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The Senate Banking Committee held a hearing Wednesday to further examine the uses and regulatory issues associated with covered bonds, to decide if they are a viable alternative to stimulate the U.S. economy and contribute to sustained growth.
Money Morning Contributing Editor Shah Gilani explained the benefits of a U.S. covered bond market in a story Wednesday. Covered bonds are debt securities backed by the cash flows from public-sector loans or from real-estate mortgages. They resemble other asset-backed securities (ABS) created through the process known as "securitization," but have one big difference: Covered-bond assets must remain on the issuer's consolidated balance sheet.
"A robust covered bond market offers many solutions to the problems that currently ail the U.S. economy, as well as its underlying financial system," said Gilani. "A covered bond market would jump-start needed lending by creating a healthy, transparent and "honest" securitization market. It would also enable the United States to regain its title as the financing center for the global economy."
Covered bonds are popular investments in Europe, offering investors high quality investments with attractive yields. Banks providing the bonds are able to lend more and fuel the housing finance market. Only a few U.S. banks issue covered bonds, but the investment vehicle is getting more attention, as the need to spur lending grows increasingly important.
Proponents of a U.S. covered bond market argued at the Senate hearing that covered bonds could be the answer to restarting the mortgage market. But the main sticking point is how much flexibility and power the Federal Deposit Insurance Corporation (FDIC) will have if a financial institution fails.
"The issue is the rub between the rights that the FDIC understandably wants to have and the clarity that the investors in covered bonds want to have in the event there is a problem with the institution," Sen. Bob Corker, R-TN, who request the hearing, told American Banker. "To me, that's the essence of what's standing in our way of having a real covered bond market, and I hope over the period of the next several months we figure out a way to resolve that."
Gilani said that while the FDIC should be concerned about bank failures, as its job entails, the idea that a covered bond market would make those failures more expensive is "utterly ridiculous."
"Securitization is the ultimate form of disintermediation, meaning the originate-to-distribute model took assets off the books of institutions that the FDIC would have had access to in the event of a failure," Gilani said. "Securitization stripped out assets from reach of the FDIC, and the very same institutions that failed held securities in lieu of direct loans that were less valuable to the FDIC because they were not local pools in the first place, and secondly had the security pool's servicer to contend with, who have their own interests, which aren't aligned with those of the FDIC. So, to say that there is any legitimacy to any contention that the FDIC should be worried that covered bonds, which are collateralized, against which reserves are held, and which remain on the balance sheets of issuing institutions is worrisome to the FDIC, is, as I said ridiculous."
U.S. Sen. Christopher Dodd, D-CT, said the hearing was intended to address investors' main concern, which was gaining clarity on what would happen should a covered bond issuer go into receivership. Dodd also question which entities should be eligible to issue covered bonds, whom should regulate them, what assets should be eligible, and what standards should apply to issuance.
But Gilani describes Dodd's questioning as more of a stall tactic than a covered bond market review.
"The answers to Senator Dodd's rhetorical questions are obvious," said Gilani. "He knows the answers, he's only asking them to delay the discussion long enough to punt the issues to his replacement, so he doesn't anger banking lobbyists and banking executives."
The underlying tone of the hearing highlighted how the amount of profits generated for big banks was the driving force in deciding on the future of covered bonds.
"Banks don't want this product because they don't make money on it like they do with their originate-to-distribute model," Gilani said. "[B]ig banks and Wall Street don't want to issue covered bonds because these securities would make banking safe again – thereby destroying the speculative machinery they built to manufacture their egregious profits."
News and Related Story Links:
- Money Morning:
Covered Bonds: The Solution to America's Economic Ills
- Money Morning:
Covered Bonds: An Investing Stalwart Through the Centuries