It is no mystery that the real estate market in the U.S. is spiraling downhill rapidly. While the noted television financial media are speedy to pronounce that "the worst is behind us" after each unfavorable news item on the subject, the evidence is suggestive that the end of the line is nowhere in sight. Prices of homes continue to plummet, 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 falter along in a terminal state, just scarcely operating.
Amidst all the bad news and despair, the US Treasury Department is offering a flicker of hope by actively promoting the development of a new type of debt known as a "covered bond" to raise money for mortgage loans. The Treasury Department can't take credit for creating the policy, as they are the primary springhead of mortgage-loan financing for European lenders.
Covered bonds are a type of mortgage-backed security, but they are very divergent from the derivative-laced speculative packages that fueled the real estate boom that peaked in 2006. It was the inclusion of extremely risky derivatives in those packaged mortgage securities that got many Wall Street banks in this predicament. They were wholly unregulated (and still are). These highly speculative "investments" were held off financial institutions' balance sheets and were almost without exception deliberately opaque. Investors received not only the rights to the mortgage payments but also the double risk of defaults and derivative failure, which have been revealed to be overbearing.
On the other hand, covered bonds are currently viewed as much safer investments because they are not packaged and sold but endure on a bank's balance sheet and the person or institution who invests in the bonds receives 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, one of which is being in good standing. If the mortgages fail to be repaid by the borrower, the bank must take the necessary steps to warrant bond holders receive their interest payments.
Banks like the idea because it ensures a persevering and dependable fountain of funding for making mortgages. The superior quality of the underlying loans translates into high credit ratings, which results in diminished interest cost to borrowers.
Banks seeking resources to make home loans also have the traditional approach -- gathering deposits from consumers. This method remains an important provenance of financing for mortgages, but deposits can be expensive to solicit and less secure than bonds sold to major institutional investors.
Until mid 2007, lending institutions had paltry trouble getting the cash to make mortgage loans. They could easily bundle mortgages into numerous forms of securities, auction them and employ the revenue to underwrite more loans.
Currently, however, investors have become timid by rising defaults and the helplessness to auction structured financial packages that hold suspicious derivatives and have absolutely lost trust in mortgage-backed financial products issued by Wall Street firms. The sole mortgage products still in favor with investors are those guaranteed by government-sponsored entities like Fannie Mae, Freddie Mac and the Federal Housing Administration.
U.S. Treasury Secretary Henry Paulson and other policy regulators perceive covered bonds as a way to furnish another wellspring of financing for the housing market. The effort is being orchestrated by Mr. Paulson, Federal Reserve Chairman Ben Bernanke, Federal Deposit Insurance Corp. Chairwoman Sheila Bair and other financial policy makers, who are mindful that the tenuous housing market will perpetuate the falling economy.
The Treasury Department is anticipated to deliver a document to provide regulatory precision within the upcoming couple of months. Another hurdle in the U.S. has been legal hesitation about the rights of investors if a bank defaults. Under prevailing rules, the Federal Deposit Insurance Corporation has 90 days in the event of a bank failure to reimburse funds for the covered bonds. The rule helps the Federal Deposit Insurance Corporation reduce the cost of dissolving a bank but concurrently creating a holdup for investors as well as some uncertainty. The Federal Deposit Insurance Corporation has come out and proposed a new regulation shrinking the time span to ten days. A final regulation could be issued as soon as this summer. This is no moment to be procrastinating. The housing and mortgage markets need all the remedy available.
