Covered Bonds An Answer for Frozen Mortgage Market?

January 10, 2010

Covered bonds are the main source of funding for fixed rate mortgages in Denmark, and have been used in other countries like Germany, as well.  They function like MBS, but there is not a forward delivery TBA market in them because the bonds are typically issued contemporaneously with the mortgage closing.  They generally require downpayments larger than the norm in the U.S..  In Denmark, these typically run 20 percent, for instance.  Ever since the collapse of the mortgage securitization market some in the industry have promoted covered bonds as an alternative.  The presumption is that large banks would issue the bonds and provide the mortgages that back them.  An article in Housing Wire notes introduction of federal legislation by NJ Republican Rep. Scott Garret designed to provide uniform federal regulation of the bonds in hopes of stimulating more widespread use.  The article says that Democratic Rep. Paul Kanjorski (PA) has signed on as a co-sponsor.

Others who have looked at the covered bond structure have cautioned that while it could be part of a future mortgage system, given the scale of the American mortgage market and consumers’ expectations for forward rate locks and lower downpayments they are not likely to absorb a very large share of the market.

Old-fashioned, pre-mania style securitization remains the predominant form of mortgage lending today.  As much as 90 percent of all loans being originated today are destined for securities guaranteed either by Ginnie Mae, Fannie Mae or Freddie Mac.