Covered bonds act may be a mortgage lifeline

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 US 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 US, where the market has been financed with mortgage-based securities.

MBS are static pools of mortgages which do not remain on an issuer's balance sheet.

Now that the US government plans to wind down mortgage financing juggernauts Fannie Mae and Freddie Mac, covered bonds are considered a serious alternative to the existing US housing-finance market. They could reduce banks' reliance on the two GSEs and provide a cheap funding alternative.

US 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 US 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 US to flourish and grow, while ensuring that US financial institutions are no longer at a competitive disadvantage to their foreign counterparts."

Garrett is Chairman of the House Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises. Maloney is ranking member of the House Financial Services Subcommittee on Financial Institutions and Consumer Credit.

"In the wake of the financial crisis, we need new investment vehicles that will attract investors to the securities market and increase the flow of credit," Maloney said.

"With their success in Europe, covered bonds present a significant opportunity for US financial markets and I look forward to working to ensure their success in this country."

This isn't the first time a covered bond bill has been introduced. Most recently, covered legislation was expected to be included in the financial-regulatory reform bill in June, only to be excised from the final bill in the eleventh hour.

Proponents of the US covered bond legislation at the time were hopeful that a separate bill could be passed by the end of 2010, but it failed to materialize.