A friend sent me an article from today's Financial Times entitled, "A Danish fix for the US mortgage crisis," in which George Soros points out how the efficient and well-balanced Danish Mortgage system would be a great solution for the inefficient and poorly balanced US mortgage mess.
Earlier this year, in February, I wrote about the 2006 IMF Report comparing the world's mortgage marketplaces. In that report, the IMF identified the US and Denmark as having the two most efficient mortgage markets in the world in terms of interest rate efficiency and availability of credit.
Since July 2007, the US has demonstrated that its mortgage market model is neither efficient at providing credit nor effective at mitigating risk, and Denmark is now the most efficient mortgage market in the world. This is why Mexico selected the Danish mortgage model for its new mortgage system.
In my earlier blog article, I recommended that the US would do well to follow the Danish example, though I hold out no great expectation that it will. In the first place, there remains an American chauvinism that prevents the adoption of many good ideas from abroad. In the second place, there are far too many vested interests in the current system, which was designed to be like managed healthcare for mortgages - private companies serving shareholders and management, lobbying Congress to protect those interests before the public's interest.
Fannie Mae and Freddie Mac are poorly run organizations who have had to restate earnings many times before the current crisis. They weakened key mortgage underwriting provisions in 2005 and allowed vast amounts of poorly documented loan originations to seep into the global MBS market undermining the very mortgage market they were designed to serve. Shareholders, the American taxpayer, and people all over the world are now paying for the gross negligence of these two firms.
I agree with George Soros. Fannie Mae and Freddie Mac should be replaced with a mortgage model similar to Denmark. It is time we fix our flawed financial model and we should be mature enough to recognize that there are indeed foreign solutions superior to our own.
"A Danish fix for the US mortgage crisis
By George Soros
Published: August 11 2008 19:21 | Last updated: August 11 2008 19:21
The recent compromise struck between the Treasury and Democrats in Congress on the fate of Fannie Mae and Freddie Mac, the government-sponsored mortgage guarantors, constitutes the worst of all possible worlds. The Treasury offered a blank cheque to come to the rescue, if necessary, but the managements of both companies were kept in place. They know that their survival depends on not drawing on that blank cheque. They will therefore do everything in their power to reduce the need for any new equity capital that would be dilutive. In short, as privately owned but undercapitalised financial institutions, the GSEs cannot fulfil their stated mission of providing stability, liquidity and affordability to the nation’s housing finance system.
In presentations to investors, which followed big quarterly losses, the GSEs said they would curtail purchases of mortgages and might shrink their holdings to preserve capital. They highlighted that fees from their insurance guarantee business had nearly doubled. They also improved the quality of new loans by focusing on borrowers with higher-quality credit, who put down greater down payments. This means that the GSEs have significantly increased the cost of mortgages and tightened lending standards.
The problems in the banking system have left the two GSEs as the only game in town in the mortgage market. Their market share of new mortgages has doubled over the past year and is now close to 80 per cent. Much of the balance is accounted for by the Federal Housing Administration, a fully guaranteed government agency. As the two companies fight for survival and try to reduce their need for new capital, the availability and cost of mortgages in the US suffer. Coming at a time when the supply of houses is swollen by a rising tide of foreclosures, this is a recipe for disaster. House prices have already fallen sharply and will continue to fall unless mortgages are made available on more favourable terms to a broader group of people.
This compromise, or stalemate, practically ensures that house prices will overshoot on the downside. That, in turn, renders the policies of the GSEs self-defeating as lower house prices increase their losses and push them further into insolvency. The GSE crisis has merely been postponed, at a cost of making the housing crisis more severe.
Confidence in GSE-backed bonds has been shaken. The stocks remain under pressure. Markets are forcing officials to come up with a better solution. We need to recognise that the business model of the GSEs is fatally flawed. They are public/private partnerships in which the risks are borne by the public sector while profits accrue to the private sector: management and shareholders. The companies have been plagued by accounting problems and other irregularities; their managements have spent enormous sums lobbying Capitol Hill. This is not a business model that deserves to be perpetuated.
Fortunately, alternatives are available. Hank Paulson, the Treasury secretary, has suggested the use of covered bonds, a mortgage-financing vehicle popular in Europe. I would recommend the system of mortgage credit used in Denmark, where loan-to-value ratios and underwriting standards are strictly enforced by a single, strong regulator. These mortgages are transformed into instantly tradable bonds. Cover for the bonds is provided by both the mortgages and the credit of the financial institutions issuing them. The mortgages remain on the balance sheets of the issuers, eliminating the moral hazard inherent in the US system, which is based on earning fees from selling them on to the market.
The standardisation of mortgages in the Danish system promotes transparency and liquidity. Householders can prepay their mortgages at any time by buying the bonds. Since house values and bond prices tend to move in unison this arrangement reduces the danger of householders’ equity falling into negative territory. For the issuing banks, owning these bonds carries lower capital requirements so the bonds sell at a premium to ordinary covered bonds. This system has survived and provided affordable home mortgages since its creation shortly after the great Copenhagen fire of 1795.
I pioneered the introduction of the Danish system in Mexico with the support of Paul O’Neill, when he was Treasury secretary. With modification, it offers a long-term solution to providing affordable mortgages in the US.
The writer, author of The New Paradigm for Financial Markets, is chairman of Soros Fund Management, which has held and continues to hold short positions in GSEs"[Read More]
Adler on Data Governance
From archive: August 2008 X