'Historic Fight' with the EU
We have previously discussed Denmark's unique mortgage credit bubble (see 'Scandinavian Sorrows' and 'Danish Sorrows' for a detailed overview). In brief: household debt in Denmark is at 310% of GDP, a world record. A large part of this consists of mortgage debt. Per capita and relative to GDP, Denmark boasts the largest mortgage credit market in the world.
Why is it a problem? It is not only the sheer overwhelming size of the debtberg that gives cause for worries. As we pointed out, the governor of Denmark's central bank, Lars Rhode, has the serenity of a true Zen master. While his central bank has been instrumental in creating an explosion in Denmark's money supply by at one point imposing negative interest rates to keep the currency from appreciating (sounds familiar), he isn't worried at all about the debtberg of Denmark's households. He reckons that the mountain of debt is balanced by large pension assets and a strong social safety net, whereby the latter has some latitude due to Denmark's low public-debt-to-GDP ratio.
Of course what he ignores is that the value of assets is often ephemeral, something that cannot be said of the size of the debt, which doesn't change in the event of falling asset prices. Also, the governments of Spain and Ireland had very low public-debt-to-GDP ratios as well before the crisis motivated them to engage in serial bailouts while their tax revenues collapsed concurrently.
Let us say though that Rhode has a point regarding this balance. That still leaves a problem. Not only have real estate prices begun to fall (there was a big bubble in prices as well of course), but the funding arrangements of Denmark's mortgage credit market look decidedly unsafe. A lot of what is really very long-term debt is funded with bonds of a duration of just one year.
This is why the EU has now begun to put pressure on Denmark's government to alter the rules. It probably fears that the whole debt edifice could topple if short term funding dries up during a crisis. New EU regulations demand that banks must have stable funding of long-term obligations, and one-year bonds probably don't really qualify. However, no-one ever interfered with Denmark's mortgage market before, and it has worked quite well up until now. It seems likely that intervention will lead to unintended consequences. This is a general principle one must always keep in mind.
“Denmark is bracing itself for an historic showdown with the European Union as lawmakers in the Nordic country settle on a definition of stable funding for mortgage banks that Brussels has yet to accept.
For the first time in the history of Denmark’s two-century-old mortgage bond market, lawmakers proposed last week adding a trigger to extend maturities on one-year notes at risk of failing to meet stable funding requirements. Never before have investors in the $530 billion market for Danish mortgage bonds faced government intervention in securities funding existing loans, according to the Danish Mortgage Bankers’ Federation.
The government in Copenhagen now needs to convince European regulators the new maturity profile satisfies stable funding rules intended to protect against market freezes. The Danish Financial Supervisory Authority, which deems funding shorter than 12 months as unstable for commercial banks, says the EU should accept the new mortgage bonds. Denmark is waiting for a response from Brussels as lawmakers, led by Economy Minister Margrethe Vestager, say they’re willing to do whatever it takes to save the world’s biggest mortgage market per capita.
“The Danish FSA’s position in the future EU development of the Net Stable Funding Ratio is that the new one-year mortgage bonds should be considered as stable funding,” Kristian Vie Madsen, the FSA’s deputy director general, said in an e-mailed response to questions on Nov. 8.
Standard & Poor’s, which warned in July that a failure to reduce issuance of one-year bonds could lead to downgrades, said it is looking at the proposal. Moody’s Investors Service, which has also criticized Denmark’s short-term mortgage bonds for introducing refinancing risks, is analyzing the proposal, it said last week. Investors still need time to decide what the changes mean, according to Pacific Investment Management Co. “We are evaluating this development,” said Kristion Mierau, senior vice president for portfolio management at the Munich office of Pimco, the world’s largest bond fund.
Without European approval, banks in Denmark will have to slash sales of mortgages with rates that are reset annually. The one-year bonds make up about 40 percent of the market, comprising the single biggest category of mortgages.”
Adding a 'trigger' to one year bonds means mainly that they actually won't change the current financing model, except under duress. Here is what the trigger feature entails:
“Under the proposed legislation, an auction failure or interest rate increase of more than 5 percentage points would trigger conversion of one-year, three-year and five-year mortgage bonds, including index-linked notes, into callable, fixed-rate bonds with a maturity matching the underlying loans. That can be as long as 30 years, minus the maturity of the original loan. Yields would be set at the coupon plus 5 percentage points.”
Single family house prices in Denmark since 1994: the bubble has burst.
'Stable Funding' vs. Mortgage Costs
A number of important aspects of the debate are revealed in the excerpt below. We get the feeling that the new 'trigger feature' could well end up setting the very crisis in motion it is designed to avert:
“At Danske Bank A/S, chief bond analyst Jens Peter Soerensen said Denmark’s proposal “might be stretching the interpretation of the net stable funding ratio a bit far, but this is dependent on the interpretation of the local FSA, and so far they seem positive. I don’t think the EU would comment on a specific Danish mortgage bond and say that’s not stable funding.”
The FSA may still limit use of the extended maturity one-year bonds when it introduces new guidelines for mortgage bond issuance, recommended earlier this year by a government-appointed committee examining the roots of Denmark’s financial crisis. Madsen at the FSA said the Copenhagen-based agency will unveil its recommendations in the first half of next year.
“We fear there will be a run on one-year bonds, and that’s why we’re emphasizing that it’s still important to have a focus” on the volume,Karsten Beltoft, head of the Mortgage Bankers’ Federation, said in an interview. The greater the volume of one-year bonds, the more likely it is that the maturity option would have to be exercised, he said.
Though banks had tried to wean borrowers off one-year funding, households resisted those efforts after rates in AAA-rated Denmark sank to record lows. That helped cushion the blow to homeowners of a 20 percent slump in property prices since their 2007 peak.
Yields on one-year mortgage bonds may be as low as 0.55 percent in auctions this month to refinance loans with a Jan. 1 interest reset date, according to Christian Heinig, chief economist at Realkredit Danmark A/S.
“The FSA will fight for the new one-year constructions as being compliant,” said Soeren Holm, chief financial officer for Copenhagen-based Nykredit Realkredit A/S, Europe’s largest issuer of covered bonds backed by home loans.
“This really eliminates the refinancing risk and reduces the interest rate risk for the customer,” Holm said. “We expected it to be at a reasonable price, 5 to 10 basis points.”
So on the one hand, a 'run on one year bonds' is feared, but on the other hand it is quite clear why Denmark's government is so eager to keep these bonds going. For mortgage debtors they currently guarantee extremely low interest rates, due to the central bank's de facto ZIRP. Of course frequent refinancing with one year debt harbors great risks for debtors should interest rates ever rise again.
On the other hand, once the bonds are enhanced with the new 'trigger' feature, sticker shock could come a lot earlier than that, namely if there really is a run on the one year bonds. Investors may well get worried about this trigger feature, since they are currently buying short term debt, which henceforth harbors the danger of suddenly being converted to long term debt. A great many mortgages may be reset to higher rates if bond maturities are extended to match the maturities of the underlying loans.
It is therefore not at all clear that this new feature will really 'remove the refinancing risk'. It may reintroduce risks, by a different avenue. For instance, if there really are many conversions forcing debtors to pay much higher rates, mortgage defaults may spike, especially in light of the decline in property prices. Banks would then be faced with unexpected losses, which could balloon if foreclosures pressure property prices further. If that were to happen, refinancing would definitely become more difficult, as investors would no longer fully trust the banks to be able to honor their commitments.
The Danish credit bubble remains a powder keg.
Danish house prices, year-on-year change, nominal and real.
Addendum: Iceland vs. Ireland
As a brief addendum to our recent article on Iceland's currency devaluation and capital controls (“Iceland – the Dark Side of Devaluation”), we want to point readers to a very interesting article by David Howden posted at Mises.org, which compares the inflationary recession in Iceland with the 'internal devaluation' of Ireland (“Inflation Has Not Cured Iceland's Economic Woes”).
As this article shows clearly, inflation merely masks the utter misery the average Icelandic citizen is facing. On the surface, Iceland's performance looks much better than Ireland's. But looking a bit more closely, by taking a peek beyond the veil of the aggregated data so to speak, it turns out that Icelanders are really far worse off than even the much imposed upon citizens of Ireland. The vaunted 'recovery' miracle of Iceland is really nothing but an inflationary Potemkin village.
Charts by Globalpropertyguide.com
Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
3 Responses to “Denmark Fights For Its Credit Bubble”
Most read in the last 20 days:
- How the Welfare State Dies
Hollande Threatens to Ban Protests Brexit has diverted attention from another little drama playing out in Europe. As of the time of writing, if you Google “Hollande threatens to ban protests” or variations thereof, you will find Russian, South African and even Iranian press reports on the topic. Otherwise, it's basically crickets (sole exception: Politico). Gee, we wonder why? They don't like him anymore: 120.000 protesters recently turned Paris into a war zone. All...
- Toward Freedom: Will The UK Write History?
Mutating Promises We are less than one week away from the EU referendum, the moment when the British people will be called upon to make a historic decision – will they vote to “Brexit” or to “Bremain”? Both camps have been going at each other with fierce campaigns to tilt the vote in their direction, but according to the latest polls, with the “Leave” camp’s latest surge still within the margin of error, the outcome is too close to call. The battle lines are...
- A Market Ready to Blow and the Flag of the Conquerors
Bold Prediction MICHAELS, Maryland – The flag in front of our hotel flies at half-mast. The little town of St. Michaels is a tourist and conference destination on the Chesapeake Bay. It is far from Orlando, and even farther from Daesh (a.k.a. ISIL) and the Mideast. St. Michaels, Maryland – the town that fooled the British (they say, today). Photo credit: Fletcher6 Out on the river, a sleek sailboat, with lacquered wood trim, glides by, making hardly a...
- Going... Going... Gone! The EU Begins to Splinter
Dark Social Mood Tsunami Washes Ashore Early this morning one might have been forgiven for thinking that Japan had probably just been hit by another tsunami. The Nikkei was down 1,300 points, the yen briefly soared above par. Gold had intermittently gained 100 smackers – if memory serves, the biggest nominal intra-day gain ever recorded (with the possible exception of one or two days in early 1980). Here is a picture of Haruhiko Kuroda in front of his Bloomberg monitor this...
- Rule Britannia
A Glorious Day What a glorious day for Britain and anyone among you who continues to believe in the ideas of liberty, freedom, and sovereign democratic rule. The British people have cast their vote and I have never ever felt so relieved about having been wrong. Against all expectations, the leave camp somehow managed to push the referendum across the center line, with 51.9% of voters counted electing to leave the European Union. Waving good-bye to...
- The Problem with Corporate Debt
Taking Off Like a Rocket There are actually two problems with corporate debt. One is that there is too much of it... the other is that a lot of it appears to be going sour. Harvey had a good time in recent years...well, not so much between mid 2014 and early 2016, but happy days are here again! Cartoon by Frank Modell As a brief report at Marketwatch last week (widely ignored as far as we are aware) informs us: “Businesses racked up debt in the...
- What Could Possibly Go Wrong?
A Convocation Of Gamblers The Wall Street Journal and BloombergView have just run articles on the shadow banking system in China. This has put me in a nostalgic mood. About 35 years ago when I was living in Japan, I made a side trip to Hong Kong. Asia's Sin City, Macau Photo credit: Nattee Chalermtiragool I took the hydrofoil to Macau one afternoon and the same service back early the next morning. On the morning trip, I am sure that I saw many of the...
- A Darwin Award for Capital Allocation
Beyond Human Capacity Distilling down and projecting out the economy’s limitless spectrum of interrelationships is near impossible to do with any regular accuracy. The inputs are too vast. The relationships are too erratic. The economy - complex and ever-changing interrelations. Image credit: Andrea Dionne Quite frankly, keeping tabs on it all is beyond human capacity. This also goes for the federal government. Even with all their data gatherers and...
- Janet Yellen’s $200-Trillion Debt Problem
Blame “Brexit” BALTIMORE – The U.S. stock market broke its losing streak on Thursday [and even more so on Monday, ed.]. After five straight losing sessions, the Dow eked out a 92-point gain. The financial media didn’t know what to say about it. So, we ended up with the typical inanities, myths, and claptrap. “Investors” are pushing the DJIA back up again..apparently any excuse will do at the moment. The idea may backfire though, as exactly the same thing happened...
- The Fed’s Doomsday Device
Bezzle BALTIMORE – Barron’s, in a lather, says the market is facing the “Two Horsemen of the Apocalypse.” Huh? Only two? There were four last time! Supposedly, the so-called Brexit – the vote in Britain this Thursday on whether to leave or remain in the European Union (EU) – and uncertainty over where the Fed will take U.S. interest rates are cutting down stocks faster than a Z-turn mower. But Brexit is a side show. As our contacts in London...
- Gold and Brexit
Going Up for the Wrong Reason Gold is soaring. It should—and a lot—but in my view not for the reason it is. Indeed gold is insurance for uncertain times, a time that Brexit seems to represent. But insurance is an administrative cost — one must minimize its use. August gold contract, daily – gold has been strong of late, but this seems to be driven by “Brexit” fears - click to enlarge. Moreover, insuring against Brexit might ironically be equivalent...
- Brexit Paranoia Creeps Into the Markets
European Stocks Look Really Bad... Late last week stock markets around the world weakened and it seemed as though recent “Brexit” polls showing that the “leave” campaign has obtained a slight lead provided the trigger. The idea was supported by a notable surge in the British pound's volatility. Battening down the hatches... On the other hand, if one looks at European stocks, one could just as well argue that their bearish trend is simply continuing – and...