21 MARTINDALE CENTER FOR THE STUDY OF PRIVATE ENTERPRISE bonds, owning nearly 25% of the outstanding stock (IMF, 2022). The interconnectedness of the mortgage market and pension funds is expected to result in nearly half of Danes with market-rate pensions seeing a decrease in pension payments in 2023 (Fixsen, 2022). With three quarters of Danish wealth inaccessibly stored in real estate and pensions and with these assets set to take a significant hit in the near future, it seems quite inaccurate to say that household wealth enables Danes’ borrowing habits and protects them from rising interest rates. Policy recommendations: limiting household overindebtedness The problem of rising debt servicing costs is ultimately a symptom of a systemic issue: overindebtedness. The goal of any policy in this scenario is to contain excessive risk taking among the most rate-sensitive households without inflicting damage on healthy borrowers and the economy. Policy measures that sharply increase the cost of borrowing threaten the housing market by reducing buyers’ ability to pay, overall loan demand, and household consumption. Danish policymakers have a variety of ways to discourage overindebtedness. They can reduce the LTV allowance, limit or eliminate MID, begin taxing capital gains, or restrict access to ARMs and IOMs. All of these measures reduce intense leveraging by increasing borrowing costs and complicating the borrowing process, but their associated short-term micro- and macroeconomic costs differ widely (Chen et al., 2020). LTV and MID policies An IMF analysis of deleveraging policies conducted in several advanced economies throughout the past two decades found that for countries with highly indebted households and little room to cut interest rates (a situation identical to Denmark’s), LTV and MID reductions are associated with a significant near-term reduction in housing prices, GDP, and consumption. A 10% reduction in the maximum LTV ratio was estimated to cause a 1.1% reduction in GDP by triggering a 2.6% decline in housing prices and an even further reduction in borrowing capacity as borrowers have less valuable collateral for loans, limiting their consumption. The consumption, GDP, and housing price contractions are, respectively, four, three, and two times larger in high-debt countries like Denmark, which are more sensitive to monetary shocks (Chen et al., 2020). The nationwide removal of MID similarly contributes to this negative feedback loop. Denmark’s 1987 tax reforms, for example, which reduced MID more than 20%, resulted in seven years of low growth, high unemployment, record high foreclosures, falling housing prices, and heavy MCI losses (Finance Denmark, 2021). Theoretically, a gradual reduction of MID would avoid these problems, but the forward-looking nature of asset prices results in the immediate decrease of housing prices, sparking the cycle of borrowing, consumption, and output reduction (Chen et al., 2020). When considering the implications of widely adopted LTV- and MID-related policies, it would be unreasonable to recommend their adoption under the recessionary environment Denmark is currently entering. Therefore, neither policy should be pursued until rates drop and growth increases. The same rationale can apply for other nationwide contractionary fiscal policy like the introduction of capital gains taxation. Household-specific borrowing restrictions If the purpose of policy recommendations is to buffer the most vulnerable of households without risking the health of the economy, it appears most reasonable to keep any immediate changes targeted at the 13% of households (450,000) with a DTI ratio above four. Currently, no lending restrictions consider a borrower’s overall debt burden, what portion of their disposable income will be absorbed by the associated servicing costs (DSTI), or the value of liabilities with respect to their income (DTI). DSTI- and DTI-oriented mortgage lending restrictions were found to generate a similar reduction in household debt with low impact on output and negligible impact on asset prices. The implementation of borrowing restrictions on the top 13% of overindebted borrowers, as opposed to nationwide LTV and MID policies, results in a minor hit to housing prices and, by proxy, consumption and output. The following three policy recommendations target borrowers with a DTI ratio of over four and certain LTV characteristics (Chen et al. 2020). These solutions are predicated on DTI and LTV measurements, but the introduction of DSTI-based policies is possible. Danish authorities can implement DSTI- or DTI-based policies in several ways. First, they can increase the mandatory fixed period in an ARM. A similar policy had been implemented by Denmark in 2018, but it required that ARMs only be fixed for at least five years, a measure that should either be increased or dropped altogether in favor of barring those with sufficiently high liabilities from utilizing ARMs entirely. The recommendation to deny access to ARMs for borrowers with LTV ratios greater than 60% and DTI above four was proposed in 2021 but
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