

Fixing Finance: A Slice of Danish - fallentimes
http://www.economist.com/finance/displayStory.cfm?story_id=12855447&source=hptextfeature

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russell
It has a very interesting way to avoid a future mortgage crisis. The issuer of
a mortgage must create a derivative bond for that mortgage and must guarantee
the payments on that bond. The issuer cant duck responsibility for the quality
of the mortgage by bundling it in a derivative package. If the value of a bond
falls, the homeowner can buy it back.

It would probably take some kind of packaging mechanism to work in a market
the size of the US, but it is certainly an interesting idea.

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ctkrohn
Very interesting. A couple comments:

\- Is there any credit enhancement? Mortgage bonds didn't take off in the US
until Fannie Mae and Freddie Mac agreed to guarantee timely payment of
principal and interest on MBS they issued. Private label MBS got around this
via overcollateralization or senior/sub structures. But these structures
provided insufficient credit enhancement, and have been shunned by investors
-- private label MBS are extremely illiquid these days and trade around 40 or
50 cents on the dollar, while Fannie and Freddie MBS remain among the most
liquid securities in the world and trade near par.

\- Are there any facilities to combine the Danish bonds into a single
instrument? In the US, a typical MBS is backed by anywhere from half a dozen
to tens of thousands of mortgages. This makes them easy to trade for the large
investors involved in the market. In the domestic MBS market, trades less than
~5mm are often punished for liquidity reasons -- you'll get a better price
trading a ~50mm block. Liquidity would be tough if you can only trade pieces
corresponding to a single mortgage.

\- The US already has MBS that are as creditworthy as the government's own
debt. Ginnie Mae MBS are explicitly backed by the full faith and credit of the
government.

\- It's a bit unrealistic to think that distressed homeowners could cheaply
get out of their mortgage by purchasing the corresponding MBS for 40 cents on
the dollar. The homeowners whose mortgages are in the most troubled bonds are
subprime and alt-A borrowers who often are too credit impaired to refinance
into an 80% LTV, 30-year fixed 5% prime mortgage. There's no way these guys
could afford to buy back their mortgages. It's an interesting idea though.

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russell
What caught my attention is that the original issuer of the bond is
responsible for the payments on the bond. I think that would be an incentive
to avoid junk mortgages because they will come back to haunt the original
bank. OTOH the repeated bank crises over the past 30 years indicate that their
view is too short sighted to care.

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tokenadult
"The second feature of the Danish system is that mortgage-holders can also buy
the bonds in the market and use them to redeem their mortgages. This is useful
if a rise in interest rates (or a fall in house prices) causes mortgage-backed
bonds to trade at a discount. Redeeming their bonds allows homeowners to
reduce the amount they owe. In America, for instance, mortgage-backed
securities have fallen far below their fundamental value in thinly traded
markets, partly because the people who would benefit most from buying them
have no mechanism to do so."

Cool. A way for the mortgage-holder to hedge a bit.

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pietro
More detailed description of the model here:
[http://www.realkreditraadet.dk/Mortgage_financing/The_Danish...](http://www.realkreditraadet.dk/Mortgage_financing/The_Danish_mortgage_credit_model.aspx)

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sokoloff
What prevents a cartel of home owners/buyers from taking out mortgages from a
single small issuer, stopping payment en-masse, hoping to push the issuer into
insolvency and drive down the value of those bonds and buy them on the open
market?

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kqr2
Under the Danish system, it appears that seizing the collateral (in this case
homes) is much easier and quicker when the borrower stops payment. Also, under
the Danish system, the home owner must have a minimum 20% downpayment which
they would lose in case of a default.

I think if we just had the simple 20% downpayment rule in the US, we would
have avoided a lot of these subprime issues.

~~~
silvestrov
An important subject which wasn't touched in the article: In Denmark jingle
mail doesn't exist: you cannot run away from your debt (they would just laugh
and send the keys back to you), and if you seriously fail to pay your
obligations, you're completely stopped from getting any kind of credit in any
bank or shop.

This means that banks in Denmark doesn't end up with the debt as easily as
they do in USA. So the Danish banks have lost money primarily on business
loans and not private mortgages.

