At a time when Fannie Mae and Freddie Mac are in serious financial difficulties, the Federal Deposit Insurance Corporation (FDIC) and the Treasury Department have both indicated that covered bonds might be an important new way to finance mortgages in the United States. Covered bonds are used extensively and successfully in Europe, but only very rarely in the United States. In a covered bond transaction, a bank sells bonds that are backed by a pool of mortgages that the bank continues to hold on its balance sheet. The bank is obligated on the bonds and must replace defaulted mortgages in the pool with performing mortgages, so that the bondholders are covered by both the bank’s liability and the collateral represented by the mortgages. This double protection should enable the bank to get and maintain a AAA rating on the bonds and very low cost financing for the mortgages. In addition, the fact that the bank has a continuing obligation to replace defaulted mortgages will require more careful underwriting in mortgage lending. All of this sounds like a promising form of competition for the much-criticized securitization financing system that has been dominated for many years by Fannie Mae and Freddie Mac. However, there are important issues to consider. Among other things, the fact that some of the bank’s assets have been designated to back the covered bonds means that fewer assets would be available for the FDIC and depositors if the bank fails. This conference will consider this and many other issues that arise in balancing covered bond financing with the requirements of the deposit insurance system.
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Saturday, November 21, 2009
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