It’s no mystery that the housing market in the United States is spiraling downhill rapidly. While the favored television financial media are fast to pronouonce that “the worst is behind us” after every negative news story on the topic, the documentation suggests that the wrap-up is nowhere to be had. Values of real estate continue to plummet, foreclosures continue to soar, it remains exceedingly difficult to get approved for a first time home buyers loan, and the secondary mortgage market continues to dodder along in a terminal state, just scarcely functioning.
Amidst all the doom and gloom, the U.S. Treasury Department is offering a flash of hopefulness by actively promoting the development of a new type of debt called a “covered bond” to raise money for mortgage lending. The Treasury Department cannot take credit for inventing the policy, as they are the number one wellspring of mortgage-loan funding for European lenders.
Covered bonds are a form of mortgage-backed security, but they’re very unrelated from the derivative-laced speculative packages that powered the housing expansion that reached its peak in 2006. It was the inclusion of high risk derivatives in those packaged mortgage securities that landed many Wall Street banks in this predicament. They were totally unregulated (and still are). These exceptionally speculative “investments” were kept off the balance sheets of financial institutions and were most of the time deliberately opaque. Investors received not only the rights to the mortgage payments but also the double risk of defaults and derivative failure, which have been revealedto be overpowering.
On the other hand, covered bonds are currently considered much safer investments because they are not packaged and sold but reside on a bank’s balance sheet and the buyer of the bonds recieves double protection. The bonds are backed first by a “cover pool” of high-quality mortgages that must meet certain criteria, one of which is being in good standing. If the mortgages fail to be repaid by the borrower, the bank must step in to guarantee bond holders get their interest.
Banks favor the notion because it ensures a sustained and stable source of funding for making mortgages. The stature of the underlying loans translates into high credit ratings, which results in lower interest cost to borrowers.
Banks seeking funds to make home loans also have the customary method — garnering deposits from consumers. This strategy is still an influential provenance of funding for mortgages, but deposits can be costly to capture and less reliable than bonds sold to major institutional investors.
Until mid 2007, lending institutions had seldom trouble getting the capital to to lend. Lenders could smoothly bundle mortgages into numerous forms of securities, auction them and parlay the receipts to write additional loans.
Currently, however, investors have become timid by rising defaults combined with helplessness to sell off structured financial packages that contain chancy derivatives and have exhaustively lost conviction in mortgage-backed financial products issued by Wall Street trading houses. The sole mortgage products still in favor with investors are the ones guaranteed by government-sponsored entities like Fannie Mae, Freddie Mac and the FHA.
U.S. TreasurySecretary Henry Paulson and other policy regulators see covered bonds as a way to provide another wellspring of funding for the housing market. The application is being championed by Mr. Paulson, Federal Reserve Chairman Ben Bernanke, Federal Deposit Insurance Corp. Chairwoman Sheila Bair and other financial regulators, who are aware that the degenerate housing market will perpetuate the falling economy.
The Treasury is anticipated to deliver a document to provide regulatory clarity within the coming few months. A further hurdle in the U.S. is legal cloudiness about the rights of investors if a bank defaults. Under current rules, the Federal Deposit Insurance Corporation has 90 days in the case of a bank failure to reimburse funds for the covered bonds. The provision helps the Federal Deposit Insurance Corporation minimize the cost of dissolving a bank while at the same time creates a holdup for investors as well injecting a level of uncertainty. The Federal Deposit Insurance Corporation has come out and proposed a new regulation decreasing the time period to 10 days. A final regulation could be issued as quickly as this summer. This is no phase to be procrastinating. The mortgage and housing markets require all the aid they can get.
