U.S. Pushes a European Method To Help Banks Make Home Loans

WASHINGTON -- The Bush administration, seeking to jump-start the struggling mortgage market, is pushing a method of financing popular in Europe that could make it easier for home buyers to obtain loans. The Treasury Department is hosting a meeting Tuesday between regulators, bankers and other financial players. On the agenda: encouraging lenders to issue a type of debt known as a "covered bond" to raise money for mortgage lending, according to people familiar with the matter. Washington's interest stems from the success of the $2.75 trillion covered-bond market in Europe. Such bonds are the primary source of mortgage-loan funding for European banks. Some analysts have predicted that a covered-bond market in the U.S. could grow to $1 trillion over the next few years. Currently, the market is minuscule compared with the $11 trillion in home mortgages outstanding in the U.S. Covered bonds are a type of mortgage-backed security, but they are quite different from the products that fueled the housing boom and landed many Wall Street banks in trouble. The problematic types were held off financial institutions' balance sheets and were sometimes backed by shaky, subprime mortgages. Investors received not only the rights to the mortgage payments but also the risk of any defaults, which turned out to be plentiful. Covered bonds are considered safer investments because they stay on a bank's balance sheet and the buyer of the bonds gets double protection. The bonds are backed first by a "cover pool" of high-quality mortgages that must meet certain criteria, such as being in good standing. If the mortgages go bad, the bank must step in to ensure bond holders get their interest. Banks like the concept because it could provide a stable source of funding for making mortgages. The quality of the underlying loans translates into high credit ratings, which can result in lower interest payments to investors. The loan quality also attracts a different group of investors than a bank's unsecured debt, which helps diversify the bank's funding sources. Banks seeking funds to make home loans also have the traditional method -- garnering deposits from consumers. That is still important, but deposits can be expensive to attract and less stable than bonds sold to big institutional investors. Until last year, lenders had little trouble getting the money to make loans. They could easily package mortgages into securities, sell them and use the proceeds to make more loans. Now, however, investors spooked by rising defaults have lost confidence in mortgage-backed securities other than those guaranteed by government-related entities like Fannie Mae, Freddie Mac and the Federal Housing Administration. Treasury Secretary Henry Paulson and other policy makers see covered bonds as a way to provide another source of funding for the housing market. "There is such enormous potential for covered bonds to play a role in mortgage financing," said Bert Ely, a banking consultant in Alexandria, Va. The effort is being orchestrated by Mr. Paulson, Federal Reserve Chairman Ben Bernanke, Federal Deposit Insurance Corp. Chairwoman Sheila Bair and other financial regulators, who fear that the weak housing market may continue hamper economic growth. U.S. banks can issue covered bonds here, but just two have done so: Bank of America Corp. and Washington Mutual Inc. The market in the U.S. has been hobbled by unfamiliarity with the concept and some regulatory hurdles. The Treasury may soon issue a document to provide regulatory clarity, said people familiar with the efforts. It also hopes to persuade some brand-name banks to spearhead the idea. In a speech earlier this year, Mr. Paulson said covered bonds "may address the current lack of liquidity in, and bring more competition to, mortgage securitization." Covered bonds have been used for centuries in Europe, where the market began in agriculture and grew to focus on residential and commercial real estate. About 20 countries in Europe have covered-bond legislation, which provides clarity to investors about their claim on the assets, interest payments and the types of collateral allowed in the pool. Another hurdle in the U.S. has been legal uncertainty about the rights of investors if a bank defaults. The FDIC has 90 days in the case of a bank failure to pay off the covered bonds. The provision helps the FDIC minimize the cost of winding up a bank but creates delay for investors and some uncertainty. The FDIC has recently proposed a new rule shrinking the time period to 10 days. A final rule could be issued later this summer.