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S. HRG. 111–886 

A COMPARISON OF INTERNATIONAL HOUSING 

FINANCE SYSTEMS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

SECURITY AND INTERNATIONAL TRADE AND 

FINANCE 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

ON 

COMPARING THE INTERNATIONAL HOUSING FINANCE SYSTEMS 

SEPTEMBER 29, 2010 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KAY BAILEY HUTCHISON, Texas 

EDWARD SILVERMAN, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

DAWN RATLIFF, Chief Clerk 

WILLIAM FIELDS, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON SECURITY AND INTERNATIONAL TRADE AND FINANCE

EVAN BAYH, Indiana, Chairman 

BOB CORKER, Tennessee, Ranking Republican Member 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

MICHAEL F. BENNET, Colorado 

CHRISTOPHER J. DODD, Connecticut 

ROBERT F. BENNETT, Utah 

ELLEN CHUBE, Staff Director 

COURTNEY GEDULDIG, Republican Staff Director 

(II)
C O N T E N T S 

WEDNESDAY, SEPTEMBER 29, 2010 

Page 

Opening statement of Chairman Bayh .................................................................. 1 

Opening statements, comments, or prepared statement of: 

Senator Corker .................................................................................................. 3 

WITNESSES 

Michael J. Lea, Director, The Corky McMillin Center for Real Estate, San 

Diego State University ........................................................................................ 4 

Prepared statement .......................................................................................... 26 

Susan M. Wachter, Richard B. Worley Professor of Financial Management, 

Professor of Real Estate, Finance, and City and Regional Planning, The 

Wharton School, University of Pennsylvania .................................................... 7 

Prepared statement .......................................................................................... 108 

Alex J. Pollock, Resident Fellow, American Enterprise Institute ....................... 9 

Prepared statement .......................................................................................... 110 

(III)

(1) 

A COMPARISON OF INTERNATIONAL 

HOUSING FINANCE SYSTEMS 

WEDNESDAY, SEPTEMBER 29, 2010 

U.S. SENATE, 

SUBCOMMITTEE ON SECURITY AND INTERNATIONAL TRADE AND

FINANCE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Subcommittee met, pursuant to notice, at 2:36 p.m., in room 

SD–538, Dirksen Senate Office Building, Hon. Evan Bayh, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN EVAN BAYH 

Chairman BAYH. If the Subcommittee would please come to 

order. Good afternoon. I am pleased to call to order this Subcommittee hearing entitled, ‘‘A Comparison of International Housing Finance Systems.’’ I want to thank and welcome my colleague 

in attendance, Senator Corker, and I am happy to say that we have 

had an excellent working relationship, to show that Democrats and 

Republicans can cooperate together when the spirit so moves us. 

So, Robert, it is great to be with you once again. As a matter of 

fact, if I have to absent myself later, I have such trust and confidence in my colleague, I will hand him the gavel. 

[Laughter.] 

Chairman BAYH. Which does not happen much here on Capitol 

Hill, but it will be in good hands when it is in his. He was, in fact, 

the impetus behind holding this hearing and having this important 

discussion today. 

To our three distinguished and learned witnesses that appear before us today, welcome and thank you for your testimony. 

All three of the academics on our panel have extensive research 

and practical experience in the area of housing finance, with a particular expertise in the systems of developed nations abroad. I understand that two of our witnesses have traveled to be with us here 

today, and so I want to thank you for your time and consideration 

with regard to the Subcommittee’s deliberations. Thank you for literally going the extra mile. 

I look forward to our dialog today, but, unfortunately, due to 

some last-minute scheduling constraints, I may be unable to stay 

for the entirety of the hearing. I am confident, however, that given 

Senator Corker’s keen interest in this issue and the appeal of the 

subject matter, we will still have a lively and informative discussion. 
2 

If the witnesses will indulge me, I may have a few written followup questions for you to be submitted for the record on certain topics that are not covered in the question-and-answer portion of today’s hearing. I promise they will not be too voluminous. 

Before we turn to the panel, I would like to give a few very brief 

remarks to provide some context for this hearing and what the 

Subcommittee would like to achieve today. And I invite Senator 

Corker to do the same when I am done. 

Today we convene as a Subcommittee to gain insight into the legislative challenge facing Congress as it considers reforms to our 

housing finance system. This is a critical economic policy issue that 

affects virtually all of those involved in the housing market: homeowners, potential borrowers, financial institutions, investors, realtors, construction, and I could go on and on. 

Many with an interest in reform are already hard at work. Last 

month, the Treasury Department held a conference on the future 

of housing finance. Some of our witnesses today participated in 

that conference, and it proved to be a worthwhile and substantive 

meeting. 

Just last week, Assistant Secretary Barr reiterated the Treasury 

Department’s intention to release a plan that will call for fundamental change by January 2011. This debate has the potential to 

become political and polarizing, but that should not prevent us 

from addressing such a consequential issue in a pragmatic fashion. 

It is the responsibility of Congress to tackle how to build a more 

stable housing finance system, with an understanding of what went 

wrong with our current system and what we can do together, given 

the economic realities, to fix it. 

To assist in that endeavor, we hold today’s hearing to explore the 

housing finance models of other developed nations, including, but 

not limited to, Canada, Denmark, the United Kingdom, Australia, 

and Germany. We will hear from the witnesses on how the housing 

finance systems of these countries differ from the United States’, 

the strengths and weaknesses of their product approach, and 

whether any lessons may be learned from their experiences prior 

to enduring the global economic crisis. More importantly, we hope 

to learn whether any aspects of their systems and policies or regulatory frameworks may be adapted to our system here in the 

United States. 

As a lead-in to that discussion, I would note that some of the policy approaches of other nations are seemingly difficult to reconcile 

with the economic data. For instance, most developed countries experienced robust growth in their housing and mortgage markets 

during the first half of the decade. Some countries also experienced 

record levels of house price inflation, relaxed underwriting standards, and increased competition. Still, no other major developed nation has experienced the type of house price decline, the staggering 

default and foreclosure rates, and drastic change to their mortgage 

finance system that the U.S. went through. Why is that? What 

have they done differently? 

At the same time, Australia, Ireland, Spain, Canada, and the 

U.K. all have higher or comparable rates of home ownership to the 

U.S., but these countries provide far less government support. In 

fact, the U.S. is unique in that it provides preferable tax treatment 
3 

for owner-occupied housing and it uses all three types of Government support: support of mortgage institutions or guarantee programs, mortgage insurance, mortgage guarantees, and Government-sponsored mortgage enterprises. 

How did they achieve those rates of home ownership without the 

Government subsidies or the types of programs that we offer here 

in the U.S.? 

In addition, some of those same jurisdictions have far stricter underwriting standards for loans and a limited number of mortgage 

products available to borrowers, with arguably less preferential 

terms, but still maintain high home ownership rates. How do we 

reconcile that paradox? 

These are just a subset of the issues we seek to explore with our 

witnesses today as we learn more about our counterparts to the 

north and abroad and how they deal with housing finance and confront the challenges and asset bubbles. 

I welcome our witnesses’ insights and perspectives on this pressing issue and gathering what we can from other nations’ experiences. Thank you all. 

Senator Corker. 

STATEMENT OF SENATOR BOB CORKER 

Senator CORKER. Well, thank you, Mr. Chairman. I very much 

appreciate your working to cause this meeting to take place. 

I want to thank our witnesses, who are outstanding. And, you 

know, the fact is that this year we are probably not going to do 

anything as it relates to housing finance, but next year we probably will, and I think understanding what has worked and what 

has not worked in other places will be helpful. I think a lot of times 

we have these myths or these built-in issues into the DNA here as 

it relates to housing finance, and sometimes looking in other places 

we can learn from that. 

So I very much appreciate you being here today. I know that we 

are at the wind-down and there is not a lot of activity as far as 

people thinking about policy. But this will be very, very helpful to 

us as we move ahead this next year, and I thank all of you for coming, and I certainly look forward to the Chairman introducing you. 

Chairman BAYH. Thank you, Senator Corker. 

I am going to ask that the introductions of our three witnesses 

be included in their entirety in the record. You all have such great 

experience and so many credentials, I am not going to take your 

time by reading them all. I will just kind of hit the highlights starting from our perspective with you, Dr. Lea, and then moving to the 

rest of the panel. 

Dr. Michael Lea is the director of the Corky McMillin Center for 

Real Estate at San Diego State University. I have already just 

mentioned that Dr. Lea is an international authority on housing 

and mortgage finance and has published over 75 articles and book 

chapters, including the editing and coauthoring of an influential 

World Bank publication on emerging market housing finance in 

2009. 

I am sure your book went higher on the Amazon scale than mine 

did, Doctor. 
4 

He has over 25 years of financial services industry experience, 

including more than 18 years of international advisory work in 28 

countries spanning six continents. He has taught at Cornell University, San Diego State University, the University of California– 

San Diego, and the Wharton International Housing Finance Program at the University of Pennsylvania. Wharton is well represented here today. He receive his Ph.D. in economics from the 

University of North Carolina at Chapel Hill. 

Welcome, Dr. Lea. 

Next we have Dr. Susan Wachter—I hope I pronounced that correctly, Doctor—the Richard B. Worley Professor of Financial Management, Professor of Real Estate and Finance, codirector at the 

Institute for Urban Research, the Wharton School, University of 

Pennsylvania. Dr. Wachter is codirector and cofounder of the Penn 

Institute for Urban Research, has served as president of the American Real Estate and Urban Economics Association, and is coeditor 

of Real Estate Economics. She was appointed Assistant Secretary 

for Policy Development and Research at HUD and served from 

1998 to 2001, where she was principal adviser to the Secretary, responsible for national housing and urban policy. Dr. Wachter received her B.A. from Harvard College, which in our part of the 

country, Doctor, we refer to as the Indiana University of the East. 

[Laughter.] 

Chairman BAYH. And her Ph.D. from Boston College. Welcome, 

Dr. Wachter. 

Next we have Alex Pollock, Resident Fellow of the American Enterprise Institute. Mr. Pollock joined AEI in 2004 after 35 years in 

banking. He was president and chief executive officer of the Federal Home Loan Bank of Chicago from 1991 to 2004. He is also the 

author of numerous articles on financial systems and the organizer 

of the ‘‘Deflating Bubble’’ series of AEI conferences. He is a director 

of the Chicago Mercantile Exchange—you employ many people in 

my State, which we appreciate, Mr. Pollock—the Great Lakes 

Higher Education Corporation, the International Housing Union 

for Housing Finance, and the Chairman of the Board of the Great 

Books Foundation. Mr. Pollock is a graduate of Williams College, 

the University of Chicago, and Princeton University. Welcome, Mr. 

Pollock. 

Dr. Lea, why don’t we begin with you. Just as a rule of thumb— 

and I do not intend to enforce this strictly, but if you have got a 

lengthy statement, if you could kind of summarize it in 5 minutes 

or so, give or take, and then we could submit the rest to the record. 

And as I said, if you go over a little bit, that is not a big deal. But 

if you can kind of keep it in that ball park, that would be great. 

And then we will go to a round of questions after all three of you 

have finished your statements. 

STATEMENT OF MICHAEL J. LEA, DIRECTOR, THE CORKY 

MCMILLIN CENTER FOR REAL ESTATE, SAN DIEGO STATE 

UNIVERSITY 

Mr. LEA. Great. Thank you, Mr. Chairman and Ranking Member 

Corker and Members of the Subcommittee, who will see it in the 

record, I guess. As you said, I am Michael Lea, and I am the director of the Corky McMillin Center for Real Estate at San Diego 
5 

State, and as Mr. Chairman’s introduction, I have had extensive 

experience in working and doing research in international mortgage markets now for more than 20 years. 

I recently completed a comparative study of developed country 

housing finance systems that is going to be published by the Brookings Institution later this fall as well as a comparative study of 

mortgage instrument design which was released this week by the 

Research Institute for Housing America. And I would ask that both 

of these papers be entered into the record. 

Chairman BAYH. Without objection. 

Mr. LEA. Thank you. 

I would like to start by looking at the U.S. owner-occupied mortgage markets in an international context. Our market is internationally unusual in several respects. First, the U.S. has a more 

extensive role of Government in our mortgage market than other 

countries. The U.S. Government backs over 50 percent of the stock 

of mortgage debt and over 95 percent of the new flow. Only Canada 

comes close, with approximately 50 percent of its loans directly or 

indirectly insured by the government, and about 25 percent of Canadian mortgage-backed securities have a government guarantee. 

Japan is the only other major developed market with a government 

security guarantee program, and the Netherlands is the only other 

market with a government-backed insurer. I did a study of about 

11 or 12 major developed markets for this work. 

No other developed market has a Government-sponsored enterprise, as you said earlier. No other market has quantitative housing goals or CRA-type legislation. 

The U.S. is also unusual in the preponderance of the long-term 

fixed-rate mortgage and funding through securitization. Currently 

over 90 percent of U.S. new originations are fixed-rate mortgages, 

and in most years, they have a 70-percent market share. The only 

other countries with predominant market share in long-term fixedrate mortgages are Denmark and France. The dominant instrument in other countries is either an adjustable-rate mortgage, such 

as Australia, Spain, or the U.K., or a short- to medium-term fixedrate, sometimes called a rollover, mortgage with a longer amortization period, such as in Canada, Germany, and the Netherlands. 

Over 60 percent of U.S. mortgages have been securitized and 

over 90 percent of current originations are funded through 

securitization. Internationally, Canada, Spain, and the U.K. have 

funded approximately 25 percent of the mortgages through 

securitization. In other countries, that markets share is quite less. 

The predominance of fixed-rate mortgages and securitization in 

the U.S. is causally linked. Experience has shown that capital market financing is necessary to manage the risk of such mortgages. 

Their dominance is both a function of and a rational for Government involvement. The Government effectively subsidizes fixedrate mortgages through the Government-sponsored enterprises and 

Ginnie Mae, the guarantees for which reduce the relative cost of 

this instrument. Investors in fixed-rate mortgages like Government 

guarantees so they do not have to worry about credit risk, only the 

underlying cash-flow risk caused by long amortization and frequent 

prepayment. 
6 

Thus, supporters of Government-sponsored enterprises argue 

that Government guarantees are needed to continue offering the 

fixed-rate mortgage. Without such guarantees, fixed-rate mortgages, in my opinion, would still exist but they would be more expensive and there would be a smaller market share. 

What has been the result of these policies? The U.S. does not 

have a higher home ownership rate than in many other countries, 

as you indicated in your introduction. In my survey of 11 major developed markets, the U.S. was in the middle. The U.S. does not 

have a deeper mortgage market, either. A number of countries 

have higher ratios of mortgage debt outstanding to GDP. The U.S. 

market was unequivocally the worst-performing market during the 

crisis, with significantly higher rates of default and foreclosure. 

There are many factors contributing to its poor performance, but 

the role of Government lending incentives and the crowding out of 

lower-risk lending by Government entities are significant contributors. 

So what can we learn from the experience in other countries? 

The role of Government in fostering home ownership through tax 

incentives and lending programs has not resulted in higher rates 

of home ownership, rather contributed to a pronounced boom and 

bust that continues to plague the economy. International experience suggests that sustainable home ownership and mortgage indebtedness can be achieved without such a large role of the Government. 

What can replace the Government-dominated funding model that 

now characterizes the U.S.? The Danish model offers several areas 

for improvement. The Principle of Balance results in a one-to-one 

correspondence between a mortgage loan and a bond that finances 

it. If mortgage rates fall, the borrower can refinance, as in the U.S. 

today. If interest rates rise, the borrower, through their mortgage 

lender, can repurchase the bond at a discount and cancel the mortgage. In this way the borrower can reduce debt and, therefore, the 

likelihood of negative equity in a rising interest rate environment. 

This feature could also reduce the significant extension risk that 

mortgage-backed security investors face in the U.S. today. With rising rates, the effective maturity of mortgages is going to be rising 

over time. 

The highly efficient Danish mortgage market is funded through 

corporate bonds in which the credit risk stays on the balance sheet 

of the lender, thus aligning incentives. The Danish model could be 

implemented initially by Fannie Mae and Freddie Mac, ultimately 

transitioning to a private model. 

The Canadian–European combination of the rollover mortgage 

and covered bond financing has desirable characteristics as well. 

For example, a 5-year fixed-rate mortgages with a 30-year amortization provides significant, though not complete, insulation of the 

borrower from interest rate risk, particularly given the fact that 

the average homeowner moves every 5 to 7 years here in the U.S. 

A shorter fixed-rate period reduces the risk for the lender and investor and will result in lower relative mortgage rates. 

A key characteristic of this model is the ability of lenders to 

charge prepayment penalties during the fixed-rate period. The penalties allow lenders to issue very simple bullet bonds or fund the 
7 

loans through swap deposits. While prepayment penalties got a bad 

reputation during the subprime lending crisis here, they do serve 

a valuable function and are common outside the U.S. 

In conclusion, I believe there is much the U.S. could learn from 

international experience, and I look forward to your questions. 

Thank you. 

Chairman BAYH. Thank you very much, Dr. Lea. 

Dr. Wachter. 

STATEMENT OF SUSAN M. WACHTER, RICHARD B. WORLEY 

PROFESSOR OF FINANCIAL MANAGEMENT, PROFESSOR OF 

REAL ESTATE, FINANCE, AND CITY AND REGIONAL PLANNING, THE WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA 

Ms. WACHTER. Chairman Bayh, Ranking Member Corker, thank 

you for the invitation to testify. 

The United States belongs to a group of countries that suffered 

particularly severe recessions driven by sharp housing price crashes. Other countries in this category include the United Kingdom 

and Spain. On the other end of the spectrum are countries where 

home prices merely leveled from 2007 to the present, resulting in 

no or mild recessions. This category encompasses Canada, Australia, and Germany. Denmark lies somewhere in the middle, with 

a late bubble and current downturn. By comparing these two 

groups, we can investigate what causes and what prevents housing 

bubbles and financial crises. In a forthcoming paper with colleagues, cited in my written testimony, we conduct just such an investigation, and we find that two institutional differences separate 

these groups: the role of mortgage insurance and the strictness of 

regulations countering the market’s tendency toward procyclical behavior. 

No country better exemplifies this procyclicality in housing and 

mortgage markets than the United States. With economic growth 

and low interest rates coming out of the recession of 2000–2001, 

mortgage lenders and securitizers increased lending and competed 

for market share among borrowers. When the available market was 

satiated, they expanded the market by lowering their standards. 

Eventually, borrowers found themselves with too much debt to 

repay, and the downward spiral of foreclosures, defaults, and home 

price declines resulted in the crisis we have today. 

While lending standards deteriorated, the extent to which this 

was occurring was unknown due to information opacity. I go 

through a short description of what happened in the United States 

to compare it to other countries. 

Contrast this experience to that of Canada, where regulators 

mandate that all high loan-to-value mortgages must be covered by 

mortgage insurance. This practice has not inhibited Canada from 

achieving levels of home ownership on par with those of the U.S. 

at their peak in 2004. Canada and in this period Australia, which 

also shows a high rate of home ownership, relied on mortgage insurers as a ‘‘third-party regulator’’ with the result that mortgage 

lending standards did not deteriorate and housing prices did not 

collapse. Mortgages in Australia and Canada were and are typically short-term variable rate, or in the case of Canada, rollover, 
8 

and were originated and to a large extent held in portfolio by 

banks. Both countries avoided recessions, home ownership, as I 

said, has been maintained at high levels, and their banking systems have been able to continue lending as the crisis has caused 

financial systems in other countries to stop functioning. 

The structure of the dominant mortgage product is also critical 

to preventing procyclicality. Most countries rely on adjustable-rate 

mortgages or rollover mortgages provided by banks and held in 

bank portfolios. The U.S., Denmark, and to a lesser extent Germany are the three notable exceptions, favoring fixed-rate mortgages or relatively long-term fixed-rate mortgages. ARMs place the 

interest rate risk on the borrower, who is not well suited to bear 

this risk. When interest rates rise, borrowers have difficulty making payments and may be forced to default. ARMs are also less conducive to systemic stability, as exhibited during the current economic crisis here and elsewhere. During the housing bubble, 

securitizers’ appetite for market share drove them to underwrite 

riskier adjustable-rate mortgages from less creditworthy borrowers. 

The U.K. and Spain also relied on ARMs with deteriorating lending 

standards. All countries with ARMs saw their lending dry up during the credit crunch with borrowers not able to refinance even 

though it was assumed that refinancing would always be possible. 

With ARMs that need to be repaid or refinanced, the illiquidity of 

the system may be transformed as in these countries into a solvency or foreclosure crisis. 

Building a system around the fixed-rate mortgage requires a secondary market. In my written testimony, I go into more detail as 

to why. 

Unlike the private label securities of ARMs, securitization allows 

a fixed-rate mortgage that would otherwise not exist. In Germany, 

a secondary market exists in the former of covered bonds, identified 

as ‘‘Pfandbriefe,’’ that are secured by standardized mortgage loans, 

which the quality of the standardized mortgage loans was not allowed to be undermined over time. 

But without proper regulation, covered bonds can get a country 

into trouble. German regulators ensure that investors get periodic 

updates on the state of the collateral securing their covered bond, 

and they do not allow covered bonds to be secured by loans with 

an LTV ratio above 60 percent. Unlike in the U.S., these regulations were not eroded during the housing bubble. Denmark also relied on covered bonds and had similarly stringent regulations until 

recently. When Danish legislation moved the system toward interest-only mortgages, the market joined the housing mania and developed a late bubble that subsequently deflated, causing the current recession in Denmark. Similarly, Spain used covered bonds extensively, yet they did not have fixed-rate mortgages; they used 

covered bonds to finance adjustable-rate mortgages. The Spanish 

banks, the savings banks, cajas, securitized ARMs through cedulas 

in an effort to generate fees and gain market share, generating a 

bubble and crisis that is severe, with Spain now suffering 20 percent unemployment. In the face of rising prices, it is tempting to 

lower lending standards, as occurred in these countries, contributing to procyclicality. 
9 

Most countries do have significant involvement of governments 

in housing and mortgage markets. Now, Canada, as we have just 

heard, provides catastrophic mortgage insurance to most of its 

mortgage market. In other countries, when the housing market is 

in crisis, when the entire system is in danger, there is a rescue. 

The British rescue of Northern Rock preceded the American bailouts; the Spanish government has intervened to protect the cajas 

and their covered bonds. To prevent a foreclosure crisis from driving an economy into a severe recession or depression, governments 

will intervene; thus, it is necessary to regulate the housing market 

before it reaches the crisis stage. The taxpayer owns the tail risk. 

Rather than raise lending standards after the fact, we can prevent 

the problems of moral hazard, shrinking equity, and bailouts by 

maintaining standards and transparency. 

In closing, the clearest difference between the U.S., the U.K., and 

Spain on the one side and Australia, Canada, and Germany on the 

other side is the stability of regulation. The first group allowed 

lending standards and capital requirements to decline, stoking the 

procyclical behavior that created a housing bubble and economic 

crisis, while the latter group maintained rules in the face of market 

pressure. 

Thank you. 

Senator CORKER [presiding]. Go ahead, Mr. Pollock. 

STATEMENT OF ALEX J. POLLOCK, RESIDENT FELLOW, 

AMERICAN ENTERPRISE INSTITUTE 

Mr. POLLOCK. Thank you, Mr. Chairman. 

As you mentioned in your opening comment, it is without doubt 

the case that it is very useful to examine American housing finance 

in an international perspective. When we do, we discover one thing 

unique in the world about American housing finance, and that was 

the dominant and disproportionate role played by Governmentsponsored enterprises—that is, Fannie Mae and Freddie Mac. 

With Fannie and Freddie so prominent, many Americans, including Members of Congress, including the two gentlemen I had lunch 

with today, thought that America had the highest home ownership 

rate in the world. As you have pointed out, we did not and we do 

not. 

In my written testimony, there is a table of comparative home 

ownership rates. Michael has 11; I have 26 advanced countries in 

my table, and I think it is about as up to date as it can be. The 

U.S. ranks 17th in this list among advanced countries, or about 

two-thirds of the way down the list, in home ownership. And as I 

say, that table is in my written testimony. 

Many countries achieve home ownership levels as high or higher 

than ours with no GSEs. Various housing finance systems operate 

without tax deductions for the interest on home mortgages, without 

our highly unusual practice of making mortgages into nonrecourse 

debt, and without government CRA-like mandates to make riskier 

loans, without 30-year fixed-rate loans, and with prepayment fees 

on mortgages. 

Of course, as bubbles and busts in these other countries show, 

you can also get in trouble with different systems. That is a gen-
10 

eral rule, I take it, of finance. You can always get into trouble in 

finance. 

The better credit performance of Canada and Canadian housing 

finance has been well known, and, indeed, Canada has mortgage 

delinquencies which are a small fraction of ours. Canadian mortgage lenders have full recourse to the borrower’s other assets and 

income, in addition to the security interest in the house. The fact 

that there is no tax deduction for interest probably increases the 

incentive to pay down the debt over time. Most Canadian mortgage 

payments are made through automatic debit of the borrower’s 

checking account and can be matched to the frequency and timing 

of the paycheck. It is a technical but I think very important point 

in terms of the behavior of borrowers. 

With this relative credit conservatism, as has been pointed out, 

Canada’s home ownership rate is 68 percent compared to 67 percent for us, and Canada does have a government body to promote 

housing finance, which has a very substantial role, as my colleagues on the panel have said, the Canada Mortgage and Housing 

Corporation, or CMHC. But at least CMHC’s status, unlike the 

American GSEs, is completely clear and honest. It is a 100-percent 

government-controlled corporation. Its government guarantee is 

completely explicit. It provides housing subsidies which are on 

budget and have to be appropriated by the Parliament. 

Canada in this respect, therefore, looks superior to the U.S. in 

candor, as well as credit performance. It has, however, had a big 

run-up in its house prices over the last decade, and this is shown 

in my written testimony. In response to this, Canadian regulators 

have taken actions to decrease the maximum loan-to-value ratios 

on some classes of mortgages, and such countercyclical movements 

in LTV limits, in my opinion, are an excellent idea and are, indeed, 

necessary to moderate the inevitable cycles in real estate credit. 

As has been discussed, the most perfect housing finance solution 

in theory, which also functions very well in practice in an admittedly small country, is the housing finance system of Denmark, 

which has been admired by many observers. The interest rate and 

prepayment characteristics of long-term fixed-rate loans in the system are passed entirely on to investors in Danish mortgage bonds. 

But at the same time, there is a total ‘‘skin in the game’’ requirement for credit risk. The lending mortgage banks retain 100 percent of the credit risk of the loans. Deficiency judgments, if foreclosure on a house does not cover the mortgage debt, are actively 

pursued. 

Some years ago, before the fall of Fannie and Freddie, I participated in an exchange with the Association of Danish Mortgage 

Banks. The idea was that they explained their bond-based and 

skin-in-the-game-based system to me, and I explained the American GSE-centric system to them. 

When I had finished my presentation, the CEO of one of the 

leading Danish mortgage banks said this: ‘‘In Denmark we always 

say that we are the socialists and America is the land of free enterprise,’’ he said. ‘‘Now I see that when it comes to mortgage finance, 

it is the opposite!’’ And, indeed, I think that is an insightful statement. 
11 

In my written testimony, I also discuss some other countries, including two ideas from Germany worth pursuing, one being covered 

bonds and the other being an emphasis on savings as part of housing finance, which has not been mentioned yet, Mr. Chairman. We 

need to rediscover the idea of savings as part of what we are doing 

in housing finance, as the old name savings and loan would indicate. 

Well, America’s GSE-centric housing finance system has collapsed, with massive taxpayer expense, as did the former thriftbased system which preceded it. 

The international perspective suggests that there is every reason 

to think broadly about how to develop a better, post-GSE U.S. 

housing finance system for the future. 

Senator CORKER. Thank you all for your testimony, and I think, 

to sort of shorten the chase here, if you will, Mr. Pollock, why do 

we not just start with that and have each of you, if you will, describe without the built-in DNA that exists around what we have 

in our own country, based on what each of you know about other 

countries and what you have seen here, if we were—because that, 

I think, is where we are going to try to go this next year—if we 

were going to design a housing finance system that worked in this 

country, taking into account the cultural aspects over the last 50 

years that have developed around housing, what would it be? 

Mr. POLLOCK. Do you want me to start, Mr. Chairman? 

Senator CORKER. Yes. 

Mr. POLLOCK. In my opinion, it would have a much bigger role 

for a truly private market. That is to say, the vast bulk of the residential market, which is the middle-class what we call conforming 

or prime mortgage market of the size that the vast bulk of the population borrows to buy houses that are in the middle of the distribution, would be a fully private market. 

I have the notion that among the participants in this market 

would be the privatized parts of Fannie Mae and Freddie Mac in 

the future, when they leave behind their bankrupt old business. 

But that needs to be a private market, and I think on that basis 

it would work well and it would succeed in delivering a better resource allocation that is not warped and distorted by all kinds of 

government subsidies and guarantees. 

For that part of the system which we would choose to subsidize 

or to do credits which a market would not do, I think that should 

be a purely and explicitly government activity, as it is in Canada, 

where the subsidies, instead of being hidden in GSEs and be able 

to allow those GSEs to exert significant political clout, those subsidies and nonmarket financings should all be explicitly in the government, have to be approved and appropriated by the U.S. Congress. So in that way, I think we would look more like other countries and we would have a superior economic model. 

Just two other points. I think that it does make sense to think 

about covered bonds as an alternative financing. As my colleagues 

have pointed out, if you want to have fixed-rate mortgage loans, 

you have to have a bond market financing. You cannot finance 

long-term fixed-rate mortgage loans on a deposit basis, and in this 

country the banks are not big enough to finance the whole mortgage market anyway. And covered bonds, I think, make an alter-
12 

native which should be explored. That alternative needs to have a 

statutory basis so the bond holders are truly given certainty about 

their collateral. And I agree with Dr. Wachter that the loans in 

such covered bonds should be conservatively underwritten loans. 

And then finally, as I said, we need to rediscover savings and an 

emphasis on saving to enter into the housing market and paying 

down the mortgage as a source of long-term savings, so that in the 

very old fashioned but correct idea you actually end up owning the 

house as you get older. 

Senator CORKER. What would the government subsidy that you 

are talking about that would be transparent, that subsidy would be 

directed at what? 

Mr. POLLOCK. Well, Mr. Chairman, of course, it would be directed at whatever the Congress decided it would be directed at, 

but typically—— 

Senator CORKER. But you are developing this—— 

Mr. POLLOCK. ——but typically low-income households who are 

trying to enter into home ownership but still have a very good 

chance of performing successfully on the debt which they undertake. Certainly, this system has to have, or should have as part of 

what we do in the future, very clear, simple, and transparent information provided to borrowers about the credit commitments they 

are making so they really understand the commitments they are 

signing up for and they can underwrite themselves, as I like to say. 

It is much more important to underwrite yourself as a borrower, 

can I do this, than for somebody else to underwrite you. 

And you, of course, never do anybody a favor by making them a 

loan they cannot afford, whether you are the government or whether you are a private factor, and we want to avoid that. 

Senator CORKER. Generally speaking, do other countries—are 

there a lot of other countries around the world that have subsidies 

for—— 

Mr. POLLOCK. Yes. 

Senator CORKER. ——for lower-income citizens? 

Mr. POLLOCK. Yes, in advanced countries. 

Senator CORKER. And they are interest rate subsidies, is that 

what you are talking about? 

Mr. POLLOCK. I think they are typically—actually, Michael would 

know this better than I, but I think they are typically credit availability programs or—and there are often rental subsidies, as well. 

A lot of countries use these subsidies, including Canada, as a rental program, government program for low-income housing. 

Senator CORKER. And for the middle- and upper-income citizens, 

would there still be—would you, if you could design it, still focus 

on long-term fixed-rate mortgages, or would you just let the market 

determine that—— 

Mr. POLLOCK. I would definitely have long-term fixed-rate mortgages in a system, because I think they would naturally evolve. 

But I think Dr. Lea is right. They would be a smaller part. They 

would probably be somewhat higher priced. And houses would be 

less expensive because you know that the most fundamental proposition in all economics is that not only lunches, but nothing is free, 

and all of the subsidies we put into housing finance merely go to 
13 

make houses more expensive. So the home buyers do not win in the 

end. 

Senator CORKER. Dr. Wachter. 

Ms. WACHTER. I agree with much of what Dr. Pollock has said. 

I do want to take a small exception to the last comment. While it 

is true that housing subsidies do raise prices some places in the 

United States, not all throughout the U.S. Housing is elastically 

supplied in much of the U.S., and in that case, it does not have 

that impact. 

But I specifically do agree with the need for subsidies and the 

need for them to be explicit. I also, as you know from my comments, I do think it is extremely important, particularly at this 

time, for there to be the necessary institutions to support the longterm fixed-rate mortgage. We are at a point of historically low interest rates. If interest rates were to rise, let us say, 20 percent, 

30 percent, in a world with an adjusted-rate mortgage, that would 

be equivalent to a 20, 30 percent rise in mortgage payments, which 

could create a crisis of similar dimensions of the crisis that we had 

if across the board mortgages went up that much, and perhaps in 

some cases doubled. If rates doubled, this would basically take people from, let us say, 30 percent of their income to 60 percent of the 

income. It is for this reason that countries that have reliance on 

adjusted-rate mortgage are attempting to create fixed-rate mortgage and move away from adjusted-rate mortgages. 

Also, there is a problem that the U.K. has spoken of, and it is 

in the Miles report, of some hesitancy to use monetary policy when 

necessary because of the fear of rising interest rates and what it 

would do to destabilize not only individual homeowners, but indeed 

the entire economy. 

So we are fortunate in having a fixed-rate mortgage. What we 

are not fortunate, obviously, what cratered our system was the deregulated private-label securitization that undermined lending 

standards. That happened nowhere else. In fact, Canada was considering a subprime mortgage market. They came to me, among 

others, to write a report to advise on that. This was in 2004. Many 

people submitted a report—I did—and advised against their moving to allowing a subprime mortgage market. 

Canada, as we have heard, does have great involvement in the 

mortgage market. Specifically, it has also recourse mortgages. Recourse mortgages really could not work in the United States. Because of our bankruptcy law, that is not really an option for us. 

And so we have for every reason, then, to be even more determined and careful in our regulation of our mortgage system so that 

we do not have crises which end up being taxpayer funded. 

So let me go back to your question of what, then, would we take 

from other systems. Systems of both Denmark and Germany have 

much in them for us to model, particularly, as Dr. Pollack has said, 

they have in their securitized—and they use covered bonds, but, in 

fact, covered bonds when regulated well are not so dissimilar from 

mortgage-backed securitization that is regulated well. These securities that go into the covered bonds are, indeed, transparent. They 

are standardized. They are—information on them is maintained 

over time. 
14 

This is significantly monitored, and it is key if we are to have 

securitization that we monitor, from my perspective, what goes into 

the securitized entities for housing finance, because capital markets will always be subject to shocks. There is no way of stopping 

that. The shocks will then be transferred through the securitization 

to the housing market. If at the same time in a procyclical way the 

securitization standards are undermined, then we will, of course, 

have what we have today and it will be recurrent. 

So to avoid both of these problems, I absolutely am in favor of 

a fixed-rate mortgage. By the way, if you just have adjusted-rate 

mortgages, you are basically reliant on your banking system and 

banking systems across the world have cratered, as we are well 

aware. Japan has had, through a kind of savings and loan crisis 

which got even larger, a basic real estate crisis beyond that, two 

decades of slow to no growth. 

So a banking system mortgage-based finance does not prevent 

crises, either. In both cases, transparency, risk monitoring by the 

private sector as well as the public sector, is necessary. 

Senator CORKER. So Mr. Pollock mentioned, I think, that the 

only involvement government had in his model would be on the 

subsidizing lower-income portion. As it relates to fixed-rate mortgages from your viewpoint, would that also—would you have government involvement, and middle- and upper-income loans also? 

Ms. WACHTER. Absolutely, as there is in Canada. There would be, 

as in Canada, a provision of catastrophic mortgage insurance that 

would be priced. It would be explicitly priced. 

Senator CORKER. And how does the insurance work in Canada? 

Ms. WACHTER. I think perhaps Dr. Lea might be able to give us 

more details on how it works, but my understanding is that both 

the private insurers, of which there are two, do have a backstop of 

catastrophic insurance if there is a crisis, as well, of course, as the 

mortgages that are insured through CMHC. 

Senator CORKER. And they are insuring the mortgage, but not 

the entity that actually—— 

Ms. WACHTER. And that is exactly where I would go. I would go 

to issuers of mortgages that are securitized that have a wrap on 

the mortgage-backed securities, but the first loss would be the private equity which would be at the risk and the companies themselves would be absolutely at risk. 

It would seem to me you could also have, although you are never 

going to get away from the risk of catastrophic insurance, you 

would also potentially have companies which are issuing mortgages, securitized, without a wrap. But that would require, from 

my perspective, that the mortgages in these securities be well understood, well vetted, tracked real time for their potential risk. 

Senator CORKER. Why do you not go ahead and jump in, Dr. Lea. 

Mr. LEA. OK. Several comments and responses. In my view, an 

ideal housing finance system should have diversity in both instruments and in funding sources. I think a model that has almost all 

of its loans being fixed rate has problems and issues because of the 

risks associated with that to investors. I would also point out, in 

a rising interest rate environment, affordability problems are going 

to be exacerbated by the inflation premium that is built into longterm fixed-rate mortgages. 
15 

Likewise, as Dr. Wachter says, I do not think it is wise to have 

an entirely adjustable rate system where you have potentially significant payment shock for a wide part of the population. Rather, 

I would like to see some of both, where borrowers and lenders selfselect with regard to the interest rate risk carrying capacities of 

the different borrowers. 

For example, in Canada, they have this rollover mortgage. While 

the typical fixed-rate term is 5 years, so this would be a 30-year 

amortization mortgage but typically fixed for 5 years, the borrower 

can select between a 1-year, a 3-year, a 5-year, or in some cases 

even a 10-year fixed rate period. So that does allow the borrower 

to manage interest rate risk to a degree, because if they think rates 

are high and going to fall, then they can go into a shorter-term 

fixed rate. If they think rates are low and going to rise, they would 

pick a longer-term fixed rate. 

I would also point out in the adjustable rate world, such as in 

the U.K., talking to the Council of Mortgage Lenders, for example, 

they credit the adjustable-rate mortgage for actually reducing defaults during the crisis because interest rates and payments have 

come down quite a bit. This is also the case of Australia. Though 

I fully agree with Dr. Wachter that we are now at historic lows and 

we are going to see significant increases going forward. 

A couple other comments. With regard to subsidy, I just do not 

think it is generally a good idea to subsidize interest rates or to 

push the market toward particular products. I think from the subsidy kind of standpoint, what we should do is focus on affordability. 

I would note that both Australia and Canada have first-time homebuyer tax credit programs. They do not have the mortgage interest 

tax deduction. The mortgage interest tax deduction does very little 

to stimulate home ownership. In fact, most of its effect is as a regressive subsidy to higher-income people as well as being capitalized in the house prices. 

And so if we are talking about an ideal world, I would gradually 

phaseout home mortgage interest deduction, but I would put in its 

place some form of first-time homebuyer tax credit which is targeted toward first-time buyers. It could also be targeted toward 

lower-income. 

I also point out that other countries do subsidize rental housing 

more extensively than we do. In most countries that I looked at, 

the types of voucher programs that assist lower-income renters are 

entitlements. You qualify, you get it, as opposed to the U.S. where 

they are still effectively rationed and there is excess demand for 

those kinds of subsidies. 

I agree with Dr. Wachter on the efficacy of the mortgage insurance. I think that using mortgage insurance initially through private mortgage insurers and having the government insurance backstop is a good idea. In Canada, the government provides a 90 percent backstop, catastrophic backstop, to private insurers. That was 

done primarily to try to level the playing field between the government insurer and the private insurers. 

I would disagree with one thing with Dr. Wachter, though I have 

not looked at this from a legal standpoint, but the contention that 

recourse is impossible in the U.S. Recourse is practiced in a number of States in the U.S. Some lenders are more aggressively going 
16 

after deficiency judgments. And it is an important, I think, incentive mechanism for avoiding things like strategic default. And 

every other developed country has recourse mortgages and lenders 

do routinely go after deficiency judgments, and I think that also 

curbs over-indebtedness and speculative behavior on the part of 

borrowers. And so I would submit that in the future, we should not 

rule that out. I think that that is an important part of any legal 

system underlying the mortgage market. 

Senator CORKER. What is it about the—and just 1 second, Mr. 

Pollock, but what is it about the bankruptcy laws that make the 

recourse issue not practical? I thought it was more the State Constitutions—— 

Ms. WACHTER. State Constitutions are actually the big—— 

Senator CORKER. So it is really not the bankruptcy laws? 

Ms. WACHTER. Well, the biggest—yes, the bankruptcy adds to it 

in the sense that if the borrower has an option to go into bankruptcy, then repaying through income, for example, may not be viable. In Denmark, actually, wages are garnished, and I do not think 

that that would be viable if the borrower was in bankruptcy, at 

least in that period. 

Senator CORKER. Mr. Pollock, you wanted to say something? 

Mr. POLLOCK. Thank you, Mr. Chairman. I just wanted to add 

three quick things. I hope it was clear in my comments, but in my 

ideal mortgage system for the U.S. going forward, there would be 

no GSEs. 

Senator CORKER. I kind of gathered that. 

Mr. POLLOCK. I just wanted to make that explicit. 

Senator CORKER. Yes. 

Mr. POLLOCK. You would either be private or you would be the 

government, but you could never be both at the same time. I think 

that is an important principle. 

A second comment is that there is also a risk for the borrower 

with fixed-rate mortgages, and that is you have a fixed-rate mortgage at some rate and rates go way down because we are having 

a recession, unemployment is high, and you cannot refinance for 

credit reasons, which is the situation of many people now. And the 

fixed-rate mortgage, in fact, puts you in a terrible place in that situation. So we need—there is nothing you can do that takes away 

all risks from everybody, and there are risks in that, as well. 

Finally, just on the fact of how Canada works, one of the things 

I would not copy is the Canadian mortgage insurance. The overwhelming amount of Canadian mortgage insurance, and there is 

about 470 billion Canadian dollars of mortgages insured out of a 

total market of about 950 billion Canadian dollars or so, so that is 

half of the market, is provided directly by the Canada Mortgage 

and Housing Association, which is the government and it, in effect, 

guarantees 100 percent of the mortgage. There is no private capital 

there. There is just the taxpayer guaranteeing it. In my judgment, 

that is a bad idea. I would not do it. 

There are Canadian critics who think that that pushing of credit, 

of mortgage credit, is contributing to the rise, which is quite dramatic if you have a chance to look at the graph in my testimony, 

in my written testimony, and they think that they may have a bubble. They say—some people in Canada say they have a bubble and 
17 

attribute this very heavy intervention as part of the cause. That is 

obviously debatable. But it is clear that in the Canadian system, 

for about half of the market, there is a direct taxpayer guarantee 

with no private equity in there, and the banks who then hold these 

insured mortgages get extremely low capital requirements for the 

mortgage. So the capital is not in the bank, either, when they are 

holding the mortgages. And, as I say, that is a part of what our 

Northern neighbors do that I would definitely not copy. 

Senator CORKER. Dr. Lea, what is required in Canada to receive 

that insurance, meaning what type of oversight and standardization has to exist for those originating these loans to be able to secure this government insurance guarantee? 

Mr. LEA. Well, first, if you are a bank or regulated lender, you 

have to have insurance if the loan is over 80 percent loan-to-value 

ratio. So that then brings a mortgage insurer, either government 

or private, into the picture and they will set the standards for what 

they will insure. 

Senator CORKER. And in a collapse, I mean, one like we have had 

here in our country, very quickly, those entities would be out of 

business, is that correct? I mean, in a crisis like we have had. That 

is an interesting thing for episodic-type, just episodes of people failing, but when you have a systemic crisis like we have had, basically, those are wiped out pretty quickly, right? 

Mr. LEA. Well, not necessarily. I would point to the fact that our 

private mortgage insurers still exist and they have basically survived. We have had one that has ceased writing new business, but 

they are still in business and several have raised new capital. 

They, I think, benefited from the fact that a lot of the riskier 

mortgages, A, they did not insure them, did not meet their standards, and B, a lot of lenders tried to circumvent the insurance by 

creating the so-called ‘‘piggyback loans,’’ 80/20 type of loans so that 

they could avoid charging borrowers mortgage insurance, and that 

also was where a lot of the riskier loans went. 

And the third thing I would say is that if you had the universal, 

everything over 80 percent, then you are spreading your risk out, 

and one of the principles of insurance is to try to get more and 

more diversification. And absent a true systemic collapse—now, 

certainly you can come up with scenarios in which the insurance 

capital will not be sufficient, but insurance capital is different than 

banking capital in the sense that it is much more risk-based and 

you cannot pay out dividends as long as your risk ratios are at particular levels. So I think that, actually, from a capital adequacy 

standpoint, insurance models may be somewhat better than bank 

capital models. 

Senator CORKER. So then back to this sort of standard issues, 

other than the mortgage insurance, what is it that happens in Canada to be able to get, if you will, that government insurance? What 

kind of standardization? What kind of oversight? 

Mr. LEA. Well, again, the mortgage insurers are regulated—— 

Senator CORKER. So it is really the mortgage insurer that is 

making that determination. 

Mr. LEA. Absolutely. 

Senator CORKER. OK. 

Mr. LEA. Absolutely. The bank—— 
18 

Mr. POLLOCK. But Michael, you would have to say the overwhelmingly dominant mortgage insurer is the government of Canada—— 

Mr. LEA. Correct—— 

Mr. POLLOCK. ——through CMHC. 

Ms. WACHTER. And two other companies—— 

Mr. POLLOCK. Yes, but they have—— 

Ms. WACHTER. ——smaller, I agree—— 

Mr. POLLOCK. ——they have a very minor share of the market. 

We are really talking about a government program. 

Mr. LEA. So the government set the standards and—— 

Senator CORKER. And are those standards stringently enforced 

and—— 

Mr. LEA. As far as I know, yes. 

Ms. WACHTER. Absolutely. 

Mr. LEA. They started to relax them a little bit during the mid2000s, kind of a boom period, and as they saw the markets starting 

to weaken, they lowered the maximum LTV. They also lowered the 

maximum term. They had been insuring out to 40 years. They 

moved that back to a maximum of 35. So they definitely tightened 

as they saw the downturn coming. 

Senator CORKER. Dr. Wachter and Mr. Pollock, do you all agree 

that the interest rate deduction does not stimulate, as Dr. Lea has 

said, does not stimulate home ownership? 

Ms. WACHTER. I agree. I would like to go back to the—but today, 

if you did withdraw the interest rate deduction, it would be a problem in the state of today’s market. 

Senator CORKER. Well, other than the rebellion that would take 

place, you are saying—but expand. Tell me, in your opinion, why 

it does not aid in home ownership or the desirability of home ownership. 

Ms. WACHTER. The way we—at this stage, the way it is structured, because many people take the standard deduction, lower-income, middle-income households take a standard deduction, we 

only have—— 

Senator CORKER. So they never bump up against the actual—— 

Ms. WACHTER. They never bump—almost 49 percent do not pay 

taxes at all, so that you can see that the deduction is more important for higher-income households—— 

Senator CORKER. Mr. Pollock—— 

Ms. WACHTER. ——who would own, also, and—— 

Senator CORKER. And on that same note? 

Mr. POLLOCK. Everything we do in housing finance, Mr. Chairman, you have to think about the interaction of finance and prices 

of the houses. Certainly, in an upper part of the market, upper half 

or so, the prices reflect the deduction, and I suspect if you took it 

away, you would not like the price reaction, and in a situation 

when a lot of people are underwater on their mortgages already, 

that gives you a real transition problem to work on if you wanted 

to get to a state of no interest deduction. We all know about politically how hard that is, but there is also a price problem especially 

now. 

Senator CORKER. So, I mean, but from a standpoint of making 

that transition, is that something that if one were to make that 
19 

transition over a decade, would that be so distortive that it would 

hurt prices immediately? 

Ms. WACHTER. Yes. This is not the decade to do it. Housing markets are too fragile. Perhaps 5 years from now, we could reconsider, 

or 2 or 3 years. But at this moment in time, housing markets are 

sufficiently fragile, they may start declining again and setting up 

a spiral of declining prices, increasing foreclosures, decreasing 

prices. We are not out of those woods yet. 

Mr. LEA. I would point out that the U.K. did, over a decade time 

period, get rid of the mortgage interest deduction. They started as 

the market was coming out of the early 1990s downturn, which 

was a very severe downturn in the U.K. So I agree fully with Dr. 

Wachter that this is not the time to do it, but if we think 2, 3 years 

out of something like a decade-long policy, what they did in the 

U.K. was starting to lower the cap. We have a million-dollar loan 

cap now on deducting interest. You start lowering that. You also 

can lower the maximum marginal tax rate that you can take the 

deduction against, so you shrink the absolute size of the deduction 

then eventually have it go away. But it would have to be in a recovered market before you would want to start eliminating that. 

Senator CORKER. How do the three of you feel about prepayment 

penalties? 

Mr. LEA. How do what? 

Senator CORKER. How do the three of you feel about prepayment 

penalties? In other words, in a normal, functioning commercial 

market, if you have a 10- or 15- or 20-year fixed-rate mortgage and 

you want to pay it off, you pay a penalty. That accounts for the 

losses that the investor would have because of the rate adjustment 

that would take place on the new mortgage they might have to replace it with. How would the prepayment penalty, should it come 

back, how would that affect the housing market and people’s mentalities as it relates to longer-term mortgages? 

Mr. LEA. Well, the countries where you have prepayment penalties, you would not have it for a full 20-, 30-year term. So typically, in countries like Canada and the Netherlands, it is predominately with a 5-year or shorter fixed-rate period. And so at the end 

of that period, then the loan rate is renegotiated and you are free 

to pay it off in entirety at that time. In Germany, you can go up 

to 10 years with a prepayment penalty, but the law caps it at that, 

even if the actual interest rate may be fixed for a longer time period. So it is not for 20- to 30-year type times. 

The second thing, I think that the market is a place for both 

loans with and without prepayment penalties, and I think borrowers can self-select based on the pricing of the loans, because remember, if we do not have a prepayment penalty, as we have in 

the U.S., there is a fee that all borrowers pay. It is incorporated 

into the mortgage rate. There is an option premium for the option 

the borrower has to have early repayment that has mortgage rates 

to be higher than if you did not have that option. So everybody is, 

in effect, paying it, whereas the European view is that you benefit, 

you pay. So it is not a socialized type of model. 

I think there is a market for both and that allows borrowers to 

self-select based on the initial rate in the mortgage, what their expectations are, both for interest rates and moving. And again, I 
20 

think more choice is better. We should not have a market that is 

all one or all of another. 

Ms. WACHTER. I agree. I think there should be a choice in the 

prepayment penalty or not, and absolutely agree with Dr. Lea that 

it is priced in. If there is no prepayment penalty, then that is going 

to affect the payment. 

I do also want to underline, however, that there is an advantage 

for the overall economic and systemic stability to having a preponderance of no prepayment penalty, and that goes just to the point 

of Dr. Pollock. Today, if we had a significant prepayment penalty, 

that would create an even more severe problem for those who wish 

to refinance out of fixed-rate mortgages into lower interest rate 

fixed-rate mortgages today, helping out the overall economy. That 

is, there is an automatic stabilizer in the ability to refinance when 

the economy declines and interest rates decline if there is an ability to refinance. Nonetheless, it should be priced. It is priced and 

there should be both options. 

Mr. POLLOCK. There is an economist at the World Bank who has 

pointed out that in America, we have very high transaction fees for 

refinances which function in a way like a prepayment penalty. And 

another of the things we should think about in a future housing 

finance system is instruments that reduce those very high transaction costs as we churn fixed-rate mortgages. That is a very high 

cost to consumers. 

I agree, in a private system, which I would favor, you would 

evolve mortgages with prepayment fees and mortgages without. 

The ones with prepayment fees would have lower interest, just like 

you have mortgages with up-front points you pay and mortgages 

that are no-point mortgages. If you pay points, you get a lower 

rate. It would work the same way and the market would work out 

the balance. We have to make sure only that the parties to the 

transaction understand what the deal really is and then the market will sort out the preferences of the various borrowers and lenders. 

Senator CORKER. What has been your experience over the last 20 

or 30 years looking at markets where most borrowers have a floating rate as opposed to a fixed rate? Over the course of time, has 

the amount of interest that they have paid, how does that compare 

to a fixed-rate market like the U.S.? 

Ms. WACHTER. Well, the dramatic issue is that over the 20 years, 

interest rates have fallen across the world. They have fallen dramatically, seeing they were on average, in the study that we have 

done of 15 countries over 1980 through 2000, they fell from about 

15 percent to 6, 7 percent. So in this scenario of declining interest 

rates, an adjustable-rate mortgage is perfectly safe. There have 

been very few countries that have had adjustable-rate mortgages a 

large share of their system that have faced a situation with rising 

interest rates. There is one exception to that that I know of, and 

that is the U.K. in the early 1990s. 

Many, actually, developed housing markets have only, as Dr. Lea 

has extensively written about, have only developed since 1980. So 

we do not really have a huge experience of a well developed mortgage system, by that I mean a system where many—where the preponderance of people do have mortgages and have adjustable-rate 
21 

mortgages in a world where there is a sharp rise in interest rates. 

We simply have not seen that. As I said, there was this exception 

in the 1990s in the U.K. The U.K. did have a very well developed 

mortgage market and entirely adjustable-rate mortgages and their 

banking system was imperiled, as was the mortgage insurance system, at that point in time as interest rates rose coming out of 1990. 

Senator CORKER. Any other comments here? 

Mr. POLLOCK. I would comment on that, Mr. Chairman. There 

was a time in the 1990s when I was refinancing my loan once a 

year and it was much cheaper—U.S. specifically—how much interest you pay on an adjustable rate versus a fixed rate. That was 

much cheaper in that setting. And Chairman Greenspan at the 

time got himself in trouble once for talking about how much cheaper it would be for people to finance on adjustable rates. But there 

are times when it is cheaper. In a market where you have choices, 

it allows consumer borrowers to make a risk-reward choice. As in 

other normal financial markets, you have got purveyors of funds 

and takers of funds and they are negotiating where they think the 

risks and rewards are. 

For a long time, starting off, let us say, around 1950 until 1980, 

interest rates were rising. People who had mortgages they took in 

the 1950s, if they were long-term mortgages, or 1960s, did very 

well relative to floating rates. Of course, the result of that was the 

failure of the entire savings and loan industry and the difference 

got to be paid by the taxpayers. 

There is no way you can mechanically set up systems to assure 

that they will not fail and get you in trouble, but I think the more 

choices people can make in informed ways, the better overall it will 

function, including the question of trying to manage their total interest rate bill. 

Ms. WACHTER. If I could just quickly follow up, the fact that we 

did have, of course, this major crisis, we were not the only country, 

and many countries had similar crises, which has led to the fact 

that banks do not make fixed-rate mortgages and hold them in 

their portfolio going forward. 

Senator CORKER. In my previous life, I borrowed a lot of money 

and it was just part of what we did in business. I can tell you, 

there was no question a built-in mentality that if you had a floating-rate loan, especially one that was recourse, you know, most 

fixed-rate mortgages in the commercial sector are nonrecourse, but 

usually floating-rate loans are not. They are recourse. And so the 

mentality of having a recourse loan and also knowing that that 

rate could change caused you to pay that loan off as quickly as possible, and every cent, every dollar you had that was extra was used 

to pay down that mortgage. And so it is easy to see, certainly with 

the mortgage deduction component that goes with it, that—I mean, 

we basically incent people not to do that. 

As you look at these other countries that have variable-rate 

mortgages mostly, that have not gotten into the kind of troubles we 

have, you know that part of the mentality in that household is that 

if there is an extra dollar or two that month, they are going to use 

it to pay the mortgage down because it, in effect, is savings, right? 

I mean, that is the same as savings and it is also deferring costs 

that are going to occur down the road due to interest payments. 
22 

Ms. WACHTER. I am certainly not disagreeing that in the commercial sector, in your experience of the commercial sector, but it 

is absolutely not the case that adjustable-rate mortgages have 

stopped borrowers from not taking on new debt. Of course, in the 

United States, the entire subprime market was an adjustable-rate 

market. So the increasing debt over time in this period from the 

late 1990s to 2006, at its height, was refinancing in the adjustablerate product. 

Senator CORKER. Yes? 

Mr. LEA. In both Australia and the U.K., you did have very high 

LTV lending, where people took on a lot of debt even with the adjustable-rate mortgages. The one thing, though, that exists is people, as you suggest, do tend to pay down their debt more rapidly. 

I think that is in part due to the fact that interest, again, is not 

tax deductible, so it pays to essentially pay off that higher rate 

mortgage, for one thing. 

The second thing is that, historically, both Australia and the 

U.K. have kind of an administered rate system, so unlike the U.S. 

adjustables, which are indexed to something like LIBOR or a 

money market rate or 1-year Treasury rate, you have what is 

called a discretionary ARM where the rate is set by the lender for 

all borrowers at the same time. Now, the positive of that is that 

lenders do tend to lag the interest rate changes, both on the up and 

the down cycle, which means that if rates do start sharply rising, 

it is not a guarantee that lenders are going to follow that up in lock 

step with whatever short-term index is going, but rather they have 

the discretion of spreading that out and lagging that, and statistically, that has been the case over the last couple of decades. 

Senator CORKER. Yes, sir? 

Mr. POLLOCK. An interesting difference between commercial 

credit markets, which you referenced, Mr. Chairman, and residential markets is commercial markets invariably have loan covenants, 

so with either private placement investors or banks or bond indentures, as a borrower, you are committing to maintaining certain 

levels of capitalization or earnings or inventory coverage or what 

not, whereas we do not have such things in residential loans. 

I was in a discussion recently, and I think it is an idea worth 

thinking about, where there might not be covenants added, and 

these might develop if we really had a private market, to residential mortgages, for example, prohibiting the taking on of second 

lien borrowings without the agreement of the first lienholder so 

that you get a more commercial-like contract and you are not allowed as a borrower to run your leverage of the household up to 

foolish levels. It is something worth thinking about, anyway. But 

it is a clear, interesting distinction between the two markets. 

Senator CORKER. And I might add, and I certainly look forward 

to hearing from you, but I might add that especially in an environment where basically the servicers of these first mortgages are usually the ones that have the locks on the second mortgage, so they 

are looking after their interest naturally more so than the prime 

lender is. 

Dr. Wachter. 

Ms. WACHTER. Yes, and this is an interesting idea, and other 

countries have other ways of getting to the same conclusion. For 
23 

example, in Canada, you cannot refinance your mortgage if it is 

over 80 percent without the mortgage insurance agreement to that. 

Senator CORKER. So it sounds like, looking at the body language, 

all three of you would support loan covenants as a part of whatever 

we might propose. It is certainly on any kind of Government support system, is that correct? 

[Panel nodding heads.] 

Senator CORKER. Is there anything demographically about our 

country that is different than others as it relates to how our whole 

loan system has evolved and why it is so different than most other 

countries? 

Mr. POLLOCK. Well, one reason we could say that Canada is an 

interesting comparison is that demographically we are both nations 

of immigrants and frontiers and pioneers and settlement, which 

gave us a land holding population. We still have heavy immigration, which we keep assimilating and trying to assimilate into 

home ownership, which is an interesting issue to think of. We 

would think about it generationally as cohorts of the family or of 

the generations of the family establish themselves in American society and move to home ownership that they could not afford in the 

beginning. 

Ms. WACHTER. There are countries with serious problems of renters versus owners, where renters are have-nots in the sense that 

they cannot become renters [sic]. Their families do not have the 

wealth. Their families have not been owners. And with development and price rises, it is possible that these sectors will be out 

of home ownership entirely, leading to real stresses. 

In our country, despite the fact that we have had these tremendous immigrants fueling our growth, we have also incorporated immigrants into home ownership so that they have a stake in our 

country. And as housing prices have risen, their wealth has risen 

with it, so that instead of being kept out of the potential of home 

ownership generation to generation, they have been able to buy 

into America’s growth. I think this is extraordinarily important 

going forward. 

Senator CORKER. Any comments? 

Mr. LEA. You know, I do not really know that there is a major 

demographic argument for a lot of the characteristics of our system. As Dr. Wachter said, we have historically had a bias or penchant for home ownership for good reasons. But if you look at the legislation and language of a lot of other countries, they will also say 

that home ownership is really good, but they do not necessarily 

think it is good for everybody, and then the question becomes do 

you have the kind of support systems for lower-income people, for 

rental or people that are doing that in order to save and in order 

to own. 

So I think that our system is actually—its characteristics are 

more defined by the very longstanding role that governments had, 

going all the way back to the 1930s, creation of FHA and Fannie 

Mae, prohibition of adjustable-rate mortgages until the early 1980s. 

That explains a lot more about why our system looks the way it 

does than any demographic feature. 

Senator CORKER. And all three of you, I think, would support 

some type of legislation to deal with covered bonds but do not see 
24 

it as a panacea to our housing, is that correct? All three of you 

think that—— 

Mr. POLLOCK. Yes. 

Ms. WACHTER. Yes. 

Mr. LEA. Yes for me. 

Ms. WACHTER. Yes for me, but I do actually think it is, in fact, 

going the other direction. Covered bonds are not only not a panacea, but they can be a source of systemic risk, as we see in Spain. 

Senator CORKER. So they can add risk to the system if you do 

not properly balance—— 

Ms. WACHTER. Absolutely. 

Senator CORKER. ——off what the FDIC’s rights are against—— 

Ms. WACHTER. Exactly. 

Senator CORKER. Yes. In closing, we have been here almost an 

hour and a half now, and are there any closing thoughts? I know 

you all had opening comments. I have asked a few questions. Are 

there any other comments or thoughts you would like to share with 

us before we adjourn? 

Mr. POLLOCK. If I could, I would just repeat, Mr. Chairman, that 

looking at this in an international context where you see a lot of 

different evolved systems around the world is really a fruitful thing 

to do because we need to think anew about the way American 

housing finance, which is a huge market, hugely important economically and socially, but it needs to work quite a bit differently, 

in my judgment, than it has in the last generation, and, in fact, in 

the generation before that. So it is definitely time for these bigger, 

more open-ended thinking about what we might do. 

Ms. WACHTER. I think it is also useful to look at the successes, 

but also to look at the failures, and the European regulators are 

looking at their failures at the same time. So cross-country examination and looking together at what works. We are not a nation 

alone. Our crisis helped bring down other markets. Other markets 

also affect us. I absolutely think it is important to have an international perspective and I do thank you for the opportunity to 

speak to it today. 

Senator CORKER. Thank you. 

Mr. LEA. And I would just add that there is no perfect system. 

We cannot say that one that is totally adjustable rate, bank deposit 

funded, or one that is totally fixed rate, security funded, is ideal. 

In act, both have their strengths and weaknesses, and I think what 

we can draw from the international experience is there is a diverse 

set of ways, both instrument and institution, that you can provide 

sufficient credit for housing and for home ownership, and I think 

we should look at, again, having a diverse menu of products, funding types with essentially the interplay of investors and borrowers 

determining what that mix looks like. 

Senator CORKER. You know, we have just gone through, obviously, a huge financial regulation bill and some tangible decisions 

were made and then some, in many cases appropriately so, regulators are making decisions. In the area of housing finance, because 

of the involvement we have had, which has been, let us face it, 90 

percent of the market today, we are going to have to make some 

tangible, hard decisions as it relates to housing finance going 

ahead. As a matter of fact, I think it is going to be in many ways 
25 

a far more difficult issue for us to come to terms with and solve 

because it affects so many people. And again, our involvement in 

it today is it is such a huge level—I am talking about our Government involvement. 

So I thank you for coming today. I know that there will be people 

here, staffers and others that represent folks that will want to ask 

additional questions, and so we will leave the record open, I am 

sure, for a couple of days and we look forward to calling on you. 

I know in our own office, we are trying to develop a sort of a thesis, if you will, about the direction that we think this ought to go. 

I know the New York Fed informally has come up with some ideas. 

I know others are doing the same. We thank you very much for 

traveling as far as many of you did today, for all of you being here, 

and look forward to your continued input. Thank you very much. 

Ms. WACHTER. Thank you. 

Mr. POLLOCK. Thank you. 

Mr. LEA. Thank you. 

Senator CORKER. The hearing is adjourned. 

[Whereupon, at 3:58 p.m., the hearing was adjourned.] 

[Prepared statements supplied for the record follow:] 
26 

PREPARED STATEMENT OF MICHAEL J. LEA 

DIRECTOR, THE CORKY MCMILLIN CENTER FOR REAL ESTATE, SAN DIEGO STATE

UNIVERSITY

SEPTEMBER 29, 2010 

Mr. Chairman, Ranking Member Corker, and Members of the Subcommittee 

thank you for the opportunity to be here today. I am Michael Lea, Director of The 

Corky McMillin Center for Real Estate and Professor of Finance at San Diego State 

University. I have an extensive background in housing finance including senior executive positions at major mortgage lenders and as Chief Economist of Freddie Mac. 

I have been actively involved in the study of international housing finance systems 

for more than 20 years having done consulting and business development work in 

30 countries and serving as Director of Research for the International Union of 

Housing Finance. I recently completed a comparative study of developed country 

mortgage markets that will be published by the Brookings Institution later this fall 

as well as a comparative study of mortgage instrument design released by the Research Institute for Housing America. I would request that both studies be entered 

in the record as they provide data support for the points I will make today. (See, 

Attachments 1 and 2 following this statement.) 

In addressing the Subcommittee today you have asked me to compare the structure and performance of major developed housing finance systems with a focus on 

Australia, Canada, Denmark, Germany, and the United Kingdom. The three major 

issues you have asked me to emphasize are home ownership and affordability, the 

role of the Government in mortgage finance, and the dominant mortgage instrument, funding mechanism, and underwriting standards. I will address each in turn. 

Home Ownership and Affordability 

The United State has a relatively high home ownership rate of 67 percent. This 

rate puts the U.S. in the middle of a group of 11 countries. Australia, Canada, Ireland, Spain, and the U.K. have higher rates while Denmark, Germany, Japan, the 

Netherlands, and Switzerland have lower rates. Countries in Northern and Western 

Europe have lower rates of home ownership in part because of significant social 

rental programs. Such programs are less significant in Southern Europe with corresponding higher home ownership rates. 

Although many countries extol the virtues of home ownership there is far less 

intervention to support affordable owner-occupied mortgage lending in other developed countries. No other developed country has ‘‘housing goals’’ or Community Reinvestment Act legislation. Only Canada and the Netherlands have government-owned 

mortgage insurance agencies and in neither case is the insurance targeted to affordable housing. 

Many European countries provide greater rental housing assistance than the U.S. 

Subsidized social rental housing is a significant sector of the market in Western and 

Northern Europe and the U.K. The housing is owned by municipal governments or 

nonprofit groups. Subsidies take the form of rent assistance and financing assistance (e.g., municipal guarantees, State loans). Generally the assistance is available 

to all households who qualify (income targeting) and in some countries (Denmark, 

Netherlands) it is available to homeowners as well as renters. Australia and Canada 

have more limited assistance programs. They provide targeted rental assistance but 

do not support social housing to a significant extent. 

The recession has had limited impact on home ownership in other countries but 

a more significant effect on house prices. High house prices in some countries limited home ownership opportunity prior to the crisis. No other country has experienced the magnitude of mortgage defaults and foreclosures that force households out 

of home ownership. However, underwriting criteria have tightened worldwide which 

will ultimately have a negative influence on home ownership, particularly for first 

time homebuyers and self-employed borrowers. 

House prices declined in all countries except Australia in 2008 and remained depressed in most countries in 2009. House prices increased significantly in Australia 

and Canada in late 2009 and 2010 and have risen in several other countries including the U.K. Only Ireland has experienced an extent of decline comparable to the 

U.S. 

Extent of Government Involvement in Mortgage Finance 

The U.S. is internationally unusual in the extent of government involvement to 

support owner-occupied mortgage finance. No other developed country has a government-sponsored enterprise similar to Fannie Mae and Freddie Mac. Only Canada 

and Japan have government mortgage security guarantee programs equivalent to 

Ginnie Mae. Only Canada and the Netherlands have government-owned mortgage 
27 

insurance companies. Australia sold its government mortgage insurer to the private 

sector in 1997. 

For countries with government mortgage market support the market share of government-supported entities is far less than the current U.S. situation in which over 

90 percent of mortgage credit is coming from Government-backed institutions. In 

Canada approximately 50 percent of mortgages have government-backed mortgage 

insurance which is required for all loans over 80 percent loan-to-value (LTV). Approximately 25 percent of mortgages have been securitized with guarantees from the 

Canada Housing and Mortgage Corporation. A similar proportion of mortgages have 

been securitized in Japan with guarantees from the Japan Housing Finance Agency. 

Governments do not support mortgage securitization in other countries. 

A minority of countries allow a tax deduction of homeowner mortgage interest. 

Only the Netherlands and Switzerland have unlimited deductibility. Denmark, Ireland and Spain limit the deduction and interest is not tax deductible in the other 

countries including Australia, Canada, Germany, and the U.K. Households in these 

countries tend to pay down debt faster reducing mortgage risk. Tax-exempt bond financing programs for owner-occupied housing are also unique to the United States. 

Australia, Canada, and the U.K. have small first time homebuyer tax credit programs. 

Mortgage regulation has been tightened in many countries as a result of the crisis. Canada and U.K. now require ARM qualification at higher than initial rates. 

Canada lowered the maximum LTV and term on bank originated mortgages. Both 

Australia and the U.K. have introduced suitability standards for mortgage lenders. 

Both the European Commission and individual country regulators are contemplating tighter underwriting parameters. 

Mortgage Instruments, Funding, and Underwriting 

The U.S. is internationally unusual in the market share of a long-term, fixed rate 

mortgage (FRM). Only two other countries have a dominance of this instrument: 

Denmark and France. Like the U.S. FRM, borrowers in Denmark can prepay their 

loan without penalty if mortgage rates fall. In France borrowers who refinance must 

pay a penalty and the typical term is shorter, 15 to 20 years. The Danish instrument adds a unique and valuable feature to its fixed rate mortgages. The Principle 

of Balance results in a one-to-one correspondence between a mortgage loan and a 

bond that finances it. If interest rates rise the borrower, through their mortgage 

lender, can repurchase the bond at a discount and cancel the mortgage. In this way 

the borrower can reduce debt and the likelihood of negative equity. 

The dominant mortgage instruments in other countries correspond to one of two 

models—either adjustable rate mortgages (ARMs) or short to medium term fixed 

rate ‘‘rollover’’ mortgages. The dominant instrument in Australia, Spain and the 

U.K. is an adjustable rate mortgage. Reliance on this instrument has been credited 

with reducing the incidence of default during the crisis. However it is clear that 

there is significant credit risk in the system if and when rates rise. 

The dominant instrument in Canada and many European countries is the rollover 

mortgage. With this instrument the loan rate is fixed for a period of 1 to 10 years 

(typically 1–5) with a longer amortization period (25–35 years). Borrowers are subject to a prepayment penalty for refinance during the time the rate is fixed. The 

rate is renegotiated at the end of the fixed rate period, adjusting to the market rate. 

Borrowers can manage interest rate risk by shortening or lengthening the fixed rate 

period at adjustment depending on the level and trend in rates. 

The dominant mortgage instrument in individual countries reflects historical patterns, funding sources and government involvement. The U.S. is internationally unusual in its dependence on securitization for funding. Over 60 percent of the stock 

of mortgages has been securitized mostly through the government-backed entities. 

Today over 90 percent of U.S. mortgage funding comes through securitization. The 

highest proportion of loans securitized in other countries is approximately 25 percent in Canada, Spain, and the U.K. The dependence on securitization in the U.S. 

is driven by two factors; the predominance of the FRM and the involvement of the 

government agencies. GSE and Ginnie Mae securities primarily fund FRMs. Government backing lowers the relative price of that instrument leading to a larger 

market share. Lenders depend on securitization to fund such loans because of the 

high degree of interest rate risk they entail (as evidenced by the savings and loan 

failures in the 1980s). 

Mortgage lending in adjustable-rate countries is dominated by commercial banks. 

They prefer this instrument because it minimizes interest rate risk for the bank— 

by passing it to the borrower. In Australia and the U.K. the rate is set for all borrowers at the discretion of the bank. Lenders typically lag the market in rate adjust-
28 

ment. In times of rising rates banks cushion the interest rate shock with gradual 

rate increases. 

Banks finance mortgage lending in rollover countries primarily through a combination of deposits and covered bonds. Covered bonds finance approximately 20 

percent of mortgage lending in the European area. Outside of Denmark the bonds 

are bullet instruments of varying maturities. Mortgages have prepayment penalties 

that facilitate match funding by covered bonds or a combination of deposits and interest rate swaps. 

Mortgage Performance and Underwriting 

The default and foreclosure experience of the U.S. market has been far worse than 

in other countries. Serious default rates remain less than 3 percent in all other 

countries and less than 1 percent in Australia and Canada. Of the countries in this 

survey only Ireland, Spain, and the U.K. have seen a significant increase in mortgage default during the crisis. 

There are several factors responsible for this result. First subprime lending was 

rare or nonexistent outside of the U.S. The only country with a significant subprime 

share was the U.K. (a peak of 8 percent of mortgages in 2006). Subprime accounted 

for 5 percent of mortgages in Canada, less than 2 percent in Australia and negligible proportions elsewhere. 

Second while some countries including Australia, Canada and the U.K. relaxed 

documentation requirements there was far less ‘‘risk layering’’ or offering limited 

documentation loans to subprime borrowers with little or no down payment. There 

was little ‘‘no doc’’ lending. 

Third, there has been less prevalence of negative equity in other countries. Although many countries allowed high LTV loans, the proportion of loans with little 

or no down payment was less than the U.S. and the decline in house prices in most 

countries was also less. 

Fourth, loans in other developed countries are with recourse and lenders routinely 

do go after borrowers for deficiency judgments. Research in Europe and the U.S. has 

found that recourse reduces the incidence of default. With a much smaller proportion of loans that are securitized lenders are more apt to work with borrowers to 

restructure loans rather than go through a lengthy and costly foreclosure process. 

Lenders have moved to tighten underwriting guidelines since the onset of the crisis. Down payment requirements have increased, loan-to-income criteria have been 

tightened, there are fewer interest only loans available and in some countries the 

maximum mortgage term has been reduced. In most cases this has been at the volition of lenders and not imposed by regulators. To date there have been few government mandated minimum underwriting standards or product restrictions such as 

those in the Dodd-Frank legislation. 

Conclusions 

There is no ideal housing finance system. Individual country arrangements reflect 

history, market structure and government policy. However, almost all developed 

country housing finance systems performed better during the crisis than that of the 

U.S. What can the U.S. learn from other countries? 

First in no other country is there as much government involvement in the mortgage market. The combined effect of the various forms of government intervention 

undoubtedly contributed to the housing boom and bust in the U.S. Other countries 

have achieved comparable or higher rates of home ownership and well-developed, 

stable mortgage markets with much less government support. 

Second, features of the Danish system offer the prospect of real improvement in 

the U.S. housing finance system. It retains the core fixed rate mortgage product but 

makes it more consumer and investor friendly by adding the option to repay the 

loan through the bond market if rates rise. This feature would have reduced some 

of the negative equity build up in the U.S. system during the crisis and the significant extension risk faced by mortgage security investors today. The Danish model 

could be adopted by the GSEs to facilitate its introduction with a transition to a 

nongovernment guaranteed bond market such as the one that exists in Denmark 

today. 

Third, European style covered bonds can provide an alternative to funding 

through GSE securitization. The market is deep and liquid in Europe and has performed much better than the structured finance markets. The instruments are simple, bullet bond structures backed by a pool of conservatively underwritten mortgage 

assets and the capital of the issuer without government guarantees. Incentives are 

aligned as credit risk remains on the balance sheet of the issuer. 

However, the fixed rate mortgages funded by covered bonds have prepayment penalties allowing issuers to meet strict asset-liability matching requirements. The re-
29 

cently passed Dodd-Frank financial reform legislation reinforces long-standing restrictions on the use of prepayment penalties that will hamper the development of 

a European style covered bond market 

Fourth it should be recognized that the high proportion of FRMs funded through 

securitization in the U.S. is both the outcome of Government involvement and a justification for its continuation. The risks inherent in the FRM realistically require 

it to be funded in the capital markets. Investors require government guarantees 

against loan or issuer default to invest in mortgage-backed securities with volatile 

cash flows. Thus the argument is made that we need to continue Government support through the GSEs and/or Ginnie Mae to keep the mortgage market functioning. 

Their guarantees lower the relative cost of the FRM sustaining its dominance. The 

result is that the Government backs the majority of all mortgages in the U.S. 

If Government guarantees for mortgage-backed securities were reduced or withdrawn over time the U.S. market would most likely achieve a more balanced mix 

of products and funding sources. Adjustable rate mortgages, medium term fixed rate 

mortgages and long term fixed rate mortgages all have a place in a robust mortgage 

market. Likewise, funding through deposits, bank bonds, covered bonds, and 

securitization allows lenders to tap a variety of funding sources and manage the 

risks of the various instrument designs. 

The experience of other countries shows that high rates of home ownership and 

stable well-developed mortgage markets can be achieved without the degree of government intervention that exists in the U.S. today. In that respect the U.S. clearly 

can learn much for international housing finance systems. 

Thank you for the opportunity to appear before this Subcommittee. 
30 

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PREPARED STATEMENT OF SUSAN M. WACHTER 

RICHARD B. WORLEY PROFESSOR OF FINANCIAL MANAGEMENT, PROFESSOR OF REAL

ESTATE, FINANCE, AND CITY AND REGIONAL PLANNING, THE WHARTON SCHOOL, 

UNIVERSITY OF PENNSYLVANIA

SEPTEMBER 29, 2010 

Chairman Bayh, Ranking Member Corker, and other distinguished Members of 

the Committee, thank you for the invitation to testify at today’s hearing on the 

‘‘Comparison of International Housing Finance Systems.’’ It is my honor to be here 

today to discuss the strengths and weaknesses of various models, how they differ 

from the United States system and any lessons or themes that may be learned from 

their experiences prior to, and during, the global economic crisis. 

The United States belongs to a group of countries that suffered particularly severe 

recessions driven by sharp housing price crashes. Other countries in this category 

include the United Kingdom, Spain, and Ireland. On the other end of the spectrum 

are countries where home prices merely leveled from 2007 to the present, resulting 

in no or mild recessions. This category encompasses Canada, Australia, and Germany. (Denmark lies somewhere in the middle, with a late bubble and current 

downturn.) By comparing these two groups, we can investigate what causes and 

what prevents housing bubbles and financial crises. In a forthcoming paper with colleagues, we conduct just such an investigation and find that two institutional differences separate these groups: the role of mortgage insurance (MI) and the strictness of regulations countering the market’s tendency toward procyclical behavior. 

No country better exemplifies this procyclicality in housing and mortgage markets 

than the U.S. With economic growth and low interest rates coming out of the recession of 2000–2001, mortgage lenders and securitizers increased lending and competed for market share among borrowers. When the available market was satiated, 

they expanded the market by lowering their standards to include less creditworthy 

borrowers. An expanding economy thus drove lax lending standards, the increase in 

nonstandard mortgages, and the proliferation of private-label securitization (PLS). 

It also encouraged regulators and bankers to increase leverage (i.e., lower capital 

requirements) to maximize profits. Eventually, borrowers found themselves with too 

much debt to repay, and the downward spiral of foreclosures, defaults, home price 

declines, and decreased aggregate demand ensued. Unfortunately, banks had too little capital—especially in liquid form—to cushion the blow, forcing them to curtail 

lending and even file for bankruptcy. The free market naturally motivates firms to 

lower lending standards and capital buffers in good times, thus adding momentum 

to the upswing, and to increase lending standards and capital buffers in bad times, 

thus reducing economic activity when the system needs it the most. 

While lending standards deteriorated, the extent to which this was occurring was 

unknown due to information opacity, the underlying mortgages were complex and 

difficulty to track, the extent of fake equity, in which the rise in house prices was 

due to unsustainable product growth was unknown. 

In the U.S., mortgage insurance and regulation declined as the housing bubble 

grew, thus magnifying this pro-cyclical behavior. Regulators who brought attention 

to declining lending standards, an increase in aggressive and predatory lending, and 

a rise in loan-to-value (LTV) ratios were ignored or overruled. Mortgage insurers 

could have served as a ‘‘third party control,’’ as they must pay the remaining value 

of the mortgage if the homeowner defaults, but originators came to rely less and 

less on MI because they could pass on the default risk to investors via 

securitization. To deal with low down payments that would have triggered the need 

for mortgage insurance, piggy back loans were originated and these too were 

securitized. When Fannie Mae and Freddie Mac securitized mortgages, they bore 

the default risk, making them the ‘‘third party control.’’ However, when Wall Street 

securitized mortgages, the default risk transferred to the buyers of the mortgagebacked securities (MBS). Because the mortgages and the MBS were becoming more 

complex and heterogeneous, investors could not assess the default risk, as evidenced 

by the fact that they were accepting lower interest rates (even in comparison to 

Treasuries) for riskier products. 

Contrast this experience to that of Canada, where regulators mandate that all 

high-LTV mortgages must be covered by MI. This practice has not inhibited Canada 

from achieving levels of home ownership on par with those of the U.S. in 2004, at 

their peak. Canada and Australia in this time period as well relied on mortgage insurers as a ‘‘third party regulator’’ with the result that mortgage lending standards 

did not deteriorate and housing prices did not collapse. Mortgages in Australia and 

Canada were and are typically short term variable rate, or in the case of Canada, 

rollover, and were originated and to a large extent held in portfolio by banks. Both 
109 

countries avoided recessions, home ownership has been maintained at high levels, 

and their banking systems have been able to continue lending as the crisis has 

caused financial systems in other countries to stop functioning. Australia has a significant ARM share, but regulators prohibited lenders from issuing ARMs to borrowers who did not qualify for the highest projected rate over the life of the loan. 

Thus, Australia was spared the fate of the U.K., Denmark, and Spain. 

A system reliant on MI can only work, however, if the insurers maintain enough 

capital to cover defaults during economic downturns. The U.S. is an example of 

what can happen when this principle is ignored. Credit default swaps (CDS) acted 

like insurance on MBS, but CDS issuers like AIG did not have enough capital to 

cover the defaults and were not required to reserve for the risk they were holding. 

Thus, MI is only one half of the equation, with strict countercyclical capital regulation being the other half. Canada is an excellent example of maintaining both ends 

of the equation. Their adjustable rates were regulated to prevent predatory behavior; for example, originators were not allowed to use low ‘‘teaser’’ rates. 

The structure of the dominant mortgage product is also critical to preventing 

procyclicality. Most countries rely on adjustable-rate mortgages (ARMs). The U.S., 

Denmark, and Germany are the three notable exceptions, favoring fixed-rate mortgages (FRMs). ARMs place the interest rate risk on the borrower, who is not as 

well-suited to bear it as lenders and investors. When interest rates rise, borrowers 

may have difficulty making payments and may be forced to default. ARMs also subject the borrower to greater market risk because their interest rates may rise when 

defaults increase elsewhere in the economy. ARMs are less conducive to systemic 

stability, as exhibited during the recent economic crisis. During the housing bubble, 

securitizers’ appetite for market share drove them to demand riskier mortgages 

from less creditworthy borrowers. Originators responded by favoring ARMs over 

FRMs, and it was these nonstandard mortgages that eventually exploded. The U.K. 

and Spain also relied on ARMs with similar consequences. All countries with ARMs 

saw their lending dry up during the credit crunch with borrowers unable to refinance at the high new rates. With ARMs that need to be repaid or refinanced the 

illiquidity of the system may be transformed as in these countries into a solvency 

or foreclosure crisis. 

Building a system around the FRM requires a secondary market. Banks do not 

want to bear the interest rate risk of ‘‘borrowing short’’ from depositors and ‘‘lending 

long’’ to homeowners. When interest rates rise, they will have to pay more to depositors but will be receiving the same low payments from homeowners that were established when the contract was signed. This mismatch was directly responsible for the 

U.S. savings and loan crisis two decades ago and similar crises elsewhere. While in 

practice they can hedge this risk with derivatives, in practice no country has a 

banking system reliant on FRMs without secondary market institutions that bear 

some of that risk and/or increase their profitability. In the U.S., Fannie Mae and 

Freddie Mac serve that role by purchasing FRMs and securitizing them. Unlike PLS 

of ARMs, this securitization yields a product that would not otherwise exist. In Germany, banks issue ‘‘covered bonds’’ (instead of MBS) that are secured by standardized mortgage loans through Pfandbrief institutions. While the investor who purchases a covered bond receives the cash flows from the homeowner, the issuer who 

sold the covered bond retains the default risk. If the homeowner defaults, the issuer 

owes the remaining balance to the investor. Unfortunately, the stringent loan to 

value requirements of the system in Germany has resulted in one of the lowest 

home ownership rates in the industrialized world, relying on renting for over half 

its population. 

But without the proper regulations, even covered bonds can get a country into 

trouble. German regulators ensure that investors get periodic updates on the state 

of the collateral securing their covered bond, and they do not allow covered bonds 

to be secured by loans with an LTV ratio above 60 percent. Unlike in the U.S., these 

regulations were not eroded during the housing bubble. Denmark also relies on covered bonds and had similarly stringent regulations until recently. When Danish legislation moved the system toward interest-only mortgages, the market joined the 

housing mania and developed a late bubble that subsequently deflated. Similarly, 

Spain used covered bonds extensively, yet they slid toward ARMs in recent years. 

The Spanish banks, cajas, securitized ARMs through cedulas in an effort to generate 

fees and gain market share, generating a bubble and crisis that is severe, with 

Spain suffering 20 percent unemployment. In the face of rising prices, it is very 

tempting to lower lending standards, contributing to procyclicality. 

All industrialized nations have significant government involvement. When the 

housing market is in crisis, it endangers the entire system. The British rescue of 

Northern Rock preceded the American bailouts and the Spanish government has intervened to protect the cajas and their covered bonds. To prevent a foreclosure crisis 
110 

from driving an economy into a severe recession or depression, governments will intervene; thus it is necessary to regulate the housing finance market before it 

reaches the crisis stage. The taxpayer owns the tail risk. Rather than raise lending 

standards after the fact, we can prevent the problems of moral hazard, shrinking 

equity, and bailouts by maintaining standards and transparency. 

The clearest difference between the U.S., the U.K., and Spain, on one side, and 

Australia, Canada, and Germany, on the other, is the stability of regulation. The 

first group allowed lending standards and capital requirements to decline, stoking 

the pro-cyclical behavior that created a housing bubble and economic crisis, while 

the latter group maintained rules in the face of market pressure. 

Bibliography 

‘‘Housing Finance in Developed Countries—In a Time of Turmoil’’, coauthored by 

Richard Green, Adam Levitan, and Susan Wachter, working paper, 2010. 

‘‘The American Mortgage in Historical and International Context’’, coauthor Richard 

K. Green, Journal of Economic Perspectives, Vol. 19, No. 4, Fall 2005, 93-114. 

http://papers.ssrn.com/sol3/papers.cfm?abstractlid=908976 

‘‘The Housing Finance Revolution’’, coauthor Richard K. Green, Housing, Housing 

Finance, and Monetary Policy: Symposium Proceedings, Federal Reserve Bank of 

Kansas City, January 2008. Reprinted in The Blackwell Companion to the Economics of Housing: The Housing Wealth of Nations, eds. Susan Smith and Beverley Searle, London: John Wiley & Sons, forthcoming 2010.http:// 

www.kansascityfed.org/Publicat/Sympos/2007/PDF/GreenlWachterl0415.pdf 

PREPARED STATEMENT OF ALEX J. POLLOCK 

RESIDENT FELLOW, AMERICAN ENTERPRISE INSTITUTE

SEPTEMBER 29, 2010 

Mr. Chairman, Ranking Member Corker, and Members of the Subcommittee, 

thank you for the opportunity to be here today. I am Alex Pollock, a resident fellow 

at the American Enterprise Institute, and these are my personal views. Before joining AEI, I was the President and CEO of the Federal Home Loan Bank of Chicago 

from 1991 to 2004. From 1999 to 2001, I also served as President of the International Union for Housing Finance, a trade association devoted to the international 

exchange of housing finance ideas and practices, and continue to be a member of 

its Executive Committee. 

A Middle of the Pack Home Ownership Rate, GSEs Notwithstanding 

As we begin the last quarter of 2010, our housing finance system (as well as those 

of some other countries) is still struggling in the wake of the great housing bubble 

of 2000–06 and its collapse into the panic and serial crises of 2007–09. 

Housing finance cannot be considered apart from its effects on house prices. When 

you push a lot of credit at an asset class, its price tends to rise. American housing 

finance practices and subsidies helped inflate house prices during the bubble. Then 

U.S. average house prices fell by more than 30 percent from peak to trough—something, we must remember, which was previously considered impossible. This 

brought them back to their long-term trend line and to the levels of 2003, with all 

of the losses and turmoil with which we are so familiar. A memorable decade! One 

of its lessons is to try to remember that things considered impossible can nonetheless happen. 

As we develop other lessons for the next decade, there is no doubt that it is educational and useful to examine American housing finance in international perspective. 

Comparing our housing finance system to other countries, we discover that one 

thing remarkable and indeed unique in the world about American housing finance 

was the dominant and disproportionate role played by Government-sponsored enterprises, namely Fannie Mae and Freddie Mac, wielding their ‘‘implied’’ Government 

guaranty. Based on this ‘‘implied’’ guaranty, massive amounts of their debt securities were sold around the world, so that foreign institutions could help inflate U.S. 

house prices without worrying about the risk and later be bailed out as creditors 

by American taxpayers. Of course the ‘‘implied’’ guaranty always was a real U.S. 

Government guaranty, as events have amply demonstrated, but it did not have to 

be accounted for as one. 

In the days of Fannie and Freddie’s pride, their representatives and political supporters used frequently to say, ‘‘American housing finance is the envy of the world!’’ 

It really wasn’t, at least based on my discussions with housing finance colleagues 

from other countries. But many Americans—including members of Congress— 
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thought it was, just as they mistakenly thought and said that the U.S. had the highest home ownership rate in the world. We didn’t and don’t. 

This is apparent from the table of Comparative Home Ownership Rates on page 

3. The U.S. ranks 17th of 26 economically advanced countries, or about two-thirds 

of the way down the list. 

I think we can agree that we would like our society to have a property-owning 

democratic citizenry, which includes widespread home ownership. But the international perspective makes it clear that many countries achieve home ownership 

levels as high or higher than ours with no GSEs. It turns out that these levels can 

be achieved without tax deductions for the interest paid on home mortgages, without our very unusual practice of making mortgages into nonrecourse debt, without 

Government mandates to make ‘‘creative’’ (that is, riskier) loans, without 30-year 

fixed-rate loans, and with prepayment fees on mortgages. Of course, as bubbles and 

busts in other countries show, you can also get in trouble with different systems. 

At a minimum, we should never assume that the particular historical development so far of the U.S. housing finance system is definitive. 

Canada 

The better credit performance of Canadian housing finance over the last several 

years has become well known. The proportion of Canadian mortgage loans more 

than 90 days delinquent in the first quarter, 2010 was less than 1⁄2 percent. This 

is about one-tenth the ratio of U.S. mortgages over 90 days delinquent at that time, 

which was 4.9 percent. If we add to the U.S. number mortgage loans in foreclosure 

to look at serious delinquencies, it jumps to 9.5 percent. Quite a contrast, as many 

people have remarked. 
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Canada makes a pertinent comparison for the U.S. It is in population and economic size much smaller, of course—about one-tenth in both cases—but is in many 

ways very similar. 

Both countries are rich, advanced, democratic, and stable, have sophisticated financial systems and pioneer histories, and stretch from Atlantic to Pacific. But Canada has no housing GSEs; mortgage loan interest is not tax deductible; it does not 

have 30-year fixed rate mortgages; it does have prepayment fees. 

Mortgage lending is more conservative and creditor-friendly. Canadian mortgage 

lenders have full recourse to the borrower’s other assets and income, in addition to 

the security interest in the house. This means there is less incentive for underwater 

borrowers to ‘‘walk away’’ from their house and mortgage. No tax deduction for interest probably increases the incentive to pay down debt. Most Canadian mortgage 

payments are made through automatic debit of the borrower’s checking account and 

can be matched to paycheck frequency—a technical but important behavioral point. 

Canadian fixed rate mortgages typically are fixed for only up to 5 years. Subprime 

mortgages were a much smaller part of the market. 

This relative conservatism has meant that Canadian banks, the principal mortgage lenders, while experiencing some pressure, have come through the international financial crisis in much better shape than their U.S. counterparts, with (as 

observed above) mortgage delinquencies so far well behaved. 

There does not appear to have been a home ownership price to pay for this relative credit conservatism. Canada’s home ownership rate is 68 percent vs. 67 per-
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cent for the United States. Two very different housing finance systems, one, as it 

turned out, much riskier than the other, produced virtually the same home ownership rate. 

It is important to recognize that Canada does have an important government body 

to promote housing finance, which has a substantial role: the Canada Mortgage and 

Housing Corporation (CMHC). Among its principal activities is insuring (guaranteeing) mortgage loans, another is securitizing some of the insured loans. So you 

could think of it in one sense as a combination of FHA and Ginnie Mae. (Its mortgage insurance program was originally modeled on the FHA in 1954.) 

CMHC’s mortgage insurance is a major factor in the market, covering about 

C$470 billion out of total mortgage debt of about C$ 950 billion, or roughly half of 

Canadian mortgages. This is the same proportion as the combined Fannie and 

Freddie in the U.S. (over $5 trillion out of about $10 trillion). 

Whether or not you like the idea of such a scale of government financing, you 

have to say that, in contrast to the American GSEs, at least CMHC’s status is completely clear and honest. It is a 100 percent government-owned and controlled corporation. Its government guaranty is explicit, so it operates with the formal full 

faith and credit of the government of Canada. It also provides housing subsidies 

which are on budget and must be appropriated by Parliament. 

Canada in this respect looks superior to the U.S. in candor, as well as credit performance. 

However, CMHC does obviously represent a large government intervention in the 

housing finance market. Recalling our previous point about the interaction of housing finance and house prices, one Canadian criticism is that this intervention has 

caused excessive inflation in Canadian house prices. Indeed, Canadian house prices 

measured relative to a base of the year 2000, have now risen higher than U.S. relative house prices at the top of the bubble, as shown in the following graph. 

A general rule is that as long as house prices are rising, mortgage loan performance will be good. Some Canadian commentators worry about whether their house 

prices are in a bubble. The Fraser Institute, a Canadian free-market think tank, has 

called the Canadian mortgage system ‘‘a high taxpayer-vulnerability model.’’ 

In response to these worries, Canadian regulators have taken important countercyclical actions to lower the maximum loan-to-value (LTV) ratios on some of the 

riskier classes of mortgage loans. In other words, they now require larger down payments and allow less leverage of the properties. Such countercyclical movement in 
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LTV limits, in my opinion, is an excellent idea and necessary to moderate the inevitable cycles in real estate credit. We should stay tuned to the highly interesting Canadian housing finance story. 

Matching Mortgage Assets and Mortgage Funding 

The traditional and still typical Canadian mortgage has a long-term amortization 

schedule (up to 35 years for CMHC-insured mortgages), but with an interest rate 

fixed for 5 years, after which the interest rate is reset for another 5 years, and so 

on. Shorter fixed periods are also common, but the debt service to income ratios are 

to be approved based on the prevailing 5-year rate. 

About two-thirds of mortgages remain on the balance sheet of the lenders, which 

are dominated by five nationwide banks. The 5-year fixed rate mortgage loans are 

often funded by the issuance of 5-year fixed rate certificates of deposit, which gives 

a very good natural matching (that is, no derivatives required) of the banks’ assets 

and liabilities. Obviously, such matching is also available for shorter fixed rate periods. 

This is a straightforward answer to a fundamental problem of every housing finance system: how to match the nature of the mortgage asset with an appropriate 

funding source, so that you are not lending long and borrowing short. Different approaches distribute the risks among the parties involved, including lenders, investors, guarantors, borrowers and the government, in various ways. The classic example of not achieving the needed match is the infamous collapse of the American savings and loan industry in the 1980s. 

There are clearly some basic variations: 

• Variable rate mortgages funded with short-term deposits; 

• Medium-term fixed rate mortgages funded with medium-term fixed rate deposits or bonds; 

• Long-term fixed rate mortgages funded with long-term fixed rate bonds or mortgage-backed securities. 

In general, variable rate mortgages put the risk of rising interest rates in the first 

place on the borrowers. To have long-term fixed rate mortgages requires funding by 

some form of access to the long-term bond market. Every housing finance system 

must address this fundamental asset-liability question; the answer results in a particular distribution of risks. 

Denmark 

The most perfect solution in theory, which also functions very well practically in 

its national setting in an admittedly small country, is that of the housing finance 

system of Denmark. It has been admired by many observers. Explicitly governed by 

what it calls the ‘‘matching principle,’’ the interest rate and prepayment characteristics of the mortgage loans being funded, which include long-term fixed rate loans, 

are passed entirely on to the investor in Danish mortgage bonds. 

At the same time, there is a total ‘‘skin in the game’’ requirement for retention 

of credit risk by the mortgage lenders. The mortgage banks retain 100 percent of 

the credit risk of the loans, in exchange for an annual fee, thus insuring alignment 

of incentives for credit performance. Deficiency judgments, if foreclosure on a house 

does not cover the mortgage debt, are actively pursued. 

The fundamentals of the Danish mortgage system go back over 200 years. There 

are no GSEs or government housing banks. This is a private housing finance system 

built on what appear to be quite robust principles. It generates a home ownership 

rate of 54 percent, below that of Canada or the U.S. 

Some years ago, when the proud hearts of Fannie and Freddie had not yet had 

their fall, I participated in an exchange with the Association of Danish Mortgage 

Banks. They explained their mortgage bond- and skin in the game-based system to 

me, then I explained the American GSE-centric mortgage system to them. 

When I was done, the CEO of one of the leading Danish mortgage banks said this: 

‘‘In Denmark we always say that we are the socialists and America is the land of 

free enterprise. Now I see that when it comes to mortgage finance, it is the opposite!’’ 

England 

England has a large economy, is financially very sophisticated, and has an entirely different housing finance structure. It also has no GSEs. The traditional and 

still typical English mortgage is a variable-rate loan financed by deposits in banks 

or mutual building societies. The interest rate on these loans can be changed up or 

down at the will of the lender, so everybody’s rate changes at the same time. This 
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is a natural asset-liability matching for the depository institutions, but is risky for 

the borrowers. 

England had a housing boom and bust in the 21st century cycle, as we did. Indeed, the first casualty of the financial panic was an English mortgage lender, 

Northern Rock, which was a well-known securitizer of mortgages. Northern Rock 

failed in 2007, long before Bear Stearns did, when the wholesale investing market 

refused to continue investing. This was followed by first a run on its retail deposits, 

then by the nationalization of the bank. 

England also had a unified financial regulator, the Financial Services Authority, 

whose jurisdiction included mortgage lenders as well as all other financial intermediaries. This unified regulatory structure did not avoid the crisis. 

Still, England has a home ownership rate of 68 percent, just ahead of the U.S. 

Germany 

Some German banks got into serious trouble in the housing bubble, but by investing in U.S. mortgage securities and other foreign mortgages, not in their domestic 

mortgage lending market, which is quite conservative. It generates a home ownership rate of 46 percent, which would not be politically acceptable in an American 

setting. 

Nevertheless, there are two German housing finance ideas worthy of study. One 

is its mortgage covered bond (Pfandbrief). With a statutory basis more than 100 

years old (and it is claimed, a history going back to Frederick the Great of Prussia), 

the covered bond has provided a relatively stable source of bond-based mortgage financing. 

Covered bonds allow a fixed rate funding for fixed rate mortgage loans, and keep 

the credit incentives of the lender intact, since the lender remains responsible for 

100 percent of the credit risk and the loans stay on its balance sheet. But they provide access to the bond market, in addition to deposit-based funding, and are indeed 

a major component of the German bond market. The mortgage loans serve as collateral for the bonds, which are also senior obligations of the issuing mortgage lender. 

Many people have proposed, and I agree, that the U.S. should introduce covered 

bonds as a mortgage funding alternative—one which does not involve a government 

guaranty. The German experience suggests these lessons: 

• There needs to be a statutory basis for these bonds, not merely a regulatory 

one, to insure the bond holders’ rights to the collateral are truly protected. 

• The mortgage loans serving as collateral for them (the ‘‘cover pool’’) should be 

subject to conservative credit standards, to reduce the volatility and uncertainty 

of their credit behavior. 

A second German housing finance idea for consideration is emphasizing (we 

should say, rediscovering the needed emphasis) on savings as part of sound housing 

finance. Thus, the German building and savings banks (Bausparkassen) continue to 

practice the traditional ‘‘savings contract,’’ by which the borrower commits to a regular savings program as part of qualifying for a mortgage loan. 

I am not recommending their specific program, but the general principle. We have 

completely lost the emphasis on savings as part of housing finance. We need to rediscover it. 

Switzerland 

Switzerland may just be mentioned as a case of the variety exhibited by housing 

finance in international perspective. It is a wealthy country with a very large and 

sophisticated financial sector. It has mortgage debt outstanding of about 100 percent 

of GDP, somewhat higher than in the U.S. 

Yet Switzerland has a home ownership ratio of only 35 percent, the lowest on our 

list. 

It is an unusual housing finance example. So is the American GSE-centric system, 

which has collapsed at heavy taxpayer expense, as did the American savings and 

loan system which preceded it. 

Conclusion 

The variety of international experience suggests that there is every reason to 

think broadly and openly about the possibilities for developing a better, post-GSE 

U.S. housing finance system for the future. 

Thank you again for the opportunity to share these views.