The Danish Dilemma

 

The author (Neil Jackson) as Danish ambassador Peter Nielsen in  'Sweet Rockall',  a piece of satirical theatre that played to sold-out audiences at Birmingham's AE Harris, 3rd-5th July 2014

The author (Neil Jackson) as Danish ambassador Peter Nielsen in ‘Sweet Rockall’, a new piece of satirical theatre that played to sold-out audiences at Birmingham’s AE Harris, 3rd-5th July 2014

The Story

Velkommen til vores slot stryke!

I have not chosen to welcome you in Danish without reason; I have spent the last week playing a Danish ambassador in Sweet Rockall, a new piece of satirical theatre by David Gray. Assuming the role of Peter Nielson I filled the evenings with comically-misused English idioms, while my stomach was filled with – what else? – Danish pastries.

But there is more to Denmark than pastries, politics, or, say, innovative methods of peeling 1kg of potatoes in under a minute: a little research reveals an interesting housing sector…and perhaps, to quote Hamlet, something rotten in the state of Denmark.

An Interesting Market

On the surface the Danish housing market looks to be in good health. For a start, the average new build in the UK, researchers have found, is just 76sq m in size, while a few hundred miles away in Denmark the average build size is a comparatively palatial 137sq m. The prices for single family homes and condominiums – the latter significant, given the increasing number of Danish parents buying apartments for their children – have been rising, with the Danish estate agent Association (DE) reporting that 59% of estate agents predict house prices will be higher in a year. Looking to the wider economy, Denmark’s inflation rate remains positive…but only just, with inflation running at 0.2% in March this year. Still, the continued prospect of low interest rates should continue to support developments in the Danish housing market in 2014.

Low interest rates have led to a Danish predilection for interest-only mortgages: in 2004 only 10% of Danish mortgages had long interest-only periods – by 2013 that number had climbed to 57%. And as the Danish rushed to purchase properties, and demand consequently rose, so did house prices.

Rather a lot, as it turns out.

The Danish Housing Bubble

At the beginning of the 21st Century Denmark experienced its own housing bubble. Danish property prices rose faster than at any point in history: between the start of 2005 and the third quarter of 2007, property prices had appreciated 41%.

Prices have come down since, falling by around a fifth, but any appearance of comfort needs to be weighed against an enormous private sector debt burden, approaching 300% of disposable incomes in 2011 – more than double the UK’s rate. Indeed, in 2011 Denmark had by far the highest share of debt as a percentage of disposable income of 28 leading international economies.

There has been no call for panic yet: Denmark has low government debt – gross debt only 46% of GDP – and its central bank has plenty of reserves…but Spain also had robust-seeming government finances before 2007, only to suffer a crisis of confidence when its banking sector started to implode.

And that’s the worry – the banking sector imploding and the housing bubble ‘popping’. Long-term forecasting relies on an understanding of Danish banks have financed themselves through the housing bubble: mortgage-backed securities – which is to say, bonds. These have been seen as low-risk – in Denmark’s 200-year history of mortgage bonds there have been no instances of defaulting – but now the European Banking Authority (EBA) are threatening to downgrade Danish mortgage bonds from their current ‘liquid’ asset status to a less favourable classification. Should this happen banks would most likely offer a higher rate of interest to attract buyers, a burden which would be passed on to borrowers. Given that interest-only mortgages are so popular, and that the average Dane is only paying down an average of 2% on their mortgage a year, any increase in interest rate could seriously stretch the finances of owner-occupiers.

And when the interest-only period ends – typically ten years into the loan – and borrowers are forced to address the remaining capital with said stretched finances…well, many would not be able to afford to pay off their loan. The Danes are typically well-off, financially speaking, but most of that wealth is tied up in their houses – which due to interest-only mortgages are often illiquid assets, i.e. they cannot be sold without a substantial loss in value to the seller – and pensions, which are not easily accessible, if at all.

Should the Danish housing bubble ‘pop’ and debtors be forced to dump their homes in order to pay down debts, the subsequent downward pressure on house prices could spark a housing slump. The Danish krone is currently pegged to the euro (i.e. the rate of exchange for Denmark’s currency is mapped to the currency of the European Union), and while it has ample reserves, Gregory Perdon of Arbuthnot Latham (a British private bank) believes the Danish central bank would find it difficult to defend their exchange-rate policy and buoy the housing market simultaneously: either trade with the EU would suffer, or the Danish housing market would enter an historic slump. Neither outcome would be desirable.

Towing Gear – The Slow Recovery

“Some of the consequences of the Danish funding structure are addressed in the bill, but the causes are not.” – Fitch, Ratings Agency

The government of Denmark has been quick to play down the aforementioned perfect storm, but despite insisting that the market is sound is not taking chances. Earlier this year a new law went into effect that would automatically extend by 12 months the maturities of existing bonds in the “very unlikely” event that new auctions failed, or if interest rates went up by more than five percentage points. This will keep the banks from failing – unlike what happened in Spain – but commentators still call for caution regarding Denmark’s ‘recovery’.

DE chief economist Troels Theill Eriksen has said that the Danish economy will continue to “run in towing gear” – a slow and steady recovery, but one that is still moving forwards. As discussed earlier Denmark are still holding out, even if only marginally, against one of the primary issues with a single currency – falling inflation. There is no sense of overt austerity from the Danes; the unemployment rate is only a bit over 4%, having peaked well below 5% in the wake of the financial crisis. Contrast this with the UK’s unemployment rate, which according to the Public and Commercial Services Union (PCS) is now at its highest for 18 years.

Conclusion

Direct parallels cannot necessarily be drawn between England and Denmark, but the Financial Services Authority (FSA) has determined that more than 40% of the UK’s outstanding home loans are interest-only, with that ratio rising to over 50% in London and the South-East. The argument has been made that since house prices seem more resilient in the South than other regions, borrowers will have greater housing equity to fall back on if they cannot meet their repayments, but much like in Denmark this relies on house prices remaining buoyant: a slump could be just as disastrous for us as it would be for the Danes.

Is Denmark’s ‘towing gear’ and trend-bucking inflation proof that austerity doesn’t work? Is it better to escape a housing bubble by moving forwards, however slow and grinding the pace, than to hunker down and hope the bubble just floats away? With so much wealth tied up in property in the South East, should we consider intervening as the Danish government have to insure against the dangers posed by the extensive amount of interest-only loans? Or are the differences between our two countries too great to draw a comparison?

Regardless, given that the UK finds itself perched precariously on the surface tension of its own housing bubble we could do worse than look to neighbouring economies experiencing similar overheating of the housing market and see if there are any methods that might be used to prevent our bubble popping. Insular pride will not help us – we must be willing to look beyond our borders, to engage with different ideologies and methodology in order to prevent an ugly collapse of our housing market.

In Sweet Rockall, my character of Peter Nielson encouraged this kind of open dialogue and discourse. Unlike Peter, however, the UK may not be able to “have its pastry and eat it as well”…even if, superficially at least, it looks like Denmark can.

References

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