I know what you are thinking – “Mike, why aren’t you writing bizarre long-winded blog entries listing details about the Danish method of securitizing mortgages, which is likely to be the future of the USA, and it’s strengths and weaknesses against our own, which appears to be destroyed.” Which is to say, “How are we going to regulate this to make it not happen again?” Denmark is not the USA – we are larger and more diverse. However money is money, and they have some things to teach us about how to set up mortgage risk-sharing. I’d love to get summaries to you, and I’m working on it. A few things upfront.
1) A few years ago, the Mexican Sociedad Hipotecaria Federal started looking around for ways to modernize their bank-end mortgage industry, and decided to turn to the Danish model, which they found to be better than the USA model.
To put that in simpler terms, The Mexican Department of Finance looked at the USA system of mortgage bond financing, and though it was terrible. (It, of course, was. Hence our problems.) That’s like the Mexican FDA saying we have a terrible way of certifying food safety.
2) This is a very fascinating op-ed by Soros, arguing against the GSE bailout, and suggestion the Danish model as the future. He alludes to, but doesn’t harp on, that one problem with the system that has grown in the United States is that it has become fee-based. People don’t profit off lending money for a house, and slowly collecting a revenue source of interest. They are now focused on the fees in the transactions, and getting a piece off each of the moves to sell it further down the train. Read about the Yield Spread Premium sometime (which one could argue was the dark core of the subprime problems), and then get ready to fight the urge to throw bricks. This is not responsible capitalism. This is robbery capitalism. The Danish model shreds that.
3) People make money under risky terms. People are venture capitalists. People are bail bondsmen. Risk isn’t the problem with subprime. The problem was that, as a result of the moral hazard of profiting off YSI and reselling bad loans, nobody knows what anything is worth, and everyone in the end believes the worst. (You still see this, in the government bailout – nobody knows what is in the products.) Regulating out these moves shines light on the problem. It allows people to understand the rules and terms of the game they are playing, rather than making it up as they go along. This is done by strong consumer protection laws (yes, things like the CRA), and balanced back by things like quick evictions.
To bring in the distinction between the regulatory and tort regime to use a simple metaphor, in the Danish system consumers get better protection upfront in exchange for less protection on their actions afterwards. In our system, you get no protection upfront (buyer beware!), and can hire a lawyer and sue all day long when things go bad. In regards to our current situation:
This, together with the transparency of the system and standardiasation of mortgage and bond terms, seems to substantially reduce investor risk. Denmark appears to have developed reliable mortgage registry systems and legal assurances of rapid mortgage foreclosure processes, which have also helped to avoid defaults on Danish MBS offerings. It is also important to note the legal restrictions on mortgage lenders which prevent them from lending more than specified percentages of the market value of the properties involved. This has further helped to safeguard Danish lenders against the effects of financial crises.
There’s going to be a lot of searching, but this is definitely one area of inquiry worth searching.