Covered Bonds Hearing Showed Bipartisan Support

WASHINGTON, D.C.   Although the prime mover in the push for U.S. covered bond legislation is a Republican (Rep. Scott Garrett of New Jersey), substantial support from the other side of the aisle will be essential for any success in the current Democrat-controlled Congress.  That political reality gives special significance to positive statements made by Democratic members of the House Committee on Financial Services during the committee's hearing on covered bonds Tuesday (Dec. 15).

Here are some examples from members' opening remarks preceding testimony by expert witnesses on the topic:

• Rep. Melissa Bean (D-IL): "Establishing a U.S. covered bond market could be very helpful to the residential and commercial real estate markets, but [also to] other asset markets like public-sector loans and other consumer loans as well."

• Rep. Bill Foster (D-IL): "We have to look at what provides over time the best stability and the best deal for consumers. And I think both of these lead to the covered bond market as a way forward."

• Rep. David Scott (D-GA): "This type of loan [funding] could provide a sense of accountability for both the lender and the borrower ... which could potentially decrease risky lending practices." (Rep. Scott also highlighted the dynamic nature of the cover pools backing covered bonds, which permit problem loans to be "swapped out for better assets.")

• Chairman Barney FrankCommittee Chairman Barney Frank (D-MA): "I am struck by ... the unanimity [here] that the European experience [with covered bonds] has been a good one — that it is instructive for us — that it gives us lessons, and that this is the case where acknowledging that something has been done in Europe has some useful lessons for us. We ought to go forward."

Members of Garrett's party who spoke also expressed support:

• Ranking Republican member Spencer Bachus (R-AL): "America is about innovation, competition in the private market, and I think covered bonds could be part of our solution.... Covered bonds are also a private market solution to the need for market participants to have 'skin in the game.'"

• Rep. Jeb Hensarling (R-TX): "Most of us have an open mind and a hopeful mind that covered bonds may pose a very promising solution."

U.S. Rep. Scott GarrettHCFS members of both parties expressed interest in covered bonds as a potential means to bring private investment back to the U.S. home mortgage market, so as to reduce dependence on government-sponsored enterprises (GSEs) — principally Fannie Mae and Freddie Mac. 

For example, on the Democratic side, Rep. Foster remarked: 

"I am also very interested in the possibilities for covered bonds to provide a path forward out of the situation we are in with Fannie and Freddie....  Having a strong covered bond market out there will make all of the decisions we are going to make that much easier."

Although no committee member at the hearing spoke in opposition to covered bonds, a couple of concerns were raised. 

Chairman Frank questioned one witness (Bert Ely) about a proposed provision that would allow the covered bond program trustee to borrow from the Federal Reserve Bank of New York if necessary to make timely bondholder payments in the event of issuer default.  The witness assured him that this borrowing power would be rarely used.

"There are some who would say that was a bailout by the Federal Reserve of short duration," Chairman Frank responded, "but it would have to be collateralized.  But the principle of allowing the Federal Reserve to intervene if [the covered bond program] is sufficiently collateralized isn't a problem for me.   That makes sense here."

A second concern by at least one member arose from the fact that covered bonds are associated with high-quality loans.  Rep. Kenny Marchant (R-TX) asked Bert Ely:

"Would [covered bonds] have the effect of taking the more conservatively underwritten loans out of the market and hav[ing] them packaged with covered bonds — leaving the more risky loans to be underwritten ... by the government?" 

Ely answered that covered bond programs could conceivably be established that dealt with loans having all degrees of risk, with corresponding adjustments in overcollateralization requirements.

All five expert witnesses submitted written testimony in advance, but oral testimony at the hearing before responding to members' questions was limited to a few minutes each.  The hearing itself was relatively short (about one hour).

One of Rep. Garrett's stated purposes in working to obtain this hearing was to help inform HCFS members about the merits of covered bonds and bring them on board.  Despite the positive remarks by members who spoke, progress with regard to the committee as a whole was difficult to assess.  Only about 20 of the committee's 70 listed members were in their seats for any portion of the hearing, but there is no way to know how many other members viewed the webcast of the event or assigned staff members to attend.

It is also difficult to assess what further action the committee may take.  The only indication — besides Chairman Frank's general comment that they should go forward (quoted above) — came as the hearing was adjourned.  At that point, the Chairman said: "This is a subject that the committee will be dealing with next year."

The five expert witnesses at the hearing were Scott A. Stengel (a Washington lawyer who spoke on behalf of U.S. Covered Bond Council);  Wesley Phoa (an investment analyst and bond portfolio manager at a privately owned investment management firm);  J. Christopher Hoeffel (who spoke on behalf of the Commercial Mortgage Securities Association); Bert Ely (a consultant on deposit insurance and banking structure issues); and Alan Boyce (CEO of a joint venture between financier George Soros and the Danish financial system relating to the distinctive Danish model of covered bonds).