the downside risk if the property value goes lower in the future. It should be easily understandable that an AG SwapRent contract will be more expensive than a corresponding Generic SwapRent contract since it will only gives the acquirer the right of future appreciation without the responsibility of the risk of downside losses.

It would be very interesting to note that in a non-recourse mortgage loan, as currently uniquely practiced in the US, the same financial profile could be simulated by conventional renting plus owning AG SwapRent contracts, i. e. appreciation only, by the home occupier. Whereas for the rest of the world, where recourse mortgage loans are usually practiced, the financial profile is equivalent to conventional renting plus Generic SwapRent contracts, i.e. the ownership units (either conventional legal or the new economic) always come automatically with the responsibility of downside depreciation risks for the owners.

In addition to economic owning and renting, the home occupier could of course also decide to buy into the underlying legal ownership in the trust in a lump sum fashion (money obtained from savings, work related bonus compensations, a sale of other financial assets or even winning a trophy prize from a game show competition, etc.) any time he wishes at the then future price level with the bank which has been his co-owner in the trust. If there is enough money at hand the home occupier could buy into the entire remaining legal ownership at the then current price in order to gain complete ownership at any time he/she wishes. However, since the legal ownership comes with very high transactional cost and many other legal and tax complications, it does not offer the same liquidity, flexibility and reversibility that making SwapRent transactions at REIDeX could easily provide.

For example, to sell back portions of the legal ownership would be quite difficult under the current Islamic mortgage practices. With the innovative economic owning/renting concepts, when the home occupier does not have enough monthly income to sustain these economic ownership, he/she will simply lose part of the future appreciation potential that is represented by these economic ownership units that he/she owns. There will no longer be a reason for foreclosing and eviction, unless he/she can not even pay for the normal real rental payments. The social safety net of providing rental payment assistance to unemployed people is a totally separate issue and it is usually provided in each developed country. Most likely those safety net would kick in at that time for the home occupiers to continue to stay in their homes to look for another job and obtain income again. This is exactly how the newly created flexible economic ownership concept as facilitated by the SwapRent methodology could help avoid defaults and foreclosures and enhance social stability in a new housing finance system.

The provider banks of this new type of SwapRent based Islamic mortgages could similarly use the very same SwapRent contracts traded at REIDeX.com with other investors around the world to hedge off their own financial and property risks from being a temporary co-owner in the co-ownership trusts with the local homeowners. The provider bank could then act solely as a middleman without having to hold any market risks of these real estate properties. As illustrated on slide #11 in the SwapRent presentation slides, the middleman banks, local governments or housing agencies could charge a fee or a spread for the services provided either as a for-profit business or as a self funded not-for-profit entity.

None of these new transactions or mortgage products described above involve the Riba concept, or the charging interests on the use money, that Sharia, the Islamic laws forbid.

If the Western societies could also learn the lesson and adopt this new innovative housing finance system made possible by the new “economic owning or renting” concepts as facilitated by SwapRent contracts, then homeowners will benefit from the flexibility and affordability, provider banks and mortgage lenders will benefit from the better risk management and governments will also enjoy higher tax revenue from enhanced property value and stronger economy. The entire society will subsequently enjoy a peaceful growth and prosperity. All these could be accomplished without the use of the concept of borrowing or lending, hence the potential abuse of it for housing people. When that nirvana time comes, before you realize it, words such as “mortgage foreclosures”, “securitizations”, “credit default swaps”, … etc. could be obliterated from both our dictionaries and eventually our human memories.

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05/26/2009 How SwapRent and REIDeX could help poor people own homes in developing countries.

There is no limit to what income levels that the SwapRent model could be applied to as this free market based “portable housing affordability” methodology could be applied to different situations depending on the local operators’ objectives in each developing country. They could be implemented in conjunction with many other more conventional charitable social assistance programs. For example, rental assistance may be best provided by the governments to the extreme poor, disabled persons or disadvantaged families. What SwapRent model can do from there is to let them, other relatively higher income poor people and low income working families become longer term homeowners instead of staying transient renters, so that they would care more about their shelters and feel good about themselves. They would spend their own efforts to improve their homes and their neighborhoods. In some situations those with increased income levels may even consider participating in future appreciation as an investment, within their means.

The key concept is that this vital sheltering function could be provided first and foremost without the undue leveraged participation in the property value gambling games for those who seek sheltering, no matter what income levels they belong to. That investment part of the housing issues will be left as a separate issue. These investment issues could be more efficiently extracted out through SwapRent contracts to allow the homeowners and other free market investors to transact in a very low cost way. Due to the fact that REIDeX’s SwapRent contracts could make investment much more efficient and effective, these assistance funds for the poor to obtain sheltering will become plentifully available willingly from other free market investors around the world so that local operators would no longer have to solely rely on local taxpayers’ money or other sources of charitable money to help the poor with housing and/or home-ownership anymore. Free market forces will automatically do social good once these new SwapRent methodologies are put in place and the corresponding supporting arrangements are properly structured.

The HELM business model could be operated as a for-profit or a not-for-profit organization as illustrated in slide #11 in the most recent SwapRent presentation file. Therefore the cost to the homeowners etc. is really up to the local operators in each country that we license the methodology and provide consultancy work to. The local implementers could be local banks, housing authorities, federal/local governments, NGOs or charitable organizations in the developing countries.

05/23/2009 From the subprime borrowers to a puppet subprime President – America's current conundrum.

The SwapRent.com web site was registered on the 19th of May, 2006 and the SwapRent related new “economic renting” ideas were formed and shaped into practical methodologies a few days prior to that date. As a reflection on the 3rd anniversary of the invention of the SwapRent related concepts, it was a pure co-incidence that the American economy has gone through a turbulent time primarily caused by the very same housing finance related problems that the package of SwapRent and REIDeX was originally invented to fix and avoid.

From the subprime borrowers to a subprime President during this period, both seem to have defaulted on their promises to deliver, the great American economic society is sinking further everyday. While many of the former have been foreclosed, the latter seems to urgently need a real work-out plan at the moment rather than letting him deliver more sweet oratorical speeches and make more false promises. To give him a due excuse, a ventriloquist’s puppet doesn’t really have much real substance over the appealing oratorical skills. But those are the right kind of skills that one would need to obtain a subprime mortgage, isn’t it? It appears that he had successfully obtained a subprime Presidency.

As one out of the many outrageous abuses, the blatant misappropriation of American taxpayers’ money to bailout AIG by the crony minority elite establishments on Wall Street and in Washington DC in order to save Goldman Sachs and other Wall Street oligarchs has left traces in history that will forever taint the puppet subprime President’s legacy.

Anyway, politics is never my forte. Back to the business topic. To draw yet another analogy, SwapRent based flexible shared ownership structure could be similar to what Insulin is to a diabetes patient, it could prevent foreclosures from spreading in the economy and create wealth from home value to boost the economy just as Insulin could help prevent glucose level from spreading and convert the necessary sugar into energy for the cells to consume in the patient’s body. If the quack doctor, for whatever reason, chooses to ignore to use Insulin to control the glucose level in the blood as a fundamental cure for the patient but instead focuses on superficially having surgical operations on the patient’s eyes to cure the blurred vision which is simply caused by high blood glucose level, the doctor may need some re-education or be immediately replaced before he/she will ask to remove the patient’s kidneys which are also failing simply because high blood glucose level again. Sadly, it appears that is exactly what those quack economic advisors to our puppet subprime President seem to have been doing to fix our economy so far, focusing on the downstream side effects rather than the upstream root causes.

On a broader scope, as the Judaic-Christian lending based Western financial system faces a global collapse, it makes an unbiased non-religious person a bit curious how a Muslim prophet and his caliphs back in the 7th century foresaw what evil deeds usury could bring to the social stability of a human society. Old wisdoms do indeed come back in fashion sometimes. When half the sky has fallen off already in America and your Shylock credit card companies still want a pound of your flesh, it makes you start wondering may be it is time for a change now.

The funny thing is that new socio-economic system changes, unlike technology gadget innovation adoptions, usually will not come without a fierce flight, or oftentimes, a revolution. That is why the empires do collapse I guess, as the stubborn political crony elite will try to hang on to whatever they already own and whatever they believe in at the expense of the interests of the majority of the people that they rule until the final big implosion inevitably occurs. Crony capitalism probably means that they could change the Darwinian evolutionary process to be the survival of the most well connected, rather than the fittest. Even the Austrian economist Joseph Schumpeter similarly, would have had to modify his “creative destruction” concept to become “creative but no destruction” as the 21st century’s powerful crony interests are simply indestructible.

While they are trying to play God, doing the selections of who gets to survive in the American economy, they fail to understand that the forces of natural selections are much mightier above their head. If the crony institutions they wanted to protect did not fall when they were supposed to, the crony government that forced them to live eventually might. With the chain of recent events in the American economy revealing exactly that, we seem to be getting much closer to that point.

Since the Wall Street/Washington ruling class failed to appreciate and adopt the repeated detailed de-leveraging proposals since way back in 2006/2007 in order to help them create a free market based shared ownership social structure to de-leverage the economy and to prepare for a soft landing of the credit bubble, it seems impossible now to make more efforts to continue to try to make them understand the significance of what a simple profit sharing co-ownership economic concept is. It would only make them to admit their own mistakes prematurely in their minds. It is like asking a losing gambler to quit when he still has a few more chips in his hand that he could double up to make back the losses if you give him another chance. Similarly they are still heading in a self-deceiving blinded direction, pushing the rest of the world to sacrifice to help them “restore the global credit system” again, lowering the interest rates to close to zero in order to lure even more borrowing, printing more money to inflate a zombie economy to make it superficially look good and eventually hoping to be able to devaluate away the value of their massive debt.

Superficially propping up stock market index through granting access to almost free money by their crony financial institutions seems to be the only trick up their sleeves now to make it appear as though the stock market is approving what they are doing. It is the same bubble building technique using borrowed money that took them here to begin with. Fighting a housing credit bubble with more stock market credit bubbles. Instead of going to rehab, they are trying to cure a heroine addiction by more cocaine addictions. Looking at the dilapidated state of our real economy, a stock market propped up to a relative bubble level by extreme low interest rates will only give people a false sense of security and demoralize their will to curb the excess and reform to turn our economy into a less consumption and more real production oriented economy. Sometimes it makes you wonder how they got their PhDs in Economics or is it politics that have darkened their minds. As it stands now, it seems that they will continue to keep on pushing it until their final Judgement Day comes. A losing gambler will not leave the gaming table until he is totally out of chips and out of options.

The only way left for the industrious Asian countries to do with their massive hard earned USD IOUs is perhaps to spend them all on real assets such as commodities around the world to turn their soon to be worthless US dollars into some real assets. Then the hell may really break loose. However, before they get to spend all the US dollars away, it would be quite stupid for them to do anything other than keeping a fake smiling face and praising Washington for what a good job it is doing now in order to keep the dollar afloat at its current fictitious good faith value. Privately, among themselves, they must be calling Washington you #@*%-*&#%$+^#! dare to peddle to us more of your junk debt in your crazy Ponzi game again ——– Wouldn’t you if you were in their shoes?

So now it may be time to turbo-charge the Islamic financial system with a Sharia compliant version of SwapRent. Hopefully it could make the Islamic banking become more mainstream and offer a timely alternative to the heavily abused lending based Western financial systems. The Western financial systems would not go away any time soon but we will need to urgently create a few more balanced alternatives before more and more people around the world may get hurt again by the boom and bust social instabilities induced by the continuing human abuse of borrowing and lending, i.e. evils of usury, due to its improper dominance and promotion under the current Western financial systems.

05/18/2009 Islamic banking application of the SwapRent transactions for homeowners.

A bit background on the current Islamic mortgage practice. Most of the current home finance products offered in Muslim countries are using either a “Murabaha” (cost plus credit sale), Ijara (leasing) or a Diminishing Musharakah (declining co-ownership) legal structures. Since the SwapRent system and its embedded mortgage HELM were originally created based on a flexible and reversible economic shared ownership concept which automatically discourages the unnecessary borrowing of money or “Riba” to own properties. In an extreme application, the borrowing of money could be totally avoided and that is why they are so attractive to be utilized as the mathematical backbone for a new type of Islamic mortgage products.

The key to understand why SwapRent could offer value to the existing home finance operations of most Islamic banks is to understand the new “economic owning or renting” concept that the current Islamic mortgages do not have. “Economic owning or renting” entails the conceptual separation of economic ownership interests away from the common underlying legal ownership structure. There are many ways to implement the SwapRent in an Islamic mortgage product. In one simple example, a homeowner could start out either as a legal owner and simultaneously a partial economic renter or as a legal renter and simultaneously a partial economic owner of a residential property. The homeowners could also reversibly buy future appreciation units represented by either Generic or AG SwapRent contracts now or when they have more money allocated for financial investment purpose in the future. This new structure is tentatively called a FARM (Flexible And Reversible Musyarakah or Musharakah) housing finance product.

The homeowners certainly are not required to buy these appreciation units of his home and it should be left as a separate investment decision for the homeowners. They could buy even more or sell away these SwapRent contracts they already bought at any time they want before the maturity date through the secondary market for these SwapRent transactions, REIDeX.com.

The second most important point is that the SwapRent package could act as a mathematical bridge between the new Islamic mortgages to the current Western financial systems. Therefore the provider banks could easily hedge off the real estate property risks and the interest rate risks themselves due to the precise quantitative linkages to the current Western financial systems at the manufacturing level by the providers, even if the banks start out owning part of the homes in a co-ownership legal structure with the homeowners. This means that the underwriting banks themselves could use the very same SwapRent contracts to efficiently transfer these real estate property exposures to other free market investors through REIDeX in a very low cost way to effectively hedge off the property exposures acquired in the co-ownership structures. There would no longer be a need to pool the real estate exposures acquired in co-ownership structures through another legal structure such as a resi fund or unit trust in order to sell them off to other investors in an inefficient and high cost way anymore.

All these new features will be crucial to create the critical mass and to make the new type of Islamic mortgages more mainstream, acceptable and widely embraced by both Muslim and non-Muslim homeowners as well as all kinds of banking institutions around the world.