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.