F R B N Y E P R , . , D
Jesper Berg, Morten Baekmand Nielsen, and James Vickery
T
he way mortgages are designed, nanced, and regulated
varies strikingly across countries.
1
Although this
variation reects adaptation to international dierences
in social, economic, and legal conditions, it likely also
stems from historical accidents and path dependence. As
the United States considers further reform of its mortgage
nance system, it is useful to examine what can be learned
from the experiences of other countries and whether any
international practices could be adapted to improve the
institutional design of the U.S. mortgage market.
With that goal in mind, this article compares and contrasts
the U.S. system with that of Denmark. e Danish mortgage
nance system is a salient reference point because, in several
respects, it is the international model most similar to the
U.S. system. In particular, Denmark relies very heavily on
capital markets for funding residential mortgages, transferring
interest rate risk and prepayment risk to fixed-income investors
in a way that is similar to U.S. mortgage securitization.
Unlike the U.S. system, however, the Danish mortgage nance
system remained stable and solvent during the 2007-09
nancial crisis and did not require government funding or
Jesper Berg is director of the Danish Financial Supervisory Authority, Morten Baekmand
Nielsen head of Investor Relations at Nykredit Realkredit A/S, and James Vickery an
assistant vice president at the Federal Reserve Bank of New Yor k. Email: jb@net.dk;
mobn@nykredit.dk; james.vickery@ny.frb.org.
e views expressed in this article are those of the authors and do not necessarily reect the
position of the Danish Financial Supervisory Authority, Nykredit, the Federal Reserve Bank
of New York, or the Federal Reserve System. To view the authors’ disclosure statements, visit
https://www.newyorkfed.org/research/epr/2018/epr_2018_US-danish-mortgage-finance_berg.
OVERVIEW
P P C
U.S. D
M F S
• As it weighs mortgage nance
reform, the United States can
draw lessons from Denmark,
whose system is similar in some
key respects to that of the United
States but enabled Denmark to
better weather the crisis.
• The U.S. and Danish mort-
gage nance models both rely
heavily on capital markets to
fund residential mortgages,
transferring interest rate and
prepayment risk, but not
credit risk, to investors. But in
Denmark, homeowners can
buy back their mortgages or
transfer them in a property sale,
avoiding the “lock-in” effects
present in the U.S. system,
and easier renancing reduces
defaults and speeds the
transmission of lower interest
rates in a downturn. Denmark’s
tighter underwriting standards
and strong creditor protections
help limit credit losses, while
its higher capital requirements
make lenders more stable.
• The Danish example suggests
that a stable mortgage nance
system is possible with a
capital-markets-centric funding
model, and without requiring a
large role for government.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
capital injections, despite experiencing a fall in home prices of similar magnitude to that in the
United States during this period.
In the Danish model, mortgages are nanced through the issuance of “covered bonds”
(bonds collateralized by a cover pool of mortgages or other debt) by a small number of specialized
mortgage banks. e system relies on the “balance principle”—the covered bonds match the
maturity and cash ows of the underlying pool of mortgages funded by the bond, and payments
by mortgage borrowers are passed directly through to covered bond investors. us, interest
rate risk and prepayment risk are borne by investors rather than by the mortgage bank that
issues the covered bond. However, ownership of the mortgages is retained by the mortgage
bank throughout its life, and the bank bears any credit losses on the mortgages.
is approach shares many similarities with the structure of the agency mortgage-backed
securities (MBS) market in the United States, where mortgage bonds carry a credit guarantee
from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage
Corporation (Freddie Mac), or the Government National Mortgage Association (Ginnie Mae).
As in the Danish system, agency mortgages are funded by capital market investors who bear
prepayment risk and interest rate risk but are not exposed to credit risk. Both agency MBS and
Danish covered bonds are widely held and traded, and in both countries these bonds remained
liquid throughout the 2007-09 crisis period and other market downturns (see Section 2 for
more details).
is shared funding model explains why Denmark is also, to our knowledge, the only
country aside from the United States where long-term (for example, thirty-year) prepayable
fixed-rate mortgages (FRMs) are widely available to homeowners. Capital market nancing is
important for the availability of such loans because they embed signicant interest rate and
prepayment risk, which makes them less well suited for short-term bank deposit nance.
Given the popularity and familiarity of FRMs in the United States, Denmark provides a useful
case study because Danish homeowners
2
have historically shared this same preference for
FRMs. e Danish model may suggest ways to improve the eciency of the U.S. mortgage
nance system without restricting the types of contracts available to borrowers.
As we will describe, the Danish system includes several features that mitigate frictions in
mortgage nancing and could potentially be usefully adapted in some form in the United States.
Prominent among these is the option for Danish homeowners to repurchase their own mort-
gages from the covered bond pool at the current market price. Mortgages are also assumable,
meaning that a homeowner can transfer his or her mortgage to a buyer as part of a property
sale. ese features are useful in an environment of rising interest rates, since they reduce the
tendency for the homeowner to become “locked in” to a mortgage with a below-market inter-
est rate. Such lock-in can have perverse eects—for instance, it can discourage homeowners
from selling their homes and moving (Quigley 1987; Ferreira, Gyourko, and Tracy 2010).
e Danish system also allows homeowners to renance easily at par with the same mortgage
bank even if their home equity has declined because of a fall in home prices. Historically, this
option has generally not been available in the United States, blunting the transmission of
lower long-term interest rates to households during the recent recession (Beraja et al. 2017).
However, recent policy changes are likely to make the U.S. system more similar to Denmark’s
in the future.
3
Although we focus mainly on mortgage funding, we also compare the primary mortgage
markets in Denmark and the United States. Here, the two systems are less similar. For instance,
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
mortgages in Denmark generally have much less credit risk, and as a result Denmark experienced
only a mild increase in credit losses during the nancial crisis despite a sustained fall in home
prices. is distinction reects tighter underwriting standards (for example, minimum down
payments of at least 20 percent are required on first-lien mortgages
4
), as well as a creditor-friendly
legal system in which foreclosure is uniformly quick and lenders have full recourse against the
borrower’s assets and future income. In that sense, Danish mortgages embed less implicit
insurance than U.S. mortgages, although that approach is partly made possible by the extensive
social safety net oered in Denmark.
Aer comparing the Danish and U.S. systems, we highlight some lessons from the Danish
experience that may be of interest in thinking about the future of U.S. housing nance.
Among these: First, the Danish experience suggests that returning to a balance-sheet funding
model is not necessary to ensure the stability of the U.S. mortgage nance system; Denmark
has a capital-markets-centric system that, to date, has been stable and robust, without reliance
on government support or bailouts. Second, it is possible within a framework similar to
agency securitization to oer innovations that mitigate frictions in mortgage renancing.
ird, capital adequacy is critical for system stability. A key reason why Danish mortgage
banks, unlike Fannie Mae and Freddie Mac, did not require government assistance during the
nancial crisis is that they were signicantly better capitalized relative to the level of risk
they assumed.
is article is related to a number of studies that discuss key features of the Danish mort-
gage nance system (Berg and Nielsen 2014; Campbell 2013; Green and Wachter 2005;
Frankel et al. 2004). Aside from some dierences in emphasis, our main contribution rela-
tive to this previous work is to present an up-to-date comparative analysis of the Danish and
U.S. systems, taking into account the experiences of both countries during and since the
nancial crisis.
Section 1 provides a history and overview of the Danish model of mortgage nance. In
Section 2, we compare the two systems side-by-side, examining both the way mortgages are
funded and the features of the primary mortgage markets. Section 3 discusses possible lessons
from the Danish experience for the path of future U.S. housing nance reform. Section 4
presents our conclusions.
. O D A M F
In Denmark, mortgage lending has long been dominated by specialized mortgage banks.
Denmark’s rst mortgage bank was established in 1797, and Nykredit, the country’s largest
mortgage bank today, traces its origins to 1851 (Møller and Nielsen 1997). Originally, these
rms were set up as mutual mortgage credit associations with a local focus. But several
waves of mergers—some encouraged or even prescribed by their then-regulator
5
—led to the
formation of the handful of large mortgage banks that today dominate mortgage lending
in Denmark.
Because the original mortgage credit associations were founded by borrowers, lending
terms were to a large extent designed to reect borrowers’ objectives and interests. At the same
time, the associations needed to build trust among the investors in covered bonds, and this led
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
to a business model aimed at balancing borrower and investor interests (Møller and Nielsen 1997).
Key aspects of this business model included:
• Mortgage lenders could not call for early redemption of a loan unless the borrower
became delinquent.
• Investors could not call the covered bonds.
• Homeowners had a right to prepay the mortgage loan at par on any payment day
without penalty.
• Homeowners were personally liable for the mortgage debt.
• Homeowners were jointly and severally liable for the covered bonds issued by the mortgage
credit association.
• Mortgage margins could be increased for the entire stock of mortgage loans—for
example, if needed in order to increase capitalization or cover loan losses.
• Strict lending guidelines were instituted that were regulated by law (maximum LTV
ratio, maximum maturity, and so forth).
6
With the exception of joint and several liability, these principles still apply to mortgage
banks today.
7
However, the mid-1990s saw the beginnings of a shi in organizational form
from mutual associations to limited liability corporations. e mortgage credit associations
were rst converted into limited liability companies owned by mutual associations, and later
many were merged with banks to form nancial conglomerates.
8
Capital market funding has been a mainstay of the Danish mortgage nancing system since
the beginning in 1797 (Møller and Nielsen 1997). Inspired by the German and Austrian models,
Denmark enacted its rst Mortgage Credit Act in 1850, requiring the specialized mortgage
credit associations to issue covered bonds to fund all mortgage lending, and prohibiting them
from taking deposits. e ban on deposits stemmed from regulators’ desire to eliminate any
risk of a run on the lenders, who carried only long-term and illiquid mortgage assets on their
balance sheets.
e specialized nature of mortgage bank assets and mortgage banks’ reliance on covered
bonds rather than deposits remain the key distinguishing features of Danish mortgage banks
today. Danish mortgage banks can be viewed as a form of “narrow banking”—they do not
engage in maturity transformation, since payments to covered bond investors match the cash
ows of the underlying mortgages. Because they do not rely on deposits for funding, mortgage
banks do not benet from any implicit subsidies arising from deposit guarantees and structural
subordination of covered bond investors relative to other creditors (the latter could be the case
in a situation where deposit-taking banks issue covered bonds).
e covered bond structure provides a funding instrument with very low credit risk to
investors, facilitating ecient funding of low-risk nancial assets such as residential mortgages.
For more background on covered bonds, see Box 1.
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Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
B
The Basics of Covered Bonds
Covered bonds are debt instruments issued by credit institutions nancing a pool of segregated,
or “ring-fenced,” assets. Several dierent legal models are used for covered bonds in Europe. In
Denmark, most covered bonds are issued by specialist mortgage banks that keep the mortgages on
their balance sheets. Covered bonds issued in the European Union comply with special legislation
from the European Union as well as national covered bond legislation.
a
Covered bonds primarily fund mortgage lending, but they can also fund other types of assets
(for example, public sector lending, ships, and infrastructure). ese nonmortgage covered bonds
are outside the scope of this article.
a
Unlike balance-sheet securitization, covered bonds oer the investor double recourse: exclusive
recourse to the segregated pool of assets on the issuer’s balance sheet, and (nonexclusive) recourse to the
overall assets of the issuer. In order to ensure that the “cover pool” (in other words, the assets nanced by
the covered bonds) is of high quality, mortgage loans in the pool must comply with several requirements
regulated by law regarding property types, maximum LTV ratios, substitute assets, and transparency.
e distinguishing feature of Danish covered bonds is that interest rate risk and prepayment risk
are fully passed through to capital market investors under the balance principle. In other European
Union countries, these risks are at least partially retained by the covered bond issuer.
e three largest covered bond markets in the world are Denmark, Germany, and France, as
shown in the chart below. e United States does not have a signicant covered bond market, in part
Outstanding Covered Bonds, 2016
0
50
Denmark
Billions of euros
Germany
France
Spain
Sweden
Italy
Switzerland
Norway
United Kingdom
Canada
100
150
200
250
300
350
400
Source: ECBC European Covered Bond Fact Book, 2017.
Notes: Statistics in the chart cover all types of covered bonds backed by mortgages or public
sector assets, for major European markets and Canada. Data are as of year-end 2016.
(C )
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
1.1 e Mortgage Origination Process
As in the United States, the traditional mortgage contract in Denmark is a fixed-rate mortgage
that fully amortizes over thirty years and may be prepaid at any time without penalty. A number
of new types of loans have been introduced in Denmark over the past two decades, the most
popular of which are adjustable-rate mortgages (ARMs) and interest-only loans.
9
However, the
growth in alternative mortgages has stopped short of the riskiest contract features seen in the
United States prior to the nancial crisis (for example, there are no negative amortization
mortgages or no-documentation loans).
e homeowner’s interest rate is directly linked to the lender’s cost of funds. Specically,
the rate is equal to the current market yield of the “on-the-run” (in other words, most recently
issued) covered bond in the capital market, plus a margin set by the lender. e bank simply
acts as an intermediary between the borrower and the capital market. In principle, when a
homeowner enters into a new mortgage, the mortgage bank provides her with covered bonds
matching the principal amount being borrowed, which the borrower can then sell on the bond
market. In practice, the mortgage bank will generally handle the sale of the bonds for a fee, and
simply transfer the net proceeds of the bond sale to the homeowner’s bank account. e mortgage
bank pools thousands of loans with similar coupons and maturities to allow the buildup of
large and liquid covered bond issues.
Danish mortgage banks have a vertically integrated business model—the same bank originates
and owns the mortgages, funds them in the covered bond market, services the mortgages,
and undertakes foreclosure proceedings if needed. In the United States, these dierent roles
are oen played by dierent nancial institutions (for example, mortgages are oen sold
aer origination, and many loans are serviced by a third-party servicer).
1.2. Covered Bond Design and the Balance Principle
Covered bonds are issued at coupon rates in 50 basis point increments, and each covered bond
security is generally on the run for three years. is means that mortgages are progressively
added to the cover pool for the bond over a three-year period, before the pool is closed. Because
the market price of the bond uctuates daily during the three-year on-the-run period, the
because lenders have access to funding collateralized by mortgages through the Federal Home Loan
Bank System (Bernanke 2009).
b
a
For more information on covered bonds, see European Covered Bond Council, https://hypo.org/ecbc/
covered-bonds/#introducing-covered-bonds.
b
See Ashcra, Bech, and Frame (2010) for more detail on the structure of the Federal Home Loan Bank
(FHLB) System and the role of FHLB advances as a stable source of funding during the 2007-09 financial crisis.
Like Fannie Mae and Freddie Mac, the FHLBs are government-sponsored enterprises (GSEs) created by
an act of Congress. See Meuli, Nellen, and Nitschka (2017) for a discussion of the Swiss Pfandbrief covered
bond instrument, which shares a number of similarities with the FHLB system.
B (C)
F R B N Y E P R , . , D
P P C U.S. D M F S
B
The Mechanics of Issuing Bonds under the Balance Principle
Mortgage banks keep bond series (each with a specic international securities identication number,
or ISIN) on the run for three years and tap them on a daily basis to fund new lending. When a new
bond series is started, it has thirty-three years to maturity. is interval allows the bank to fund
loans with the maximum legal loan term of thirty years until the bond goes o the run. No loan in
the cover pool backing the bond series will have a maturity in excess of thirty years, but since the
loan portfolio is constructed over time, the amortization prole of the bond will reect the gradual
buildup of the underlying cover pool. e long three-year on-the-run period makes it possible to
build up large and liquid series of covered bonds.
Under the balance principle, the amount lent to the homeowner exactly matches the net
amount raised by selling covered bonds in the capital market. Bond market funding for each loan
is obtained on the day the loan is disbursed, thus avoiding any pipeline risk for the bank.
e eective mortgage rate paid by the borrower will reect the yield on the corresponding
covered bond. Since bond prices uctuate over time, dierent homeowners may have dierent
yields-to-maturity despite being funded in the same bond series with the same coupon. Mechani-
cally, this variation is achieved by adjusting the principal on the mortgage in a manner analogous
to the U.S. practice of paying mortgage points. e following example illustrates the mechanics
(for the sake of simplicity we exclude all fees and so forth):
A homeowner needs 1 million Danish kroner (kr.1 million) to purchase a house.
e on-the-run 2 percent thirty-year xed-rate-mortgage bond trades at 99.00. e
bank will then make a loan oer with a principal of 1/0.99 = kr.1.01 million. e
homeowner is liable for the bond amount issued and will receive the proceeds of
kr.1 million. e quarterly interest payment will be 2 percent/4*kr.1.01 million, and
hence, the homeowner’s eective loan rate will be slightly above the 2 percent coupon
of the bond, reecting the fact that the 2 percent bond is trading at a discount.
Another homeowner taking out a loan the following day when the same bond series
trades at 99.25 will be liable for a slightly smaller bond principal and pay a marginally
lower eective interest rate.
Coupon rates are set at increments of 50 basis points. At the time of this writing, the Danish mort-
gage banks had bonds open for issuance with nal maturity on October 1, 2050, with coupons of
1.5 percent, 2.0 percent, and 2.5 percent. Each homeowner will have her loan funded in the bond
trading closest to par, thereby minimizing the number of points paid. If long-term interest rates,
for instance, increase, mortgage banks will open new on-the-run bonds with higher coupons and
start tapping them instead of the bonds with coupons below market rates. e end-date for the
on-the-run period will be the same for all bonds of the same “vintage,” irrespective of when in the
three-year period they begin to be on the run.
homeowner’s interest rate is set in a manner similar to the system known in the United States
as paying points (see Box 2 for more details on the mechanics).
e funds received by the homeowner match the net amount raised from selling the corre-
sponding covered bonds in the capital markets. Furthermore, on a ow basis, the cash ows
received by covered bond investors exactly match the cash ows from the underlying pool of
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Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
mortgages (except for a margin that is retained by the lender). Hence, if a mortgage has a
renancing option, the bond has a similar option. As mentioned earlier, this complete
pass-through funding model is known as the balance principle.
e homeowner’s quarterly mortgage payment equals the cash ow on the bonds issued to
fund her loan plus a xed margin to the mortgage bank. us, there is little market risk to the
mortgage bank. However, the mortgage bank lender is exposed to credit risk, since the loan
remains on its balance sheet until maturity. If the borrower becomes delinquent, the mortgage
bank will use its capital buers to repay the holders of covered bonds and will start foreclosure
proceedings against the homeowner. In practice, however, mortgage credit losses in Denmark
have historically been low, even during signicant housing market downturns (see Section 1.4
for a more detailed discussion).
Unlike an “originate to distribute” approach, the retention of credit risk by the originator
creates skin in the game and reduces information asymmetries, which together may contribute
to the low mortgage default rates observed in Denmark.
10
e market risk is less subject to
asymmetric information and therefore easier to distribute to capital market investors.
is allocation of market and credit risk means that the mortgage bank has an incentive to
renance the loans of existing borrowers. Renancing a mortgage at par to a lower interest rate
reduces credit risk because it lowers the borrower’s interest payments; while there is a loss in
the market value of the loan because of the renancing at par, this loss is borne by the covered
bond investor owing to the balance principle. Since the original lender is responsible for loan
servicing, there is also no disincentive to renance associated with a loss of servicing fees.
1.3. Renancing and Prepayment
Mortgage renancing is an integrated process in which a borrower simultaneously takes out a
new loan and uses the proceeds to repay the old loan. If the interest rate on the new mortgage
is below that of the original loan, the repayment of the loan is at par. e homeowner will
call the mortgage, and the mortgage bank will call a corresponding amount of the outstanding
bonds at par at the same time. e mortgage bank will only call bonds corresponding to the
actual mortgages that are being prepaid and thus does not take on any interest rate risk or
prepayment risk.
In contrast, if the market interest rate exceeds the original loan rate, it is possible to prepay
the loan below par. In this case, the mortgage bank will repurchase, at the current market price,
the bonds backed by the homeowner’s mortgage in the market, and then retire them. ese bonds
will be trading at a discount, given that market interest rates have increased since the old mortgage
was originated. us, when the homeowner renances, her new mortgage will have a smaller
principal (since the old loan was redeemed at below par value) but a higher loan rate. Generally,
these two eects will roughly oset each other, implying little net change in the borrower’s
mortgage payments.
11
Danish mortgages are also assumable, which means it is possible for the
homeowner to transfer her mortgage to a buyer as part of a property sale. is, in eect, is an
alternative way for homeowners to “buy back” their mortgages.
is ability of Danish borrowers to repurchase their own loans at the market price has
potentially important advantages in a rising interest rate environment (as emphasized by
Campbell 2013). In the U.S. system, where FRM prepayment only occurs at par and the mortgage
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
is generally due upon sale of the home, homeowners with a below-market mortgage interest
rate face a “lock-in” eect: they have disincentives to move to a new home or change their loan
terms (for example, from an FRM to an ARM, or to a loan with a dierent maturity), because
doing so means they will have to retire their below-market-rate mortgage and take out a new
loan at the higher current rate. is lock-in eect could generate allocative ineciencies; for
example, it may reduce housing market turnover and limit homeowners’ ability to adjust their
consumption of housing services in response to changes in economic circumstances. Ferreira,
Gyourko, and Tracy (2010) and Quigley (1987) present empirical evidence that mortgage rate
lock-in reduces household mobility in the United States. e lock-in eect is not present in
Denmark, given that the cost of renancing to a new, higher interest rate is oset by the capital
gain from repurchasing the old mortgage below par.
An additional implication of borrowers’ ability to repurchase their loans from the cover
pool is that homeowners can act as a source of liquidity in the covered bond market. When
interest rates increase and liquidity in the market for existing bonds typically suers, renancing
activity adds to the demand for bonds for redemption. Homeowners can also act as “buyers of
last resort” in situations where covered bond prices become too low relative to fundamentals.
Streamlined mortgage renancing is available to Danish homeowners who renance their
mortgage with the same lender, as long as the homeowner does not want to extend the term
of the loan or extract equity from the home by increasing the mortgage principal amount.
12
A
property appraisal is not needed, and the borrower is not required to provide updated documen-
tation of income or assets. Streamlined renancing is permitted even if home prices have fallen
and the homeowner’s updated LTV ratio has risen beyond the statutory maximum of 80 percent
for purchase mortgages.
13
As noted earlier, the logic behind this “no questions asked”
approach is that re-underwriting the loan is not necessary because the lender already bears
the credit risk on the mortgage. In fact, allowing the borrower to renance to a lower market
interest rate actually reduces the lender’s credit risk exposure because it reduces the homeowner’s
debt payments.
e availability of streamlined renancing makes it easier for borrowers to renance during
periods of depressed home prices. is contract feature could have been of signicant value in
the United States in the wake of the 2008 nancial crisis (see Section 2.3 for further discussion).
1.4 Credit Risk and Foreclosure
Realized mortgage credit losses in Denmark have been low over a long period of time. Historical
credit loss rates on mortgages and other loans back to the early twentieth century are plotted
in Chart 1. Over that period, credit losses for Danish mortgage banks have averaged about
10 basis points per annum and have consistently been much lower and less volatile than losses
on nonmortgage loans held by deposit-taking banks. Even during the 2007-09 nancial crisis,
the mortgage credit loss rate topped out at only around 20 basis points. e peak mortgage
credit loss rate for the full period was realized during the Scandinavian banking crisis in the
early 1990s, although this peak was driven in part by a change in accounting standards to a
more forward-looking method for calculating provisions.
e low credit losses experienced by Danish mortgage banks are not simply the result of a
lack of economic volatility. e drop in Danish house prices during the nancial crisis was on
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
par with the fall in U.S. house prices (Berg and Nielsen 2014), and in an International Monetary
Fund (2000) study, the Danish housing market was characterized as the most volatile in the
western world over the post–Bretton Woods era.
14
Denmark has also experienced signicant
business cycle uctuations, as reected in the high and variable loss rates on nonmortgage
loans in Chart 1.
15
Instead, low mortgage credit loss rates primarily reect limits on up-front loan-to-value
ratios, as well as strong creditor protections in Denmark, as in other countries with a German
or Scandinavian legal tradition (Djankov, McLeish, and Shleifer 2007). Most important among
these protections, the homeowner is personally liable for her mortgage loan; thus, the lender
is protected both by the value of the collateral and the payment capacity of the homeowner.
Control rights are also strongly enforceable; in Denmark, a foreclosure is typically completed
six to nine months from the time the homeowner misses a payment. Even aer a foreclosure
is completed, the borrower remains liable for any debt that remains unpaid. ese factors
discourage mortgage delinquency and generally ensure that “loss given default”—the amount
of money the bank loses when a borrower defaults—is low.
e creditor-friendliness of the Danish system in turn means that relatively more price risk
is borne by the homeowner. However, this risk is oset by an extensive social safety net,
including a city obligation to provide rental housing to homeowners displaced by foreclosure. In
this sense, some features of the Danish mortgage system reect broader societal choices about
social insurance and the role of government. Although these choices dier between Denmark
and the United States, there are a number of close parallels in mortgage funding arrangements
between the two countries, as we now explain.
Chart 1
Credit Loss Rates on Danish Covered Bond Assets and Bank Loans
Loan Impairments as a Percentage of Loans and Guarantees
-1
0
1
2
3
4
5
6
1
880
1
890
1
900
1
910
1
920
1
930
1
940
1
950
1
960
1
970
1
980
1
990
2
000
2
010
Banks Mortgage banks
Percent
Source: Danmarks Nationalbank.
Note: The chart shows annual credit loss rates for mortgage banks and deposit banks.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
. C D M U.S. M
Table 1 compares the key features of the Danish mortgage nance system with those of the
U.S. system, focusing on secondary mortgage markets. Although nearly all Danish mortgages
are nanced through covered bonds, the United States has a more heterogeneous system that
makes use of a mix of three main funding sources:
1. Agency securitization, in which the resulting mortgage-backed securities have a credit
guarantee from one of the housing government-sponsored enterprises (GSEs) Fannie Mae
or Freddie Mac or from the government agency Ginnie Mae.
2. Non-agency securitization, in which MBS are securitized by an investment bank or
other private sector firm.
3. Balance-sheet lending, in which the mortgage is kept in portfolio as a whole loan by
the originator, or sometimes by another investor (for example, a large bank that pur-
chases the loan from a correspondent lender, or a real estate investment trust). Most
balance-sheet loans are owned by commercial banks and funded by a mix of deposits
and advances from the FHLB system.
Of these three approaches, agency securitization is the one most similar to the Danish
covered bond model. In both cases, mortgages are ultimately nanced by the issuance of mortgage
bonds that transfer interest rate risk and prepayment risk—but not credit risk—to capital market
investors. In Denmark, credit risk is borne by the covered bond issuer, who retains ownership
of the mortgages; this guarantee is credible because mortgages themselves have low credit risk
and because mortgage banks are well capitalized. In the United States, a credit guarantee is
provided to MBS investors by Fannie Mae, Freddie Mac, or Ginnie Mae. ese guarantees are
credible because Ginnie Mae is a government agency and Fannie Mae and Freddie Mac are
viewed as being backed by an implicit federal government guarantee.
Like the Danish mortgage banks, Fannie Mae and Freddie Mac are specialized nancial
institutions focused on the mortgage market. Unlike Danish mortgage banks, however, Fannie
Mae and Freddie Mac are not mortgage lenders; they operate only in the secondary mortgage
market, purchasing loans from banks and other mortgage originators and assembling them
into MBS pools. us, the intermediation chain is at least one step longer in the U.S. agency
mortgage market than in Denmark.
16
e Danish model has less in common with non-agency securitization and balance-sheet
lending. Unlike the case with covered bonds or agency MBS, non-agency MBS investors are
directly exposed to credit risk. Subordination and other forms of credit enhancement are used
to mitigate this risk and redistribute it across investors. e non-agency MBS market is also
traditionally less standardized than the agency market, with a much larger number of issuers
and greater variation in security design. Non-agency securitization, while very popular in the
period before the 2007-09 nancial crisis, has not been a major source of mortgage funding
since the crisis. Still, non-agency securitization represents the use of capital markets to fund
residential mortgages, in common with the Danish model.
In the case of balance-sheet lending, however, the lender does not make use of capital
markets; instead, the mortgage is retained in the portfolio of a nancial intermediary, usually a
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
commercial bank. e marginal source of nancing for such loans includes deposits and FHLB
advances. is more traditional approach aligns incentives but does not allow for the transfer
of any of the major types of risk associated with mortgage lending.
2.1 Mortgage Bond Secondary Market Liquidity
As we have noted, a key feature shared by the U.S. agency MBS market and the Danish covered
bond market is that mortgage bonds have little or no credit risk to the investor. is feature
allowed both markets to remain active throughout the period of the nancial crisis and aerward,
as illustrated in Chart 2. Although spreads on Danish mortgage bonds were elevated during
the crisis, the market continued to operate and to intermediate mortgage credit. Similarly,
primary market issuance and secondary market trading remained robust for agency MBS,
despite the collapse in home prices and the nancial distress experienced by Fannie Mae and
Freddie Mac. In contrast, the U.S. non-agency MBS market was not robust during the crisis
period: Issuance froze in the second half of 2007 and the market was closed as a source of
funding for mortgage originators throughout the crisis period.
Table 1
Mortgage Funding in Denmark and the United States
United States
Denmark
Agency
Securitization
Non-agency
Securitization
Balance-Sheet
Lending
How are loans funded? Capital
markets
Capital
markets
Capital
markets
Deposits or
FHLB advances
Capital markets instrument Covered bonds Agency MBS Non-agency
MBS
N.A.
Originator retains the credit risk? Yes No No Usually
Borrower can repurchase mortgage
from secondary market pool?
Yes
No
No N.A.
Who bears:
Interest rate risk? Investor Investor Investor Bank
Prepayment risk? Investor Investor Investor Bank
Credit risk? Mortgage bank Fannie Mae,
Freddie Mac, or
U.S. government
Investor Bank
Notes: FHLB is Federal Home Loan Bank; MBS is mortgage-backed securities.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
In our view, the presence of a credible credit guarantee by the issuer is a key reason why
both the agency MBS market and the Danish covered bond market remained relatively liquid
and functioned relatively well during the crisis. e lack of credit risk on these instruments
greatly reduces the adverse selection that arises from asymmetric information about mortgage
credit risk, a factor that likely contributed to the freeze in non-agency MBS issuance in 2007.
e credit guarantee also helps standardize mortgage bonds and is an important factor under-
lying the operation of the to-be-announced (TBA) market in the United States, where most
secondary market trading of U.S. agency MBS occurs (Vickery and Wright 2013).
Chart 2
Mortgage Bond Liquidity during the Crisis
Covered bonds
Government bonds
Bid-Ask Spread for Long-Term Bonds in Denmark
U.S. MBS Trading Volume
Daily average volume (billions of dollars)
Basis points
0
100
200
300
400
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Non-agency CMBS + RMBS
Agency
(Survey of
Primary Dealers)
Agency
Agency
(TBA only)
0
10
20
30
40
50
60
2005 2006 2007 20092008 2010
Sources: Nasdaq OMX; Danish Financial Supervisory Authority; Danmarks NationalBank; Securities Industry
and Financial Markets Association (SIFMA). Drawn from SIFMA Trade Reporting and Compliance Engine
(TRACE) data, unless otherwise noted.
Notes: In the top panel, only bonds with an outstanding nominal amount of at least €1 billion and trades of at
least kr.10 million have been included. MBS is mortgage-backed securities; TBA is to-be-announced; CMBS
is commercial mortgage-backed securities; RMBS is residential mortgage-backed securities. The vertical
dashed lines mark the September 15, 2008, failure of Lehman Brothers.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
2.2 Mortgage Contract Design
A comparison of mortgage contract design and other aspects of primary mortgage markets is
presented in Table 2. As Green and Wachter (2005) and others have observed, a notable
implication of the U.S. and Danish capital-markets-centric mortgage systems is that in both
countries, mortgage intermediaries are willing to originate long-term fixed-rate mortgages
(with a xed rate for as long as thirty years) and to oer borrowers the option to freely prepay
such mortgages at par.
Long-term, prepayable FRMs are not generally available outside of Denmark and the
United States (Green and Wachter 2005; Campbell 2013). is distinction is likely owing, at
least in part, to the duration mismatch between these instruments and deposit nance and
other shorter-duration liabilities that are the usual sources of bank funding. Capital markets
funding allows the interest rate risk and prepayment risk of FRMs to be shared with other
types of fixed-income investors that have lower leverage, long investment horizons, or a less con-
centrated exposure to mortgages (for example, pension funds, life insurance companies,
sovereign wealth funds, and other asset managers). Fuster and Vickery (2015) present empiri-
cal evidence that the availability of liquid securitization markets facilitates the availability of
long-term, prepayable fixed-rate mortgages in the United States.
17
In both countries, mortgages with variable interest rates are also available. In the United States,
the most popular such mortgages are hybrid adjustable-rate mortgages (ARMs), where the rate is
xed for an initial time period (for example, ve years) and then becomes a oating rate that
adjusts periodically based on movements in market interest rates. In Denmark, as we noted in
Section 1, adjustable-rate mortgages consist of a number of equally spaced, shorter fixed-rate
periods (usually either three years or ve years), between which the interest rate resets.
2.3 Prepayment and Refinancing
Although the United States and Denmark both rely heavily on long-term FRMs, some signicant
dierences exist between the two countries in borrowers’ ability to easily renance or repurchase
their mortgages. Notably, although both countries allow mortgages to be prepaid freely at par,
the United States, unlike Denmark, does not allow homeowners to redeem their mortgages at
the current market price by purchasing mortgage bonds and surrendering them to the lender
(as described in Section 1.3). Furthermore, mortgages in the United States are usually not
assumable, meaning that a homeowner cannot “sell” her mortgage to a buyer as part of a property
sale.
18
In Denmark, however, mortgages can uniformly be assumed as part of a property sale
(on approval of the lender), and the practice is common.
As we have detailed, an implication of these features is that, in a rising rate environment,
U.S. fixed-rate mortgage borrowers may nd themselves locked into a loan with an interest rate
below current market rates. Such borrowers would have a disincentive to sell their home and
move, even if their current dwelling no longer best t their economic circumstances. Borrowers
also have a disincentive to renance to a mortgage with dierent contract features or a higher
principal balance because doing so would require them to prepay their below-market-rate loan
and take out a new loan at the higher current rate.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
In addition, renancing an existing mortgage at par has historically been a more streamlined
process in Denmark than in the United States. As noted in Section 1.3, renancing with the
same mortgage bank in Denmark does not require a new credit check, proof of employment,
or home appraisal, and homeowners can still freely renance even if their home value has
fallen and they have little or no remaining equity. A similar structure in the United States would
likely have helped stabilize economic conditions during the Great Recession, when falling
Table 2
Primary Mortgage Markets in Denmark and the United States
Denmark United States
Mortgage contract design
Long-term xed-rate mortgages available?
Yes Yes
Maximum xed-rate term?
30 years 30 years
Mortgages prepayable on demand?
Yes Yes
Mortgage is assumable in a property sale?
Yes Usually not
Renancing requires underwriting?
Not with same lender Usually
Other mortgage types available?
ARMs, oating-rate,
capped oating-rate
Hybrid ARMs, reverse
mortgages, HELOCs
Default and underwriting standards
Recourse in case of default?
Full Limited
Maximum rst-lien mortgage loan-to-value?
80% 97-100%
Role of government
Government provides mortgage insurance?
No Yes
Mortgage interest is tax deductible?
Yes Yes
Market size and structure
Mortgage debt outstanding (billions of dollars)
470 10,600
Concentration: market share of four largest
mortgage lenders
100%
18%
Sources: Data sources for market size and structure: Federal Reserve Board, Financial Accounts of the
United States; Bloomberg L.P.; Home Mortgage Disclosure Act data.
Notes: ARM is adjustable-rate mortgage; HELOC is home equity line of credit.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
home prices and tighter underwriting standards meant that many borrowers could not re-
nance to take advantage of lower interest rates. Beraja et al. (2017) find evidence that these
renancing frictions blunted the transmission of lower interest rates to the real economy in
regions hardest hit by the housing market decline. e Home Aordable Renancing Program
(HARP) was eventually introduced to facilitate renancing for borrowers with little or no
remaining home equity. Researchers have found that HARP signicantly increased mortgage
renancing, leading to higher consumption of durable goods and reduced foreclosure rates
(Agarwal et al. 2017).
Although HARP is scheduled to expire at the end of 2018, permanent post-crisis changes in
renancing rules should bring the U.S. system signicantly closer to Denmark’s in facilitating
mortgage renancing during periods of falling home prices. Specically, Fannie Mae and
Freddie Mac have announced that starting in late 2018 they will introduce permanent streamlined
renancing programs that will allow borrowers with high LTVs as a result of falling property
prices to renance using an automated appraisal and with no minimum credit score (Federal
Housing Financing Agency 2017; Freddie Mac 2017).
19
Some restrictions apply regarding the
types of borrowers who will be able to participate.
20
Prior research has noted that limited
competition and other frictions reduced the eectiveness of the HARP program to some extent
(Agarwal et al. 2017; Amromin and Kearns 2014). It will be interesting to assess the new
streamlined renancing programs in the wake of any future regional or national housing
market downturns to conrm their eectiveness.
2.4 Other Features of Primary Mortgage Markets
Table 2 also highlights several starker dierences between the two countries in the structure
of primary mortgage markets. As we have noted, Danish mortgage contracts are very
creditor-friendly and foreclosure is quick; this is not generally the case in the United States,
although creditor rights vary signicantly from state to state (Ghent and Kudlyak 2011). e
U.S. mortgage market is much less concentrated, encompassing several thousand originators
(compared with only four in Denmark), and it features competition between banks and nonbanks,
with nonbanks currently originating about half of new loans. is dynamic of competition
between banks and nonbanks may be one reason that U.S. lending standards have uctuated
over time. e United States is also, of course, a much larger market, given its greater population.
. W C U S L
D E
e Danish experience oers a number of lessons that may be of interest for U.S. policymakers
in considering the path of housing nance reform. We summarize these lessons below.
A capital-markets-centric system doesn’t necessarily imply instability. Criticism of the U.S. mortgage
nance system oen focuses on securitization and the system’s reliance on capital markets.
But Denmark’s experience suggests that a stable and robust mortgage nance system is possible
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
even with a capital-markets-centric funding model and without requiring a large role for
government. Returning to a bank-deposit-based funding model isn’t necessary to achieve stability
for the U.S. mortgage nance system. In our view, a signicant reduction in systemic risk is
possible when capital markets are used to broaden the mortgage investor base and diversify the
market risk of long-term fixed-rate mortgages.
21
Mortgage intermediaries should be well-capitalized. Danish mortgage banks remained solvent
throughout the nancial crisis in part because they retain relatively little risk (credit risk is low,
and Danish mortgage banks transfer essentially all market risk to investors under the balance
principle). But Danish banks are also well-capitalized, with a risk-based capital ratio that has
not fallen below 10 percent since 2001, and a leverage ratio of about 5 percent (see Chart 3). In
contrast, Fannie Mae and Freddie Mac retained large portfolios of mortgage assets prior to
their conservatorships and held only a thin layer of capital for the mortgages they guaranteed
(the required capital ratio for securitized agency mortgages was only 0.45 percent).
22
In any
future reform of mortgage nance, limiting the role of implicit government guarantees in the
mortgage nance system will only be possible if systemically important private sector mortgage
intermediaries are nanced with sucient capital relative to their risks.
Chart 3
Capitalization of Danish Mortgage Credit Institutions, 2001-16
Source: Firm lings to the Danish Financial Supervisory Authority.
Notes: The chart is based on Basel I regulation 2001-07, Basel II regulation 2008-13, and Basel III regulation
2014-. Basel standards are transformed into European regulation and directives (CRR/CRD). Data are
reported by institutions at a consolidated level.
Capital as a percentage of risk-weighted assets
Capital as a percentage of total assets
Percent
Basel I
Basel II
Basel III
0
5
10
15
20
25
30
2001 2003 2005 2007 2009 2011 2013 2015
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
Mortgage system design can help facilitate more ecient renancing. As we have noted, the Danish
system includes features that help facilitate ecient mortgage prepayment and renancing.
23
Danish homeowners are able to repurchase their mortgage out of a covered bond at the prevailing
market price and to transfer a mortgage as part of a property sale. ese features reduce
mortgage lock-in eects during rising rate environments. Danish lenders also oer streamlined
renancing to homeowners even if home prices have fallen and the borrower’s equity has
declined or disappeared.
e centralized structure of the U.S. agency MBS market may oer opportunities to introduce
these features in some form or to introduce other changes that could improve the eciency
of mortgage renancing and facilitate interest-rate pass-through.
24
Indeed, the permanent
high-LTV renancing programs being implemented by Fannie Mae and Freddie Mac are a step
in this direction. Changes in ex ante mortgage design reduce the need for ex post government
programs during periods of stress; such programs are dicult to design and scale up “on the y”
and take time to be implemented.
Credit guarantees on mortgage bonds support market functioning. e Danish covered bond market
continued to operate and to intermediate mortgage credit during the 2007-09 nancial crisis
period, an outcome similar to that seen in the agency MBS market in the United States but unlike
that in the U.S. non-agency market, which froze in 2007. e presence of a credible credit guaran-
tee on the mortgage bonds was a key feature supporting market functioning in both the agency
MBS and Danish covered bond markets during this period. is guarantee reduced adverse selec-
tion stemming from asymmetric information about mortgage credit risk (a factor that likely
contributed to the freeze in non-agency MBS issuance in 2007) and helped standardize mortgage
bonds, thereby supporting the operation of the TBA market in the United States, where most sec-
ondary market MBS trading occurs (Vickery and Wright 2013). In short, both the Danish and the
U.S. experience suggest that a credible credit guarantee on mortgage bonds helps stabilize the
supply of mortgage nance over the cycle and supports secondary market liquidity.
Government can play a smaller role. Government plays a much smaller role in the Danish mort-
gage nance system than in the U.S. system. For instance, Denmark does not have government
mortgage insurance programs or hybrid private-public mortgage entities like the GSEs in the
United States. is fact is particularly striking given that Denmark overall has a larger public
sector and a greater role for government in economic life. Entanglements between the private
and public sectors played a signicant role in the instability of the U.S. mortgage market leading
up to and during the nancial crisis. For example, implicit government guarantees of the liabili-
ties of Fannie Mae and Freddie Mac allowed the two rms to issue debt more cheaply than other
private rms, fueling the growth in the GSEs’ balance sheets and exacerbating their exposure to
the housing downturn (Passmore 2005; Frame et al. 2015).
Given the size and systemic importance of housing and mortgage markets, the government is
always likely to bear some tail risk exposure to the mortgage nance system. Even so, the Danish
example shows that a system similar to the U.S. agency MBS market can operate with a signi-
cantly smaller role for government than is the case in the United States. A range of GSE reform
proposals include ways to reduce the role of government in mortgage nance. For example, the
credit risk transfer programs introduced by the GSEs provide a mechanism to shi mortgage
credit risk to the private sector.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
e ve discussion points highlighted above focus on secondary mortgage markets and
funding arrangements, the areas where the Danish and U.S. mortgage systems are most
similar. Other features of the mortgage markets dier more starkly, in part owing to broader dif-
ferences in the design of social insurance and the role of government in the two countries.
Denmark has a more extensive social safety net than the United States, although debt markets
in the United States have more “insurance-like” features that allow non-repayment in
response to negative shocks, through personal bankruptcy law and limits on mortgage
recourse.
25
An evaluation of the broader trade-offs between these and other forms of private
and social insurance is beyond the scope of this article, but the topic is studied in the public
economics literature (for example, Hsu, Matsa, and Meltzer 2017; White 2007; Brown and
Finkelstein 2008).
. C
We have highlighted a number of similarities between the U.S. and Danish mortgage nance
systems and oered a number of potential lessons from the Danish experience that may be of
interest for U.S. policymakers in charting the course of mortgage nance reform. e Danish
example shows that a capital-markets-centric model of mortgage nance does not necessar-
ily imply structural instability or require a large role for government. e Danish model also
oers a number of design features that could mitigate renancing frictions and facilitate monetary
policy transmission through the mortgage market during housing downturns.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
Notes
Acknowledgments: e authors thank Scott Frame and Joseph Tracy for helpful comments.
1
See Campbell (2013), Lea (2010), and Green and Wachter (2005) for surveys and discussion of international
variation in mortgage market design.
2
In this article we generally restrict our attention to the residential mortgage market and refer to Danish borrowers
as homeowners, even though Danish mortgage banks also finance commercial real estate and farms along the
same principles as described here.
3
The Home Affordable Refinancing Program (HARP) was introduced in the United States in the wake of the financial
crisis to facilitate refinancing for borrowers with little or no remaining home equity. HARP is scheduled to expire at
the end of 2018 but will be replaced by permanent high loan-to-value (LTV) streamlined refinancing programs offered
by Fannie Mae and Freddie Mac. See Section 3 for a more detailed discussion.
4
Danish commercial banks are willing to finance up to 15 percent of the remaining 20 percent, but this financing takes
place outside the covered bond system. By comparison, in the United States, Federal Housing Administration (FHA)
loans can have down payments as low as 3.5 percent. Fannie Mae and Freddie Mac also purchase loans with low
down payments, although third-party credit enhancement is required for loans with LTV ratios exceeding 80 percent.
5
Mortgage banks were originally regulated and supervised by the Danish Ministry of Housing. Today, the Ministry
of Industry, Business, and Financial Affairs is the mortgage bank regulator, and the Danish Financial Supervisory Authority
is the supervisor.
6
Specically, legislation in Denmark titled “Law on Mortgage Lending and Mortgage Bonds” includes restrictions
such as an 80 percent maximum LTV, thirty-year maximum maturity, full amortization with a maximum initial
interest-only period of ten years, a legal documentation requirement, and specific principles for assessing the value of
a property.
7
Although borrowers are no longer personally liable for the covered bonds, mortgage banks can still elect to
increase margins on existing borrowers if needed to increase capitalization or cover loan losses. This option to adjust
margins arises out of the original mutual structure of the mortgage banks. This feature implies that, contrary to U.S.
practice, small interest rate changes are possible even for a fixed-rate mortgage. In practice, raising margins affects the
lender’s reputation and competitiveness, and since mortgage borrowers can easily move from one bank to another,
the scope to raise margins is limited, unless there is a general increase in credit losses or funding costs that affects
all banks at the same time. As a result, margins tend to fluctuate little and often remain constant for several years at a
time. Over the past ten years, average mortgage margins have increased from approximately 50 basis points to just
over 80 basis points.
8
When Denmark implemented the Capital Requirement Directive in 2007, it also decided to allow deposit-taking banks
to issue covered bonds. So far, only one bank has opted to issue covered bonds.
9
Unlike U.S ARMs, which typically switch to a floating interest rate after an initial fixed-rate period, ARMs in
Denmark consist of a number of equally spaced xed-rate periods, most commonly either three years or five years.
However, the borrower has the option to change the length of the fixed-rate period on each reset date. On each reset date,
the new mortgage interest rate is based on bond market yields at the time the rate is fixed, removing any basis risk
for the bond issuer. For interest-only mortgages, the initial interest-only period cannot exceed ten years.
10
In the agency mortgage market in the United States, Fannie Mae and Freddie Mac retain mortgage credit risk in
the same way as Danish mortgage banks, but Fannie and Freddie do not originate mortgages. Demiroglu and
James (2012) find evidence that securitized mortgage losses in the United States were lower for securities in cases
where the issuer was also the mortgage originator. See Willen (2014) for the case against mandatory mortgage
risk retention.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
Notes (Continued)
11
For example, if mortgage rates increase by 200 basis points, our homeowner from the example in Box 2 will now
see the bonds issued to fund her loan trading at, say, 85 cents to the dollar. Assuming that a new mortgage loan with a
coupon of 4 percent could be disbursed at par value, the homeowner will need a new mortgage of just over kr.0.85 million
to redeem her old loan. The homeowner will thus realize a capital gain of kr.0.15 million. However, her annual mortgage
payment, including amortization, will remain broadly unchanged at approximately kr.38,000 after tax (taking into
account a 32 percent tax rate deduction for interest payments) because the lower principal will be offset by a higher
interest rate on the new loan.
12
However, the homeowner is allowed to roll refinancing costs (for example, origination fees) into the renancing,
in which case the new principal will be slightly higher than the old principal.
13
The updated LTV is estimated based on an automated valuation of the property, taking into account price appreciation
or depreciation in the local geographic area. Homeowners with an updated LTV exceeding 80 percent face some
restrictions on taking out an interest-only mortgage. Specically, the lender must record a credit impairment charge if
the borrower refinances to an interest-only loan. For this reason, some lenders will require the homeowner to refinance
to an amortizing loan, even if the old mortgage is interest-only.
14
One reason for this volatility is the pegging of the Danish currency to that of Germany and, subsequently, the euro zone.
As a result, for the past thirty years, Danish monetary policy has focused on maintaining a fixed exchange rate rather
than stabilizing the domestic economy.
15
In recent decades, Denmark has experienced negative or zero annual GDP growth in 1974-75, 1980-81, 1988, 1991,
2008, and 2009.
16
The U.S. primary mortgage market is much more fragmented than that of Denmark, encompassing thousands of
individual small lenders, many of which are nonbanks. In practice, a Danish-style system in which all mortgage bonds
are issued by the original lender does not seem possible under the current market structure in the United States.
17
Fuster and Vickery (2015) find that the share of FRMs is significantly lower when mortgages are difficult to
securitize. Shocks to MBS liquidity and cutoff rules governing which loans are eligible for agency purchase are
found to be sources of variation in the ease of securitization.
18
In general, conventional U.S. mortgages have a due-on-sale clause and are not assumable except in the case of the
borrower’s death. FHA and Veterans Administration (VA) mortgages may be assumed, subject to lender approval
(see, for example, Guttentag [2010] for more details).
19
The FHA and VA already offer streamlined refinancing programs that waive the requirement for an appraisal
and require less verification of income, assets, or credit when refinancing to a lower interest rate.
20
For example, the homeowner must be performing on her existing mortgage and have no recent delinquencies,
the loan must be at least fifteen months old, and the LTV must exceed a minimum threshold (95 percent for
a single-family owner-occupied home). HARP loans are also ineligible. See Freddie Mac (2017) for more details.
21
The savings and loan crisis of the 1980s is a case study of the problems that can arise from funding long-term
xed-rate mortgages using bank deposits. See Kane (1989) and Barth (1991) for a detailed discussion of the crisis.
22
Significant progress has been made since the financial crisis to reduce the risk footprint of the GSEs, for example
by shrinking the size of the two firms’ retained portfolios of mortgage assets and by using credit risk transfer
instruments to hedge mortgage credit risk (see Finkelstein, Strzodka, and Vickery [2018], in this volume, for an
overview of the credit risk transfer programs). However, the two GSEs today operate with essentially no equity capital
and thus are entirely reliant on government support to cover any losses.
23
It should be noted that such features are not a free lunch, in the sense that facilitating easier refinancing ex post will
be “priced in” by MBS investors and therefore affect mortgage interest rates at origination. However, reducing these
frictions would likely reduce distortions in other economic decisions (for example, decisions to move by otherwise
locked-in borrowers) and could enhance the pass-through of monetary policy.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
Notes (Continued)
24
For instance, Eberly and Krishnamurthy (2014) propose an “automatic stabilizer” mortgage that would convert into
a lower adjustable interest rate during housing downturns. The GSEs could require that agency-eligible fixed-rate
mortgages contain such a feature. More ambitious proposals to reduce refinancing frictions and transaction costs
include fixed-rate mortgages with a “ratchet” feature, under which the interest rate adjusts downward automatically
if market interest rates fall (Kalotay 2015). This type of automatic refinancing mortgage would address the fact
that many mortgage borrowers do not refinance optimally, as shown by Keys, Pope, and Pope (2016) in the case of
the United States, and by Andersen et al. (2017) for Denmark. These issues were discussed in detail in a 2015
conference on “Mortgage Contract Design: Implications for Households, Monetary Policy, and Financial Stability”
held at the Federal Reserve Bank of New York. The conference agenda and presentation slides are available at https://
www.newyorkfed.org/research/conference/2015/mortgage_design.html.
25
Bankruptcy and limits on recourse for secured debt represent implicit forms of insurance because they provide
options for some borrowers to repay less than the outstanding face value of their debt in situations where they have
experienced negative shocks to their net wealth. See Livshits, MacGee, and Tertilt (2007), Gross and Notowidigdo (2011),
and Feibelman (2005) for further discussion and evidence on the role of bankruptcy as a form of social insurance.
F R B N Y E P R , . , D
Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems
R
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