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.