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.
- 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.
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.
"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.
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?
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.
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.
The 20% is not a required downpayment in cash, but you have to finance it using normal bank loans. The (sellers) estate agent normally takes care of the complete loan taking, so the buyer just has to provide proof of income for the last 3 months and sign the papers. The rest is taken care of without the buyer needing to do anything himself.
(There's no buyers agent in Denmark).
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.