Editor’s note: This is Part 1 of a two-part series. Read Part 2.
In 2002 I wrote a column contrasting the housing finance systems of Denmark and the United States. Recently, both systems have been stressed by the worldwide financial crisis, prompting me to take another look. I was interested in whether the impact of the crisis on the two systems revealed anything further about their relative strengths and weaknesses?
The core of the Danish system is eight specialized mortgage banks that originate all home mortgages, and a mortgage bond market where the loans are funded. There are bonds with fixed and adjustable rates, and within each category there are separate bonds for different terms. Each new loan is immediately sold in the market for the equivalent bond. If the new loan is a 30-year fixed-rate mortgage (FRM), for example, it will be sold to investors as an increase in the balance of the 30-year fixed-rate bond.
The Danish system makes it easy for borrowers to shop for a mortgage. On a given day, all borrowers pay the same interest rate on a given type of loan. (Borrowers either meet the credit and other requirements, or they don’t.) The interest rate on a new mortgage loan is the current market yield on the specific bond that will fund the loan, plus the mortgage bank’s markup. Bonds are traded on the Copenhagen stock market, and their yields are readily available.
Danish mortgage banks do not adjust the interest rate for points, nor do they tack on a series of fixed-dollar charges to cover specific expenses, as is the practice in the U.S. Total upfront fees are modest and pretty much the same at all the mortgage banks.
The strength of the Danish system is its transparency and low origination costs. Its major weakness is that it does not serve as large a segment of the population as the U.S. system. Loans are not priced for risk, so borrowers who have poor credit or who cannot make a downpayment of 20 percent are not served. In a financial crisis, however, this "weakness" is a source of strength, as we have recently learned.
Both countries were afflicted by the worldwide loss of confidence in financial institutions. Both governments responded by guaranteeing the liabilities of banks and other financial firms, including mortgage banks in Denmark. However, in Denmark that guarantee did not include mortgage bonds because it was not considered necessary. The Danish mortgage bond market continued to function normally during the crisis, which meant that new loans continued to be written as before.
In the U.S., in contrast, markets in mortgage-backed securities (MBS) not guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae ceased functioning. This is why "jumbo" loans — those too large for purchase or insurance by a government entity — which before the crisis were often placed in MBS, are so costly in today’s market relative to conforming loans. …CONTINUED