Economy

Look What's Not Rotten In Denmark

Using the same "toxic" assets that led to the subprime crisis, Denmark has created what they believe to be the best home mortgage system in the world. It's been 200 years since someone defaulted on payment.

A row of houses in Copenhagen (Giam)
A row of houses in Copenhagen (Giam)
Philipp Löpfe

COPENHAGEN - Danes have the reputation of being life-loving, friendly people with a developed sense of environmental awareness. They aren't known as particularly talented finance engineers – but this could all change. In the first four months of 2012, the OMX-C-20, the leading index on the Copenhagen stock exchange, took a sprint forward that left everybody else well behind. The Danes pride themselves on being the best in the world in one very specific area: mortgages.

They have a good reason for being so proud: the Danish mortgage model is truly worthy of admiration. It was created in 1795, following the Great Fire in Copenhagen. In its 200 years of existence, the mortgage bond market has never known a single case of default. Yet the market is relatively huge: the country's 5.5 million citizens have a collective mortgage debt of over 320 billion euros, which is about 50% higher than the national debt. By way of comparison, Switzerland with its 8 million people has 800 billion Swiss francs (666 billion euros) in property loans, amounting to 3.7 times the national debt.

And while Scandinavians in general have the reputation for being pro-state, the Danish mortgage bond market is a real market – but one that's intelligently constructed and sensibly regulated. It's based on a few simple principles. House owners take out long-term loans, with an 80% lending limit for residential property and 60% limit for business real estate. The terms of the mortgages are not negotiated between a bank and the borrower. Rather, financial institutions act as brokers, who bundle loans into obligations and sell them on to investors who buy directly or via general, specialized funds. The mortgage institutions earn a small margin on these transactions.

Collateral Debt Obligations don't have to be toxic

Bundling mortgages and selling them on the market as obligations? That idea should get a few alarm bells ringing. Because exactly that is the underlying idea behind Collateral Debt Obligations, the nefarious CDOs that made the American subprime market possible and led to the irresponsible sale of over-valued real estate to under-capitalized wannabee homeowners. CDOs relieved the banks of their control duties and contributed significantly to the US real estate bubble, the bursting of which unleashed the world financial crisis. Nowadays, CDOs are considered toxic junk that responsible investors won't touch. Yet this system is supposed to work in some miraculous way for the Danes?

The Danish mortgage bond market works because it differs from the failed American bond experiment in critical ways – the main one being the "balance principle" which stipulates that the needs of both lenders and borrowers have to be in synch. In other words, a borrower can only get a mortgage after a bank has established under what terms he or she could reasonably be expected to service that loan, and if the lender is agreed. Selling the debts to third parties is forbidden, as is granting mortgages to borrowers with low credit. Added to the 80% limit there is enough protection to prevent a U.S.-style real estate crisis.

Yet there's also enough room within the system to be able to use market advantages. Danish homeowners don't have to opt for long-term mortgages with fixed interest or LIBOR rates to get cheap interest rates. The can refinance, or pay a mortgage back and then take out another one at a lower rate.

As a rule, the return on Danish mortgage obligations is 100 to 150 basis points higher than the return on Danish government bonds.

Read the original article in German

Photo - Giam

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