Follow the Great Danes
by Tony on Jan.06, 2009, under The Gooch
I read an article in the Economist titled “A Slice of Danish” that outlined the best fix for the U.S. housing market. Denmark has not escaped the credit crunch entirely but their mortgage market has been fully functioning due to the mechanics of the market. First of all, Danish homebuyers are REQUIRED to make at least a 20% downpayment on the purchase of their new home. It was 0% down, 120% mortgage financings, and a dislocation of risk that really drove this market to bubble levels. If Americans were required to make a 20% down payment, as all our parents and grandparents remember as being standard, the market would not be down 20%. Secondly, when a Danish bank issues a mortgage, it remains on the hook, whereas in the U.S. most mortages were immediately sold to naive investors that relied on the rating agencies to evaluate collateral risk (the banks were only responisible if the borrower defaulted within 6 months). Therefore, I give Joe the Plumber a $600k loan supported by his $60k income, the next week I sell that loan to Insaneinthemembrane Capital Partners for a profit. Since Joe the Plumber won’t default within 6 months unless he loses his job, I can care less whether he defaults or not. I think it is critical that lenders have “skin in the game” and are responsible for the loan they issue. The biggest difference between the Danish mortgage market and the U.S. market is that if my $480k loan (80% of 600k) was trading at 100 cents on the dollar immediately after issuance and 2 years later it is trading at 50 cents on the dollar due to higher perceived default risk and lower collateral value, I can buy back my loan in the market at 50% of the loan value. In other words, I can get rid of my loan by buying it back for half the mortgage value, or $240k (50% x 480k). It makes sense that the party with the most to benefit has the ability to buy back their loan.
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January 8th, 2009 on 9:19 am
Will, excellent point. the no recourse feature on american mortgages makes purchasing real esatate just like purchasing a call option and a free call option in the case of these zero down financings. there’s no way this bubble would have occurred if lenders had access to your other assets in a default. it seems unfathomable that a lender would be willing to give you a mortgage with zero down and no ability to go after your other assets in the event of default. now thats what i call a real “buyer’s market”. people like to call the current environment a buyer’s market, but the zero down, free options days were really the buyer’s market.
January 8th, 2009 on 9:23 am
Many European mortgages also have secured collateral packages beyond the property, providing lenders there with enhanced security. Borrowers are more inclined to stay current because banks have the ability to go after other assets on mortgages. Here, you can simply give the bank the keys, with the only hit coming to your credit score.