Does Long Bond Financing Enhance Financial Stability?

["Per Gunnar Berglund" <pgb@xxxxxxxxxxxxxxxxxx>]

Systems of mortgage financing of housing differ considerably between the
industrialised nations.
	Two pretty good large-country examples are the US and Britain. In the
former, mortgage interest rates are usually "tied" for very long periods --
thirty years being a rule rather than an exception. In the latter, however,
mortgage rates are "floating", that is determined by the central bank short
rate plus some credit risk markup charged by the mortgage institute.
	As to small countries, a fine example is the difference between mortgaging
habits in Denmark and Sweden. Denmark shares much of the characteristics of
the US system, with mortgage rates commonly being "tied" for 20--30 years,
while in Sweden, much of the mortgaging is made at "floating" rates. There
is also a considerable amount of "tied" mortgaging in Sweden, but the tying
period is seldom longer than 5 years.
	I guess that both the US and Denmark have been characterised by a
considerably higher degree of financial stability than Britain and Sweden.
At first sight, this might be taken for an indication that long financing
is superior to short, when it comes to stability.
	However, judging from the Swedish experience, I am not quite convinced
that such is the case. Government has been doing a great deal of long
financing here, even though the bonds are seldom longer than 10--15 years.
Still, it was the strategy of the Swedish National Debt Office to place
long paper during the severe depression of 1991--94, when budget deficits
were running up to 13 percent of the GDP. During this period, there was
severe unrest in the bond markets, culminating in the bond market
depression of 1994.
	Since the lever between bond yield and present value is much greater for
long paper than for short, I would consider long financing to be conducive
to speculation in rate changes, thus destabilising rather than stabilising
the markets. On the other hand, a general resort to short financing might
make the long paper market thinner, and thus create some more instability
due to the greater impact of every marginal purchase or sale.
	I would like some of the many financial experts on PKT to throw some
reflections on this problem of maturity structure of both private and
government debt. What system would you prefer? The US--Danish or the
British--Swedish? and For what reason?


Best,
Per


Per Gunnar Berglund
Lilla Sallskapets vag 60
127 61  SKARHOLMEN
SWEDEN

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