Fixing the Mortgage Mess

In an earlier posts, here and here, I discussed ethics and the disconnect between market actors that contributed to the mortgage mess that has in turn contributed to our financial meltdown. Specifically, the fact that mortgage holders now can't even tell who owns their mortgages is causing many of our troubles, because no re-negotiations are possible. I was at a loss as to how to solve it.

Turns out that this problem has been solved in Denmark, of all places. When a Danish mortgage bank makes a loan to a homeowner, it is required to sell a bond of equal value and interest rate (plus a tiny bit extra for its fees). So far, no difference. In Denmark, however, the issuer of the bond is required to continue to make the payments even if the borrower defaults. As pointed out in the Economist article, this maintains the link between those who sell mortgages and those who bear the risk of default. Also, mortgage-holders can buy the bonds in the market in a process similar to re-financing. Danish law also requires borrowers to finance no more than 80% of the purchase price.

A criticism of the system is that it makes it hard for risky borrowers to get loans, albeit at higher interest rates. Excuse me? I find that reassuring. Also, mortgage banks are very quick to seize homes for non-payment, since they are the one's paying on the bonds. However, this leads to very good lending practices.

Amazingly, this whole mechanism has been in place since 1850. However, it has also been updated to take advantage of new lending innovations such as adjustable rate mortgages. Further, the Danes have not seen the free fall in housing prices that plagues the U.S and U.K. Further, because there is a large securities market for mortgage bonds, it obviates the need for the likes of Fannie Mae to create such a market to insure liquidity. That too, is another advantage, because it gets quasi-government agencies out of this business. Even though the Danes regulate this market, no taxpayer money is at risk. But best of all, this system restores the transparency needed for the proper functioning of capital markets.