A bill on covered bonds introduced to Congress on Tuesday may pave the way for the creation of a market already well-established in Europe, where it supports a large mortgage market.
Representatives Scott Garrett (R-NJ) and Carolyn Maloney (D-NY) introduced the United States Covered Bond Act of 2011 to the House of Representatives, the first step in setting up a market for the securities issued by domestic financial institutions.
Covered bonds are low-yielding securities issued by banks and backed by a dynamic pool of loans – usually high-quality mortgages – that remain on the issuer’s balance sheet. For a long time they have been popular in Europe but have failed to catch on in the U.S., where the market has been financed with mortgage-based securities (MBS).
MBS are static pools of mortgages which do not remain on an issuer’s balance sheet.
Now that the federal government plans to wind down mortgage financing juggernauts Fannie Mae and Freddie Mac, covered bonds are considered a serious alternative to the nation’s existing housing-finance market. They could reduce banks’ reliance on the two GSEs and provide a cheap funding alternative.
Banks have been generally optimistic about a domestic market for covered bonds. Indeed, two firms have issued covered bonds of their own, Washington Mutual in 2009 and Bank of America in 2007.
But the credit crisis foiled the development of a sustainable covered bond market. Covered-bond advocates view the securities as a new, untapped lifeline for the country’s ailing housing market.
"As our country recovers from the fallout of the financial crisis, it’s more important now than ever before to provide the U.S. capital markets with new and innovative ways to unlock credit and encourage private sector capital to get off the sidelines," said Garrett.
"This legislation will provide the necessary framework for a covered bond market in the U.S. to flourish and grow, while ensuring that U.S. financial institutions are no longer at a competitive disadvantage to their foreign counterparts."
