Last year, mortgage securitization fell apart, taking with it some of the world's biggest banks and brokerage houses. But not in Denmark. Outside of a few days last March when market makers couldn't keep up with demand for sales, the Danes have been securitizing commercial and residential mortgages throughout the crisis, just as they have almost every day since 1797.

Despite a slide in Copenhagen property values of more than 14% over the past two years, Standard & Poor's in November reissued its AAA rating on the $154 billion in commercial and residential mortgage bonds of Nykredit Realkredit, Denmark's biggest mortgage bank.

Before the crash, the Danish model was ho-hum to most bankers. The system is so transparent and regulated, there isn't the same opportunity to make money. Nykredit earned just 2.1% income on its new mortgages last year. Now, low risk and low reward hold some appeal.

Now some policy wonks, notably billionaire George Soros, the New York hedge fund manager, are asking Washington and Wall Street to look at the world's oldest credit market.

Fire sale

The Danes began securitizing mortgages after a fire destroyed a huge chunk of Copenhagen in 1795. The city needed to raise money for new houses quickly, and decided to adopt a fund-raising method operating in Germany.

Compared with the modern U.S. version, the Danish model is simple. Each mortgage bank handles the full securitization process, from origination to servicing. The bank originates the loan, packages the collateral, and sells the bond. Also, unlike the U.S. model where mortgages are made and the originator recoups lent money when bonds are sold, Danes first sell the bonds, then fund the loan.

The reversed process means the bank never gets caught short by a shift in interest rates between the time the loan is issued and the time the loan is sold. It also means the bank is not left hanging, if the issue fails entirely.

In Denmark, loan-to-value requirements are strictly enforced: 80% LTV for a house, 60% for commercial property. Banks service the loans, avoiding another pitfall of the U.S. system. Subprime borrowers also receive mortgage insurance support from the government, keeping credit quality up.

Most loans are long-term and fixed-rate, which the mortgage holder can refinance through the bank at any time, just as in the U.S. However, if interest rates rise and the bond is selling at a discount to par, property owners can buy mortgage bonds to pay down their principal.

From the investor's point of view, allowing the homeowner to purchase the bonds reduces the risk that a borrower will look at his negative equity and decide to send in the keys.

In Denmark, this seems to work well. “Since 1795, there has never been a Danish mortgage bond in default,” says Jorne Strunge of the Association of Danish Mortgage Banks. “It's a long tradition.”

Not surprisingly, Denmark has the second-largest covered bond market in Europe, with over $300 billion in outstanding loans, all issued without the government taking a direct role in lending, as is the case in the U.S.

Can it happen here?

Lawrence White, professor of finance at New York University, cautions that the Danish system could work well in a small, homogenous country, but might not in a diverse country of 300 million.

Soros, however, argues that the Danish private-sector system would be an improvement over the current system in which profits accrue to the private sector but risks are borne by the government.

Mexico is taking a cue from Denmark. Hipotecaria Total (HiTo), a Danish-style mortgage bank founded partly through a grant from the Soros Foundation, began issuing a small number of mortgages last year, but more are on the way.

Remco Polman, HiTo's CEO, hopes to issue 20,000 residential mortgages over the next two years, but could support as many as 500,000. “I don't think it's specifically a good model for Mexico alone,” he says. “I'm convinced that it's the best model for mortgages worldwide.”

Bennett Voyles is a veteran commercial real estate reporter and NREI's Paris correspondent. For questions or comments, readers can e-mail him at benvoyles@yahoo.com.