As discussed in an earlier post, this Act is fundamentally flawed as losses on the collateral backing covered bonds are ultimately covered by the US Treasury. Therefore, as it is currently written, the Act should never be passed and signed into law.
The earlier post describes how adding disclosure on the current performance of the assets in the covered pool would protect investors and the US Treasury. Europe, in particular the ECB, must think this is a good idea because it is currently considering this type of disclosure for covered bonds that are eligible to pledge as collateral.
Unfortunately, Congress elected not to include disclosure on the current performance of the assets in the covered pool into the Act.
The House Financial Services Committee voted 44-7 in favor of a bill to establish a regulatory framework for a U.S. covered bond market.
...The bill would allow a U.S. covered bond market to pool residential and commercial mortgages into debt securities. Unlike the European system, however, the bill would include auto loans, credit cards, student loans and government-guaranteed small business loans.So the pre-credit crisis securitization market could be repackaged as covered bonds.
Issuers of covered bonds are on the hook against losses.In theory, this statement is true. But what happens if the issuer goes bankrupt? Remember, the issuer is a bank. Are investors in covered bonds still protected against losses on the underlying collateral? The Act says yes. As a result, the taxpayer is on the hook when the FDIC steps in to take over the issuer.
Payment to investors is via swap agreements and are meant to cover the scheduled payments should the issuer become insolvent or there is a discrepancy in timing, where the interest being paid on the loans does not align with payments due to investors.
A third party trustee represents covered bondholders. Adding these layers of additional recourse, as it compares to securitization, makes it pricier by comparison.In the Act, the swap agreements smooth out the cash flow. They do not guarantee the payments should the issuer become insolvent.
... The housing and mortgage industry supported the bill, including the National Association of Realtors, the Mortgage Bankers Association and the Securities Industry and Financial Markets Association.Since it is good for Wall Street, Wall Street's trade associations support it.
The committee passed an amendment introduced by Rep. John Campbell (R-Calif.). According to the amendment, regulators will set a maximum amount of outstanding covered bonds as a percentage of an issuer's total assets. The issuer's regulator will then review that cap for possible adjustments every quarter.
"The number 4% has been thrown around," Campbell said.At 4% of total assets, an issuer can issue covered bonds equal to its total loss absorbing capital required under Basel III.
The committee denied two amendments introduced by Rep. Barney Frank (D-Mass.) that would grant the Federal Deposit Insurance Corp. powers to establish a covered bond oversight program and veto power for any program submitted by an eligible issuer. Frank said the FDIC raised concerns the covered bond program would put the still recovering deposit insurance fund at risk.
"The FDIC has concerns not with the concept but with the extent to which the FDIC will be protected," Frank said.
Garrett said such oversight would subject investors to prepayment risks he said do not belong in the definition of a working covered bond market. Lawmakers continued work to determine to what extent the FDIC would play in the new system.
"Neither of us want to see the FDIC as a government backstop," Garrett said.
"If the government is going to provide a guarantee let's make it clear and explicit not some backdoor method," Campbell added.Clearly, Congress recognizes that the US Treasury through the FDIC is backstopping covered bonds issued under the Covered Bond Act of 2011.
The question is, do the US taxpayers get any benefit from guaranteeing the losses?
As HousingWire reported in a separate article on the covered bond legislation, the US taxpayers do not get any benefit from guaranteeing the losses.
"The covered bond legislation now pending before the Garrett subcommittee in the House is all about Wall Street and does nothing to increase the availability of housing credit," said market analyst Christopher Whalen with Institutional Risk Analytics.
"The bill lacks basic protections for investors in bonds and for the FDIC, which would be fully exposed to losses from covered bonds under the Garrett proposal," he said.
"Most banks today have more funding than can be employed. (Covered bonds) do not add any new, non-bank funding leverage to the system, which is the key objective if we are to avoid a catastrophe in housing."