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Paulson: New way to help mortgage market

The Bush administration and federal banking regulators joined with the nation’s four largest banks to endorse a new way to pump money into the battered U.S. mortgage market.
/ Source: The Associated Press

The Bush administration and federal banking regulators joined with the nation’s four largest banks Monday to endorse a new way to pump money into the battered U.S. mortgage market.

Treasury Secretary Henry Paulson unveiled a set of best practices designed to encourage banks to issue a debt instrument known as a covered bond. The administration hopes these bonds will replace some of the mortgage financing that has disappeared as investors have incurred billions of dollars of losses on mortgage-backed securities.

“As we are all aware, the availability of affordable mortgage financing is essential to turning the corner on the current housing correction,” Paulson said in launching the new effort.

“We are at the early stages of what should be a promising path, where the nascent U.S. covered bond market can grow and provide a new source of mortgage financing,” he said.

Paulson was joined at the news conference by officials from the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision. All the agencies said they endorsed the new set of best practices compiled by Treasury.

Officials from banking giants Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. issued a joint statement saying, “We look forward to being leading issuers as the U.S. covered bond market develops.”

Private analysts said that the new initiative could offer help stabilize the U.S. mortgage market but they did not view the effort as a cure-all for all the problems facing the financial sector at the moment.

Wall Street failed to be impressed, taking another dive on Monday as investors worried about the rising mountain of bad debt confronting financial institutions. The Dow Jones industrial average fell by 239.61 points. Worries were increased when the International Monetary Fund issued a report stating that problems in the credit and housing markets would continue to hurt the financial industry and “at the moment a bottom for the housing market is not visible.”

This effort to jump-start a U.S. market for covered bonds followed action earlier this month by the FDIC to approve new regulations for the bonds, which are a way of packaging mortgage investments similar to an approach that is used in Europe where the market for covered bonds exceeds $3 trillion.

Covered bonds are issued by banks and backed by cash flows from mortgages or other types of debt. Under this approach, banks guarantee the bonds, thus providing an incentive for less risky lending practices. Unlike mortgage backed securities, covered bonds remain on the balance sheet of the bank that sells the bonds.

Encouraging such a market to grow could be one way to decrease the dominance that Fannie Mae and Freddie Mac wield in the U.S. mortgage market.

David Wyss, an economist at Standard & Poor’s in New York, said covered bonds could serve to encourage less risky lending practices because they stay on the books of the banks that sell them.

One of the criticisms of mortgage-backed securities was that banks failed to do a proper job of assessing the ability of borrowers to pay off their mortgages. The mortgages were being packaged with other mortgages and sold to investors as securities, getting them off the books of the banks that originated the loans.

“Banks were going out and telling people they could have mortgages regardless of their credit rating, down payment or anything else,” Wyss said. “Covered bonds make sure that banks have enough skin in the game that they will care about the quality of the mortgages they are making.”

John Douglas, a former general counsel of the FDIC and now an attorney at Paul Hastings, a New York-based law firm, said that it could take as long as a year to develop a track record in the United States to show how investors will respond to buying the covered bonds.

“I don’t think anybody believes that this will be the salvation for the banking industry, but it is another tool that banks can use,” he said.