Why is CB legislation tied to GSE reform?

Why is the adoption of covered bond legislation linked to housing finance reform? Housing finance reform is all about the role of the GSEs. While covered bonds certainly can be used to finance residential mortgage loans, they do not require any form of government support. The consideration of the proper role of the government in housing finance can occur independent of covered bonds. However, I hear from many sources that covered bond legislation would only be considered after GSE reform had been adopted or perhaps considered with GSE reform.

There is no apparent logic to this position. Covered bonds are a private sector financing technique that has proved very effective in other jurisdictions. There is nothing in GSE reform that would be a necessary predicate to the issuance of covered bonds by U.S. banks. Covered bond legislation would not touch the status of the GSEs. It is possible that covered bond issuance by U.S. banks could develop into an attractive alternative to financing through the GSE and thus reduce the tension in GSE reform, but that would be beneficial to GSE reform.

It seems as though both sides are determined to keep as much pressure on GSE reform as possible in order to achieve their objectives and not permit any private sector initiatives to sidetrack the discussion until the role of the government in housing finance has been solved. But this seems to put the cart before the horse. Shouldn’t the government intervene only where the private sector is not functioning properly? Wouldn’t it make sense to let private sector initiatives develop first before assigning the government a role? If we can agree that the answer to those two questions is yes, why not adopt covered bond legislation and see how the market develops while we debate how to wind down the GSEs and what would be the appropriate future structure for the government’s role in housing finance?

Certainly we can have a fulsome debate on how the government can support housing access for those who need assistance independent of how covered bond legislation is drafted. Certainly if covered bonds, RMBS and the federal home loan banks fail to provide adequate private sector funding for residential mortgage loans there may be a need to consider a larger government role.

It is not essential that covered bonds be enabled through legislation as it is possible to achieve covered bond issuance through securitization techniques, as has been done in other countries. See, e.g., Time for a US alternative. However, investors will have more confidence in a covered bond sector established through legislation and the market may be expected to develop quicker with legislation. Enacting legislation for covered bonds would be a low cost experiment that would have no harmful side effects. Covered bond legislation, therefor, should be enacted before GSE reform is attempted so that we have a better chance to assess what works in the private sector before designing the government’s role in housing finance.

Treasury trying to encourage private funding

Speaking in Washington on June 26 before the Making Homes Affordable Five Year Anniversary Summit, U.S. Secretary of the Treasury, Jacob Lew, gave a speech in which he addressed the need for housing finance reform. He also noted almost a complete absence of a private label securities market almost six years after the crisis and a need to restore private funding to the residential mortgage market. He noted that a series of questions was posted to the Treasury website seeking comment by August 8, 2014 on recommendations for reviving the private label securities market.

Neither Secretary Lew’s speech nor the posted questions mention covered bonds. Clearly covered bond legislation for the United States should be considered by the Treasury. The legislation introduced in 2011 by Representative Garrett, H.R. 940, passed the House Financial Services Committee by a very strong bi-partisan vote of 44-7. Passage of covered bond legislation should be easily achievable with Treasury backing and covered bonds could provide an important channel of private funding for the mortgage market. After all, covered bonds provide funding for about €3 trillion in the European market and the domestic U.S. market for covered bonds issued by foreign has shown healthy growth.

Johnson-Crapo Amendment to S. 1217

On Sunday, March 16, 2014, the Senate Banking Committee released a draft of an Amendment to S. 1217, which is the housing finance reform bill introduced last year by Committee members Mark Warner (D-VA) and Bob Corker (R-TN) to shut down FNMA and FHLMC and establish a new federal role for housing finance.  The amendment released by the Committee is authored by Committee Chairman Timothy Johnson (D-SD) and Ranking Member Michael Crapo (R-ID).  The amendment is introduced following a series of hearings held by the Committee last fall on S. 1217.  Most significantly, the amendment continues to provide for the establishment of the Federal Mortgage Insurance Corporation and the elimination of FNMA and FHLMC.

The general view is that S. 1217 is likely to be the basis of any bill adopted to reform housing finance.  Unfortunately for covered bonds, there is nothing in the amendment, and nothing in the original bill, to establish a statutory covered bond regime in the United States.  Accordingly, any hope for including covered bond provisions in the bill apparently rests with the House including such provisions in any final bill through the conference committee process.

However, a strong majority of those present at a panel on housing finance reform at the SFIG conference this year in Las Vegas do not expect housing reform legislation to be enacted before 2017.  The best prospects then for covered bond legislation in the near future probably lie elsewhere.

Fed Mortgage Role Expands

With rising rates, new mortgage loan productions has declined. WSJ reports that in November the FED bought 90% of eligible mortgage bond issuance, up from 2/3 earlier in the year, raising liquidity concerns. FNMA/FHLMC issuance fell 59% from a year earlier in November to $82.3 B.

Why is RMBS issuance not growing?

FT on 12/2/2013 said that CMBS issuance is at the highest since the crisis with year to date issuance at $92.9B. CLO issuance is also booming, but RMBS issuance is anemic. Why is that? Is it because of FNMA and FHLMC? See, CMBS and CLOs are booming, but not RMBS. What does that tell us?