What problem exists in the structure of the American mortgage backed security market and are the same elements present in the structure of the Danish mortgage backed security market?

Alexander Anders Bjerno

Student thesis: Master thesis


The purpose of this thesis is to analyze the differences between the Danish and the American mortgage backed securities market to see if the factors that contributed to losses in the American can be found in the Danish. The difference between the two mortgage markets is significant; the American market has a free link between funding and lending, where the Danish market in many years has been characterized by mortgage backed securities where interest and principle payments are passed through to the final investor. Especially in relation to credit risk this is important. The issuers of Danish mortgage backed securities are not allowed to sell of the credit risk on the mortgages which, on the contrary, is possible in America. This thesis analyzes the implications that this difference has on especially contracting problems, where the American market experiences more moral hazard and adverse selection problems as a consequence. The findings of this thesis are that both contracting problems and macro economical factors contributed to the unexpected losses in the American mortgage market. Since 2001 the macro economic factors, especially low interest rate, have been a driver for the expansion of mortgages to less credit worthy borrowers the so-called sub-prime borrowers. Thus, macro economic factors played an important role to the losses seen in the American mortgage backed securities. Though, macro economic factors do not explain it all; an analysis of the securitization of sub-prime loans finds several moral hazard problems. These problems are driven by a fee-based structure that promotes moral hazard behavior. The moral hazard problems in the structure of the American mortgage backed securities market cause an increased complexity in the securities which increases the need for credit rating agencies to ensure the quality of the securities. Many of the ratings did turn out to be too optimistic and thus the investors in American mortgage backed securities experienced losses and writedowns as a consequence. Last, the thesis analyzes the Danish market to see if a similar situation could happen on this market. With the historical tight connection between funding and lending of the Danish mortgage backed securities, many of the problems in the American market are not found in the Danish. This is primarily due to the balance principle that ensures that the originators of mortgages are also kept responsible for adequate underwriting standards. New legislation on the Danish mortgage market can potentially expose the market for some of the problems in the future. Though, the thesis does not find that the problems are similar with the once found in the American market.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2009
Number of pages93