Sunday, January 18, 2009

Danish mortgage model

The Economist draws attention to an alternative model of home mortgage financing in Denmark, which traces its origins to 1795. At a time of such carnage in the mortgage lending market, many leading voices have been calling for trying out the Danish model.

When a Danish mortgage bank grants a mortgage it is obliged to sell an equivalent bond with a maturity and cashflow that matches those of the underlying loan almost perfectly. This bond has two features
1. Unlike the "originate-to-distribute" securitization models that was responsible for much of the sub-prime crisis, the issuers of mortgage bonds in Denmark remain responsible for making payments on them. In other words, the mortgage bonds cannot be securitized.
2. Mortgage-holders can also buy the bonds in the market and use them to redeem their mortgages. Therefore, a rise in interest rates or fall in home values, which causes the mortgage bonds to trade at a discount, encourages the homeowners to snap them up. By redeeming their bonds, the homeowners can reduce the amount they owe.

The model has many benefits. The mortgage bond so issued is a hedge for homeowners and acts as a type of "put option" for them. Since the homeowners have an interest in buying these bonds, the market in mortgage bonds remains always deep and liquid (regular investors can buy them when the bonds are up). In fact, these mortgage bonds are a form of the macro-securities that Robert Shiller had been talking about for sometime.

1 comment:

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