The Danish Mortgage System

Our current mortgage system has broken down because the originators of mortgages have not retained any part of the credit risk. They are motivated to maximize their fee income. As agents, their interests
are not identical with the interests of the ultimate owners.

In the Danish system, the service companies retain the credit
risk--they have to replace the mortgages that are in default.
In contrast to our reliance on government sponsored
enterprises (GSEs)--namely Fannie Mae and Freddie Mac--
the Danish is an open system in which all mortgage originators
participate on equal terms, and it operates without government
guarantees. Yet Danish mortgage bonds are traditionally very
highly rated; often they yield less than government bonds.

This could not be replicated in the United States at present
because of the demoralized state of the market, but it may be
achieved later. Danish mortgage bonds are highly standardized, and their distinguishing feature is that they are identical to and interchangeable with the underlying mortgages.
House owners can redeem their mortgages at any time by purchasing t
the equivalent mortgage bond in the market and exchanging it
for the mortgage. Since bond prices and house prices normally
move in the same direction, this feature--called the
principle of balance--reduces the chances of householders
having negative equity in their houses.
The mortgage originators are strictly regulated, and their interests are closely aligned with those of the bondholders. They pass on only the interest rate risk to bondholders, retaining the credit risk. That is why the bonds are so highly rated. The U.S.Treasury has supported this plan in certain situations.