US to fund mortgages with covered bonds

July 30, 2008
US to fund mortgages with covered bonds

NEW YORK - THE American financial establishment has come together in
search of a new way for banks to find cash for home mortgages.

Regulators, bankers and traders, led by Treasury Secretary Henry
Paulson, have all pledged to do their best to get a 'covered bond
market' going in the United States.

It is highly unusual for the government to take such a major role in
getting a market established, but Treasury officials said their
action was needed to get more money into housing loans.

'We are at the early stages of what should be a promising path, where
the nascent US covered bond market can grow and provide a new source
of mortgage financing,' Mr Paulson announced on Monday.

'We spoke to 50 or 60 market participants,' a senior Treasury
official said. 'It became clear that if we took the lead, we had a
real chance to kick-start this market.'

Four major banks - Bank of America, Citigroup, JPMorgan Chase and
Wells Fargo - said they hoped to issue such bonds, while a group of
investment banks and brokerage firms pledged to establish desks to
trade the securities.

What remains to be seen is if there will be buyers. Mr Paulson said
the bonds appeared to be attractive to major banks, which would be
able to pledge them to obtain loans from the Federal Reserve, and to
some institutional investors.

With banks reluctant to lend their own money for mortgages, and the
private debt market down if not dead, the cost of mortgage loans has
been rising even as housing prices fall, making a bad situation
worse.

At best, a covered bond market would provide a cheaper source of
financing for banks while reassuring investors that their money is
safe.

Essentially, investors would buy into a pool of mortgages that would
be kept on the balance sheet of the bank that made the loans.

These would be highquality loans, and at the first sign of trouble in
the underlying mortgages, those mortgages would be replaced in the
mortgage pool.

Thus, investors would be assured of repayment unless the underlying
mortgages suffered major losses and the issuing bank failed.

That might make investors burned by existing mortgage securitiesmore
willing to return to the market.