European Funding Program Comes To America
Tuesday, June 17th, 2008 Subscribe To Our Feed
It is no mystery that the real estate market in the U.S. is spiraling downhill rapidly. While the notorious television financial media are speedy to pronounce that “the worst is behind us” after each adverse news item on the subject, the documentation is suggestive that the wrap-up is nowhere to be had. Prices of real estate continue to fall, 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 wobble along in a terminal state, just scarcely functioning.
Amidst all this doom and gloom, the US Treasury Department is providing a sparkle of hopefulness by actively promoting the issuance of a new species of debt known as a “covered bond” to raise money for mortgage lending. The Treasury Department can’t declare credit for inventing the program, as they are the number one wellspring of mortgage-loan funding for European banks.
Covered bonds are a type of mortgage-backed security, but they’re very unrelated from the derivative-laced speculative packages that fueled the real estate explosion that reached its zenith in 2006. It was the inclusion of extremely risky derivatives in those packaged mortgage securities that got many Wall Street banks in this hardship. They were totally unregulated (and still are). These highly speculative “investments” were held off the balance sheets of financial institutions and were almost always deliberately opaque. Investors had not only the rights to the mortgage payments but also the double risk of defaults and derivative failure, which turned out to be overwhelming.
On the other hand, covered bonds are currently viewed as much safer investments because they’re not packaged and sold but remain on a bank’s balance sheet and the buyer of the bonds gets protection in not one, but two ways. The bonds are backed first by a “cover pool” of high-quality mortgages that have to meet certain financial and regulatory, such as being in good standing. If the mortgages go bad, the bank must proactively take action to warrant bond holders receive their interest payments.
Banks seeking funds to lend to homebuyers also have the traditional approach — gathering deposits from consumers. That remains an important source of funding for mortgages, but deposits can be costly to lure and less enduring than bonds sold to major institutional investors.
Until mid 2007, lending institutions had seldom trouble obtaining the money to make loans. They could easily do up mortgages into different forms of securities, auction those packages and apply the proceeds to make additional loans.
At present, however, investors have become timid by rising defaults combined with inability to sell off structured financial instruments that have questionable derivatives and have absolutely lost confidence in mortgage-backed products issued by Wall Street firms. The only mortgage securities that investors are willing to place funds in are the ones guaranteed by government-sponsored entities like Fannie Mae, Freddie Mac and the FHA.
U.S. TreasurySecretary Henry Paulson and other policy makers envision covered bonds as a way to furnish a fresh source of funding for the housing market. The endeavor is being orchestrated by Mr. Paulson, Federal Reserve Chairman Ben Bernanke, FDIC. Chairwoman Sheila Bair and other financial policy makers, who are aware that the tenuous housing market will perpetuate the falling economy.
The Treasury Department is expected to deliver a manuscript to stipulate regulatory precision within the upcoming few months. Another hurdle in the U.S. has been legal cloudiness about the rights of investors if a bank goes under. Under current rules, the Federal Deposit Insurance Corporation has 90 days in the event of a bank failure to reimburse funds for the covered bonds. The regulation helps the Federal Deposit Insurance Corporation decrease the cost of dissolving a bank but at the same time creates a holdup for investors as well as some uncertainty. The Federal Deposit Insurance Corporation has come out and proposed a new regulation decreasing the time duration to ten days. A final regulation could be issued as soon asthis summer. This is no period to be procrastinating. The mortgage and housing markets need all the assistance available.
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