Reforming Housing Finance: Perspectives from Denmark

Abstract

This paper investigates the consequence of adding a distinct feature of the Danish mortgage market to the market in the United States. This feature, a buyback option, enables mortgagors to purchase back their share of the mortgage-backed security at market price. Extending a standard referenc pricing prototype the findings indicate that the introduction of the buyback option brings the credit spread required by the agency of the financial intermediary by 23% potentially reducing the contingent liability of the U conduct Furthermore, the buyback option shelters households against the risk of being fasteninged in after an increase in interest rates. This could be of particular benefit to low-to-middle income households.

This paper received the award for the best paper upon Real Estate Finance (sponsored by the agency of the Fannie Mae Foundation) neared at the 2004 ARES Annual Meeting.

Introduction

There is an ongoing strife of words regarding the costs and benefits of Fannie Mae and Freddie Mac. The disputation has many aspects, but it mainly develops around the fact that, in spite of any legal basis, investors treat due and mortgage-backed securities issued by the agency of Fannie Mae and Freddie Mac (F&F) as if the United States conduct guarantees them. It is a fact, however, that they take pleasure in certain benefits and have certain restrictions to be paid to their close relationship with the federal rule a summary for this relationship being that they are "government sponsored enterprises" or GSE

The altercation concerns a range of aspects of the GSE of which sum of two units are of particular interest in this paper. First, it is argued in the literature that the GSE attitude a contingent liability for the U regulation (e.g., White, 2003; and Frame and White, 2004 According to Frame and White (2004) the liability constitutes approximately USD 288 billion above a 25-year period. On the other hand, make revolve (2003) argues that the retained mortgage portfolios of F&F provide a range of benefits to the homeowner in general. next to the first some critics argue that in spite of their charters, the GSE do not improve abode ownership for low-to-middle income (LMI) households. This is, for example, the case in White (2003) and Passmore (2003) while Blinder, Flannery and Kamihachi (2004) criticize the approach in Passmore (2003) and generally find larger benefits of the implicit subsidy. Further, Bostic and Surette (2001) find that from 1989 to 1998 abiding-place ownership increased from 63% to 662% The increase appears while there is a general decline in disparity between different clumps The authors attribute this to a change in the mortgage markets, and diocese this as an indication that regulation works. In short, there is considerable disagreement concerning the risks pos through the GSEs to the taxpayers and in what manner good a job the GSE have done at promoting domicile ownership for the LMI households.

This paper contributes to the literature by means of addressing the possibility of a contingent liability of the U conduct and the benefit to LMI households. It examines the issues of introducing a distinct feature from the Danish mortgage market into the U mortgage market, which obeys to reduce the contingent liability of the U rule and improve the conditions of LMI households. The distinct feature that will be introduced is the buyback option. This option enables the mortgagor, in addition to the standard prepayment option, to purchase back the mortgage at the prevailing cord price. This will have a number of positive consequences First, the paper argues and supports with calculations that the credit risk of the GSE could be decreased if mortgagors could purchase back their loans at the market price. next to the first having a buyback option covers the mortgagor from the lock-in issue and could thereby encourage LMI households, which are particularly expos to lock-in events to become homeowners. Third, from a macro economic perspective, introducing the buyback option could increase the mobility of the labor force in general, as it would make it easier for nation to move if their the loan could be terminated at its general value.

This paper highlights a particular difference between the U and the Danish mortgage markets, which are generally true similar. As is the case for the U the Danish market for mortgage-backed links is very large. The total whirl of outstanding mortgage debt totaled 101% of GDP in 2003 compared to 81% in the U In Europe the Danish market is the next to the first largest, which is exceeded alone by Germany.

Four large mortgage credit institutions (MCIs) who originate, securitize and service the loans dominate the Danish mortgage market. grounded as a cooperative system, the institutions are today private on the other hand highly regulated. For example, the MCIs are not allowed to retain any prepayment risk themselves. Despite being private companies, there is, like in the U a widespread belief that the management will never allow the MCIs to default. As in the U the Danish MCIs guarantee the loans like that in the event of default through mortgagors, the investor receives face value. The MCIs are required by the agency of law to follow the so-called 'balance principle,' which requires that all lending activities must be stocked by issuing bonds with exactly matching cash streams In that sense, Danish mortgage-backed ligaments are genuine pass-through securities where the payments from an individual mortgagor can be traced into a pond and on to the ligature for which the mortgage labor fors as collateral.