September 15, 2010 / 4:16 PM / 9 years ago

UPDATE 1-US regulator questions push for covered bond law

* FDIC says need for law on covered bond market unclear

* Some lawmakers, industry supports formal framework

* Time running out to pass legislation this year (Adds background, Corker quote)

By Dave Clarke

WASHINGTON, Sept 15 (Reuters) - A top U.S. banking regulator on Wednesday questioned the need for legislation intended to speed development of a covered bonds market.

Potential issuers of these bonds, including banks like Bank of America, argue that a legislative framework could boost the market and provide a safer method for banks to raise funds and credit to consumers for mortgages and other loans.

Covered bonds are debt securities backed by cash flows from mortgages but, unlike loans that are securitized, they remain on the issuer’s balance sheet and thus are seen as safer than non-guaranteed mortgage securities.

A vibrant covered bond market could relieve some dependence on goverment backing from mortgage financiers Fannie and Freddie, but banks may be reluctant to keep the loan risk on their balance sheets.

Covered bonds have become part of the larger debate over how to overhaul U.S. housing policies. They have been promoted as an alternative to government-backed mortgage funding and are widely used in Europe.

But a limited legislative calendar and doubts about the need for formal congressional action make it unlikely that a covered bond market framework law will be passed soon.


A key to the debate is the FDIC’s concern that legislation would impair its ability to recover losses from its deposit insurance fund when it winds down a failed bank by allowing covered bond holders to be treated differently than other creditors.

“The essence is going to be the rub between the FDIC and everyone else,” said Republican Senator Bob Corker.

An official from the Federal Deposit Insurance Corp told the Senate Banking Committee on Wednesday that existing guidance from federal regulators may be all that is needed for this market to thrive.

“Given the FDIC’s existing statement of policy, the Treasury Department’s companion Best Practices, and the prior successful covered bond programs developed in the cooperation with the FDIC, it is unclear that legislation is necessary to re-launch the market,” said Michael Krimminger, deputy to the FDIC chairman.

Krimminger added that the agency “supports a vibrant covered bond market in the U.S.” and that it could get behind legislation so long as it meets certain criteria such as ensuring that taxpayers would not be on the hook to pay for any failures in the market.

An industry representative disagreed with FDIC’s position that legislation may not be needed and pushed lawmakers to act soon.

“Dedicated covered-bond legislation and public supervision, from the perspective of market participants, creates a degree of legal certainty that regulatory initiatives just cannot replicate,” testified Scott Stengel, who was representing the Securities Industry and Financial Markets Association (SIFMA), a group that includes possible covered bond issuers.

A representative from another U.S. banking regulator was more supportive of the push for legislation.

“We are encouraged by the continuing interest in establishing a statutory structure for covered bonds in the U.S.,” Julie Williams, chief counsel at the Office of the Comptroller of the Currency, testified.

“Such a step, prudently structured and implemented, holds promise as an additional, complementary funding source for financial institutions, and a catalyst for sound competition among the financial product funding alternatives available in the U.S.”


The Obama administration plans to unveil its housing proposal, including what to do with federally-backed Fannie Mae FNMA.OB and Freddie Mac, in January and covered bonds may be dealt with in the ensuing debate.

Covered bonds, a top source of mortgage money in Europe, are modeled on German “pfandbrief” that date back to the mid-18th century.

Before the financial crisis, the bonds were heralded by Bank of America and Washington Mutual as a way for banks to retain control of mortgages they make and get cheaper funding.

But the nascent market sputtered as investors fled risk in 2008, and remain wary of anything but the programs of federally-backed Fannie Mae and Freddie Mac.

Investors are thus demanding greater protections for covered bonds, setting up a dispute over the claims of the “cover pool” in the event of failure at the issuing bank.

A bill sponsored by Republican Scott Garrett is pending in the House of Representatives but given the lack of time on the congressional calendar any legislation faces long odds of being enacted this year.

Democrats promised to hold the hearing earlier this summer after Republicans agreed not to try to force the issue during final negotiations over the Dodd-Frank Act, the sweeping overhaul of the financial regulatory framework enacted in July. (Editing by Clive McKeef)

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