Academic journal article Cityscape

Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems

Academic journal article Cityscape

Peas in a Pod? Comparing the U.S. and Danish Mortgage Finance Systems

Article excerpt

Foreign Exchange

Foreign Exchange, a department of Cityscape, reports on what the U.S. Department of Housing and Urban Development's Office for International and Philanthropic Innovation has learned about new departures in housing and development policy in cities and suburbs throughout the world that might have value if applied in U.S. communities. If you have a recent research report or article of fewer than 2,000 words to share in a forthcoming issue of Cityscape, please send a one-paragraph abstract to

The views expressed in this article are those of the authors and do not necessarily reflect the position of the Danish Financial Supervisory Authority, Nykredit, the Federal Reserve Bank of New York, or the Federal Reserve System. To view the authors' disclosure statements, visit epr/2018/epr_2018_US-danish-mortgage-finance_berg.

The material on pages 215-238 is reprinted from the Economic Policy Review by permission of the Federal Reserve Bank of New York, 2018.


* As it weighs mortgage finance reform, the United States can draw lessons from Denmark, whose system is similar in some key respects to that of the United States but enabled Denmark to better weather the crisis.

* The U.S. and Danish mortgage finance models both rely heavily on capital markets to fund residential mortgages, transferring interest rate and prepayment risk, but not credit risk, to investors. But in Denmark, homeowners can buy back their mortgages or transfer them in a property sale, avoiding the "lock-in" effects present in the U.S. system, and easier refinancing reduces defaults and speeds the transmission of lower interest rates in a downturn. Denmark's tighter underwriting standards and strong creditor protections help limit credit losses, while its higher capital requirements make lenders more stable.

* The Danish example suggests that a stable mortgage finance system is possible with a capitalmarkets-centric funding model, and without requiring a large role for government.

The way mortgages are designed, financed, and regulated varies strikingly across countries.1Although this variation reflects adaptation to international differences in social, economic, and legal conditions, it likely also stems from historical accidents and path dependence. As the United States considers further reform of its mortgage finance system, it is useful to examine what can be learned from the experiences of other countries and whether any international practices could be adapted to improve the institutional design of the U.S. mortgage market.

With that goal in mind, this article compares and contrasts the U.S. system with that of Denmark. The Danish mortgage finance system is a salient reference point because, in several respects, it is the international model most similar to the U.S. system. In particular, Denmark relies very heavily on capital markets for funding residential mortgages, transferring interest rate risk and prepayment risk to fixed-income investors in a way that is similar to U.S. mortgage securitization. Unlike the U.S. system, however, the Danish mortgage finance system remained stable and solvent during the 2007-09 financial crisis and did not require government funding or capital injections, despite experiencing a fall in home prices of similar magnitude to that in the United States during this period.

In the Danish model, mortgages are financed through the issuance of "covered bonds" (bonds collateralized by a cover pool of mortgages or other debt) by a small number of specialized mortgage banks. The system relies on the "balance principle"-the covered bonds match the maturity and cash flows of the underlying pool of mortgages funded by the bond, and payments by mortgage borrowers are passed directly through to covered bond investors. Thus, interest rate risk and prepayment risk are borne by investors rather than by the mortgage bank that issues the covered bond. …

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