http://online.wsj.com/article/SB122360660328622015.html?mod=googlenews_wsj Denmark Offers a Model Mortgage Market There is a safe way to securitize home loans. By George Soros The American system of mortgage financing is broken and needs a total overhaul. Until there is a raealistic prospect of stabilizing housing prices, the value of mortgage-related securities will erode and Treasury Secretary Henry Paulson’s efforts will come to naught. There are four fundamental problems with our current system of mortgage financing. First, the business model of Government Sponsored Entities (GSEs) in which profits accrue to the private sector but risks are underwritten by the public has proven unworkable. It would be a grave mistake to preserve the GSEs in anything resembling their current form. Second, the American style of mortgage securitization is rife with conflicts where entities that originate, securitize and service mortgages are generally not the same as those that invest in mortgage securities. As a result, the incentives to originate sound mortgages and to service them well are inadequate. No wonder that the quality of mortgages degenerated so rapidly. Third, mortgage-backed securitizations, which were meant to reduce risk by creating geographically diversified pools of mortgages, actually increased risk by creating complex capital structures that impede the modification of mortgages in the case of default. Finally, and most fundamentally, the American mortgages market is asymmetric. When interest rates fall and house prices rise, mortgages can be refinanced at par value, generating the mortgage equity withdrawals that fueled the housing bubble. However, when interest rates rise and house prices fall, mortgages can only be refinanced at par value even though the market price of the securitized mortgage has fallen. To reconstruct our mortgage system on a sounder basis, we ought to look to the Danish model, which has withstood many tests since it was brought into existence after the great fire of Copenhagen in 1795. It remains the best performing in Europe during the current crisis. First, it is an open system in which all mortgage originators can participate on equal terms as long as they meet the rigorous regulatory requirements. There are no GSEs enjoying a quasimonopolistic position. Second, mortgage originators are required to retain credit risk and to perform the servicing functions, thereby properly aligning the incentives. Third, the mortgage is funded by the issuance of standardized bonds, creating a large and liquid market. Indeed, the spread on Danish mortgage bonds is similar to the option-adjusted spread on bonds issued by the GSEs, although they carry no implicit government guarantees. Finally, the asymmetric nature of American mortgages is replaced by what the Danes call the Principle of Balance. Every mortgage is instantly converted into a security of the same amount and the two remain interchangeable at all times. Homeowners can retire mortgages not only by paying them off, but also by buying an equivalent face amount of bonds at market price. Because the value of homes and the associated mortgage bonds tend to move in the same direction, homeowners should not end up with negative equity in their homes. To state it more clearly, as home prices decline, the amount that a homeowner must spend to retire his mortgage decreases because he can buy the bonds at lower prices. The U.S. can emulate the Danish system with surprisingly few modifications from our current practices. What is required is transparent, standardized securities which create large and fungible pools. Today in the U.S., over half of all mortgages are securitized by Ginnie Mae, which issues standardized securities. All that is missing is allowing the borrowers to redeem their mortgages at the lower of par or market. Because of the current havoc in the mortgage market, there is no confidence in the origination and securitization process. As a result, a government guarantee is indispensable at this time, and may be needed for the next few years. As the private sector regains its strength, the government guarantees could, and should, be gradually phased out. How to get there from here? It will involve modifying the existing stock of mortgages, so that the principal does not exceed the current market value of the houses, and refinancing them with Danish-style loans. The modification will have to be done by servicing companies that need to be properly incentivized. Modifying mortgages that have been sliced and diced into securitizations may require legislative authorization. The virtual monopoly of the GSEs would be terminated and they would be liquidated over time. A plan to reorganize the mortgage industry along these lines would inspire the confidence that would allow a successful recapitalization of the banking system with the help of the $700 billion package approved last week.
This is an elegant and eloquent piece by one of this generation’s leading finance minds. But lets face it, would this kind of utopian mortgage market ever see the light of day in Washington? Probably not. Willy
Well Soros owns the democrat party? THe problem is what he suggests is A BAD IDEA. How will you feel when your neighbor who went over his head now pays less for his house then you. Not very happy. Let the market correct itself. “it will involve modifying the existing stock of mortgages, so that the principal does not exceed the current market value of the houses,”
The government intervention has already killed the market correction mechanism. There’s a house I want to buy. The seller stopped paying the mortgage. The seller stopped paying taxes. In fact, the seller has even moved out. The bank won’t foreclose. The bank won’t accept an offer from me that is higher than the appraisal. The bank is just going to sell the note to the tax payer (TARP fund). The bank doesn’t care because it’s now owned by FED. Nobody cares. It’s a valuable piece of property just sitting there rotting away. Taxes are going unpaid. Yard dead. Hey, maybe i’ll go grab the copper pipes.
The US has to bleed for its naive boosting ‘house ownership’ which created a massive housing bubble built on a pile of bad mortgages. It doesn’ t matter if you go right or left, it was a bubble and it consists of a lot of nothing. If you fill it, that stuff has to be taken away somewhere else. Yes… I’m bearish. Not on the markets per se but definitely on the US as leading economy. The US is broke.
PtrainerNY Wrote: ------------------------------------------------------- > Well Soros owns the democrat party? > > > THe problem is what he suggests is A BAD IDEA. George Soros is a pretty smart guy. I’d be really cautious about capitalizing bad idea in regards to just about anything he says. > How will you feel when your neighbor who went over > his head now pays less for his house then you. Not > very happy. Let the market correct itself. “it > will involve modifying the existing stock of > mortgages, so that the principal does not exceed > the current market value of the houses,” This isn’t his proposal at all - it means his neighbor can always buy his own house at market value, not just mortgage par value. If you object to this, perhaps you would object to someone new moving to the neighborhood and buying a nearby, better house than yours for less money than you paid?
WillyR Wrote: ------------------------------------------------------- > This is an elegant and eloquent piece by one of > this generation’s leading finance minds. But lets > face it, would this kind of utopian mortgage > market ever see the light of day in Washington? > Probably not. > > Willy Maybe. But Washington has to face up to the GSE problem really soon (early next year I guess) and reconstituting them the way they used to be is hopeless and stupid. Which doesn’t mean that a Nancy Pelosi-led House won’t do that… Anyway, it seems to me that there are a couple of issues here: a) Denmark is so small that Vikings used to capture it over the Labor Day weekend and then go home for work on Tuesday morning. Changes in real estate prices shouldn’t be too different from one part of the country to another. Suppose that I live in the US in some place that has a booming real estate market despite a national slump - I get to buy my way out of the mortgage at a bogus MV because its a MV based on national real estate not my local real estate. b) The bonds need to be nearly homogenous which means that there will be really rigorous credit controls for individuals buying houses. This is not good for the goal of universal home ownership, chicken in every pot, etc… c) Diversifying default risk was a good idea, we just messed it up by trying to diversify away too much default risk. d) A homeowner/mortgagee is now sitting on another set of options. Besides the interest rate options, they also have real estate options. If you are a bond buyer (i.e., lender), you are now short a humongous stack of options. Given the current state of real estate vol, I would really need to be compensated for that.
virginCFAhooker Wrote: ------------------------------------------------------- > The government intervention has already killed the > market correction mechanism. There’s a house I > want to buy. The seller stopped paying the > mortgage. The seller stopped paying taxes. In > fact, the seller has even moved out. The bank > won’t foreclose. The bank won’t accept an offer > from me that is higher than the appraisal. The > bank is just going to sell the note to the tax > payer (TARP fund). The bank doesn’t care because > it’s now owned by FED. Nobody cares. It’s a > valuable piece of property just sitting there > rotting away. Taxes are going unpaid. Yard dead. > Hey, maybe i’ll go grab the copper pipes. There are major questions about how beneficial it would be to sell into TARP. These securities are already very difficult to value - and I would imagine the government will use very conservative assumptions. If the institution can afford to hold the securities and doesnt need the capital, they will likely be incentivized to NOT sell into TARP as they would likely get a poor price
JoeyDVivre Wrote: ------------------------------------------------------- > This isn’t his proposal at all - it means his > neighbor can always buy his own house at market > value, not just mortgage par value. If you object > to this, perhaps you would object to someone new > moving to the neighborhood and buying a nearby, > better house than yours for less money than you > paid? The problem is banks want to completely transfer this risk to the borrower in return for taking on the pre-payment risk. This system eliminates both which I think is very clever.
Or you just go back to requiring a good credit score and a reasonable down payment before giving someone a mortgage.