Government regulators are promoting covered bonds to help shore up mortgage market liquidity.
In a statement today, Treasury Secretary Henry M. Paulson Jr. trumpeted the benefits of a U.S. covered bond market.
Unlike residential mortgage-backed securities, which are held off-balance sheet in special purpose entities, high-quality mortgage assets securing covered bonds remain on the lender's balance sheet, he said. And while MBS investors only receive income from loans backing the issuances, covered-bond investors receive income from the issue. In addition, as loans backing covered bonds paydown, they must be replaced.
Paulson explained that a $3.3 trillion covered bond market already exists in Europe. But only two U.S. institutions have so far issued covered bonds as market participants awaited structural clarity about such a market in this country.
"We are at the early stages of what should be a promising path, where the nascent U.S. covered bond market can grow and provide a new source of mortgage financing," the secretary stated.
The Federal Deposit Insurance Corporation issued a final policy statement on July 15, and the Treasury issued a best practices guide to complement FDIC's statement. The guide was the result of a joint effort between FDIC, the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Securities and Exchange Commission.
"Covered bonds represent an important new source of funding for the U.S. mortgage industry," Comptroller of the Currency John C. Dugan said in a statement today. "For the banking system, covered bonds provide a new source of funding that is both more stable than unsecured borrowing and potentially less expensive."
Dugan added that banks have a strong incentive to maintain prudent underwriting standards because they retain the credit risk.
Mortgage Market Liquidity Proposals
A banking regulator has warned Congress that the mortgage market will get worse before it gets better and offered proposals that can help improve the situation.