Patient Financiers or Secret Gamblers? - Institutional Change in German Mortgage Banking

This paper investigates the change in the refinancing preferences of German mortgage banks from the perspective of institutional theory. While the US mortgage market has increasingly been studied since the US mortgage meltdown was widely identified as the origin of the outbreak of the GFC, examinations of changes in mortgage sectors of European political economies are less developed. German mortgage banks that are famous in global capital markets for their long-term high quality covered bonds (Pfandbriefe), discovered new financial tools such as derivatives for their refinancing business in the early 1990s. While on the surface the banks continued German-style of securitization through the issuance of conservative Pfandbriefe, their changed refinancing behaviour turned out as risky speculative lending practices and made it to the headlines of the international finance press in the late 1990s calling the banks “Germany’s secret gamblers” and “Hypo-hedge-funds”. Such a changed behaviour is especially puzzling for German mortgage banking that is understood to be riskless by law. With German mortgage banks as a least-likely case for excessive risk-taking the main finding of this paper is that a combination of a sociological account (belief formation) with a behavioural institutionalist (prospect theory) perspective helps to explain the preference change of German mortgage banks. The study is based on an intensive assessment of various primary documents, the media press and field interviews. It applies the method of systematic process analysis to compare the historical record of the change in German mortgage banking with the expectations of rival institutional approaches.