What is a covered bond? A covered bond is a debt security backed by cash flows from mortgages or public sector loans. They are similar in ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet. A covered bond continues as an obligation of the issuer (usually a bank).
This is in stark contrast to the experience of the housing bubble where non-bank lenders originated loans, sold them to investment banks who then issued asset-back securities. The non-bank lenders, in this case, kept little or none of the loans on their balance sheets.
But the US mortgage market is anything but a perfect world (or market). It is dominated by The Federal government in the form of mortgage giants Fannie Mae and Freddie Mac and the Federal Housing Administration (FHA). But lest we forget, there is also the Department of Agriculture and the Federal Home Loan Bank system playing in this market. Not to mention a myriad of regulators (The Fed, Office of the Comproller of the Currency, FDIC, Consumer Financial Protection Bureau, etc).
Like in the game “Whack-a-mole,” you can get rid of, for example, Fannie Mae and Freddie Mac, but you still have the FHA, the Federal Home Loan Banks, the Department of Agriculture remaining. Each provides taxpayer-subsidized financing and have low cost of financing.
How can a superior model like covered bonds compete with the Federal government leviathan of subsidized mortgage financing? At Professor Guttentag suggests, it will take time.
But the tangled web of bank and mortgage regulators makes it even more difficult. Hopefully, stripping the Consumer Financial Protection Bureau of some of their regulatory bite will help. But there has to be a “meeting of the minds” between the numerous regulatory bodies to make covered bonds work.
Yes, the US mortgage market remains like a “Whack-a-mole” game. You knock down one Federal entity (and taxpayer subsidy) and another one jumps out. Not to mention regulators.