Will ARMs de-stabilise the covered bond mortgage system?
By Niels Jensen
Ed asked me to comment on hidden contingent sovereign liabilities of Danish mortgage bonds given the most recent Absolute Return Letter. Claus Vistesen’s point on the hidden contingent sovereign liability of Danish mortgage bonds is a valid one but only to a degree. As one can see from chart 1 in my letter, Denmark’s TOTAL DEBT as a % of GDP is broadly in line with other Western European countries. I know that being no worse off than your peer group is not in itself a good defence; all I want to point out is that there is no case for suggesting that Denmark’s situation is particularly bad.
Denmark’s mortgage debt (as a % of GDP) has always been relatively high because of the combination of high home ownership and a finance system which is easily accessible and relatively cheap to use. In other countries a lot of mortgage debt is disguised as other types of debt, so direct comparisons can be very misleading. Hence I don’t think high mortgage debt levels are a reason for concern.
The real issue, which Claus doesn’t touch on, is whether Moody’s has a point or not, i.e. will the emergence of ARMs into the Danish system de-stabilise it when we get the next big upward move in interest rates? Since ARMs were first introduced in Denmark we have not had a big move up in rates, so the system hasn’t really been tested. I think that is the big question; however, as an investor in Danish mortgage bonds, there are two mitigating factors:
- If you buy, say, 20-year bonds, the underlying loans will be 20-year fixed mortgages, not ARMs (this is the pass-through principle which ensures balance between assets and liabilities)
- When Danish homeowners take out a floating rate loan, under Danish law, the lender must ensure that the borrower could afford the cost of a fixed rate mortgage before the ARM loan is granted.
The Osterlars church on Bornholm (fingernail) was built between 1150 and 1200 and I don’t know exactly but I’m going to guess that the mortgage has been paid off.
The picture is of a famous Danish building not of one with a mortgage :)
it’s quite impressive, I bicycled up to it last summer, highly recommended (the church and the island)
Lets see. He can’t afford a short, fixed rate mortgage so he buys an ARM…a mortgage that is affordable now…but 20-30% will most assuredly be unaffordable later. Not IF we will have another crisis but WHEN. ARMS should be outlawed.
The Australian residential mortgage market is mostly comprised of ARMs. At the peak of the previous interest rate cycle, the standard ARM (and upwards of 80%+ of mortgages are ARMs) was pricing close to 10%. At this time arrears topped out at around 1.8% in the RMBS market and somewhat lower for the mortgages on bank balance sheets.
A key elemnet supporting this performance is that Australia has a national consumer credit regulatory environment which ensures that a borrower has the capacity to meet their obligations (include an allowance for interest rate stress) and which provides relief where the lender has been negligent or has engaged in deceptive conduct.
ARMs [not necessary] and a sound and well supervised regulatory environment [absolutely necessary] can go a long way in supporting the integrity and performance of a residential mortgage market.