Valuable Lessons from Europe

What lessons can the U.S. learn from housing programs, policies, or regulatory frameworks in other countries? Are there specific tools in use (e.g., covered bonds, full recourse loans, prepayment penalties, etc.) that we should consider adopting or using on a larger scale?

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Many countries maintain high homeownership levels and functional mortgage markets. As the U.S. undergoes regulatory reform and market contraction, it is timely to draw on other countries’ experiences. Some European countries offer insight into alternative finance mechanisms, reform and accounting convergence for U.S. policymakers and lawmakers. Although the U.S. ranks relatively high in homeownership at 66.1 percent of the population in 2011 (although if you back-out the estimated 1.6 million homes where the borrower has not made a payment in more than 24 months the rate could be as low as 63%), several European countries have higher rates (U.S. Census Bureau 2011).

Spain had one of the highest homeownership rates at 85 percent (European Mortgage Federation); England’s homeownership rate was also higher than the U.S. at 68 percent (Building Societies Association). While homeownership is not a direct indication of the vitality of mortgage markets, these rates do suggest that other countries have in place robust and viable housing finance systems worthy of further review by U.S. policymakers. 

One of the hallmarks of the U.S. mortgage market has been its non-recourse feature whereby the loan is secured by the property. The borrower can technically walk-away from the property and the lender cannot seize any of the borrower’s other assets.  While most other countries including Australia offer only recourse lending, it is doubtful that legislators and policymakers in the U.S. would consider such a dramatic change to the nation’s mortgage market.  That said, it is a timely topic to question if the non-recourse feature has been a hindrance or help to the U.S. housing finance system.

Certainly today’s secondary mortgage market suffers from an absence of liquidity, largely due to diminished confidence in investment security after the widespread MBS defaults. The U.S. has considered covered bonds as an alternative funding mechanism since the financial crisis. The House Financial Services Committee has considered bills to establish a cover bond market, including the U.S. Covered Bond Act. The Treasury Department has also issued guidance and best practices for covered bonds.

Covered bonds give investors preferential claims to mortgage collateral if an institution fails. European countries have used covered bonds as funding mechanisms for over a decade.  In 2010, covered bonds generated $2.5 trillion in volume in 25 European countries (European Covered Bond Council). Although covered bonds have not yet gained traction in the U.S., they should still be considered as a possible alternative to securitization.

Denmark offers another case study on funding arrangements.  Denmark is recognized as having “one of the most sophisticated housing finance systems in the world (IMF Country Report 2007).” Denmark’s success is largely attributed to its match funding principle, which requires mortgage assets to match liabilities, i.e., a loan is funded by the issuance of a bond with identical features. 

During the reform of mortgage products, practices and consumer protection it is important that regulators weigh the effectiveness of policies in other countries.

For example, the U.S. restricts prepayment penalties.  Other countries, however, do not limit prepayment penalties, and don’t incur the higher costs associated with prepayment premiums.  Issuers are also able to cover prepayment losses. The CFPB should consider the practical applications of prepayment penalties in deciding whether to limit them under the Ability to Repay rule.

Iceland has a public housing finance fund and was one of the hardest hit markets during the financial crisis. U.S. policymakers can benefit from examining reform measures proposed in Iceland.  Iceland has considered reducing the government’s support of housing through reduced mortgage tax rebates (Organization for Economic Cooperation and Development). 

The Dodd-Frank Act created the CFPB to address the need for consumer protection. Other countries have employed consumer protection regulation without overburdening the industry by focusing on borrower qualification standards (Research Institute for Housing America).  It remains to be seen if the CFPB and other regulators can achieve a similar outcome.

Lastly, as accounting convergence occurs, policymakers should monitor parallel tracks in European countries.  In 2011, the IASB and FASB issued guidance on fair value accounting. The European Union and U.K. generally accepted accounting principles (GAAP) have already been moving towards fair value accounting, but have faced some resistance. As U.S. GAAP moves in a similar direction, regulators should consider industry criticism in other countries.

Brian Montgomery is the Vice Chairman of The Collingwood Group LLC.

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