Denmark is ready to do for its two- centuries-old mortgage system what European Central Bank President Mario Draghi has done for the euro: whatever it takes.
Danish Economy Minister Margrethe Vestager says the government is “disappointed” its demands were overlooked by Basel bank regulators last month as the nation lobbies to ensure its home-finance model isn’t wiped out by proposed liquidity rules.
“That’s a key issue for us,” Vestager said in an interview in Copenhagen. Denmark is fighting for a mortgage system that “has endured any stress test that you can come up with,” she said.
By echoing Draghi’s July pledge to use every tool at his disposal to protect the euro, Vestager is sending a clear warning to international regulators that Denmark won’t rest until its demands are met. At stake is the nation’s $600 billion mortgage-bond market, the world’s biggest, relative to the size of the population.
“Danish housing finance is extremely cheap, stable and trustworthy,” Vestager said. “We’ll do whatever it takes to guard it.”
Banks in AAA rated Denmark meet their liquidity needs by holding the covered bonds, which are backed by home loans. The Basel Committee on Banking Supervision wants to limit use of the securities, even though they’re rated higher than more than half the nations in the euro area. Instead, Basel would make lenders more reliant on government debt.
Denmark, which doesn’t have a seat on the 27-member Basel Committee, argues the group is ignoring the lessons of the debt crisis. Thanks to its fiscal restraint, Denmark’s public debt burden is about half the euro area’s average, meaning there aren’t enough sovereign bonds to fill the liquidity shortfall the Basel rules would create. Nykredit A/S, Europe’s biggest issuer of covered bonds backed by mortgages, estimates the gap is 200 billion kroner ($36 billion).
“The recent Basel announcement still focuses very much on the issuer and not on the objective characteristics,” Vestager said in the Feb. 7 interview. The rules assail a “very old and well-working mortgage system,” she said.
Implementing the so-called Basel III liquidity rules would force Danish banks to sell off mortgage bonds, drive up home finance costs and send tremors through the whole economy, according to Steen Bocian, head of economic research at Danske Bank A/S, Denmark’s largest lender.
Danish mortgage bonds, which made it through the Napoleonic wars without any defaults even as Denmark’s government went bankrupt in 1813, need to be given the same liquidity status as sovereign debt, the government in Copenhagen argues.
Yet Basel isn’t the only group to question the safety of the bonds. Moody’s Investors Service argues the spread of adjustable-rate mortgage bonds, which now make up about half the market, has created a refinancing risk because bonds as short as a year are used to fund 20-year mortgages. The industry counters that any change in borrowing rates is passed on to the borrower, while the issuer only bears a far more remote risk of default.
The central bank has also urged issuers to consider phasing out interest-only mortgages amid concern the loans fanned imbalances that culminated in Denmark’s housing bubble, which burst in 2008. Since their peak a year earlier, house prices have slumped more than 20 percent, sending the nation into a recession.
Still, investor demand for mortgage bonds has grown, and the Nykredit Index of the most-traded notes backed by home loans soared to a record in December. It ended last week less than 1 percent shy of its Dec. 10 peak.
The Nykredit index has returned about 35 percent since September 2008, the month Lehman Brothers Holdings Inc. collapsed. In the same period, U.S. Treasuries with maturities longer than a year returned 24 percent, according to Bloomberg/EFFAS Indexes. The figures include re-invested interest.
The current Basel proposal limits banks’ use of covered bonds to 40 percent of liquid assets. It also requires lenders to book the securities at 85 percent of their market value.
Though global central bank chiefs, meeting last month in Basel, Switzerland, agreed to some concessions, including extending the deadline to meet the rules to 2019 from 2015, Denmark’s pleas were ignored.
“We thought a lesson was learned with the recent experience with the bonds issued by states,” Vestager said.
The European Commission is working on legislation to implement the Basel recommendations, and agreed last year to submit assets to a series of tests to determine liquidity, rather than basing assumptions on an asset’s class.
Top ranked benchmark Danish mortgage securities are, on average, as liquid as the nation’s government debt, even in periods of market stress, the central bank said in a Nov. 22 working paper. The study confirmed a 2010 finding.
Denmark’s financial regulator has already told banks to ignore the Basel rules. The decision shows Denmark won’t impose rules on its banks it expects will harm the industry and the economy. Vestager says she’d rather assume that Basel and the commission in Brussels will accommodate Denmark’s demands.
“We think it will work out,” she said. “As long as we can agree on the fact that it’s objective criteria rather than the issuer, then there is space for us as well.”