Kansas City Fed Conference Included Covered Bonds

KANSAS CITY, MO —  My participation at the inaugural Financial Policy Conference held at the Federal Reserve Bank of Kansas City Friday (June 19) came both as a speaker and an attendee.  The fact that organizers wanted the covered bonds angle to be represented is another sign that the topic remains on the public agenda in the U.S.

Federal Reserve Bank of Kansas CityThe event—titled "Financing Real Estate"—was sponsored jointly by the Kansas City Fed and the University of Kansas School of Business.  About 150 participants from lending institutions, real estate finance and regulatory organizations engaged on many fronts from financing in residential and commercial real estate markets to related government policy-making.

A flyer aptly described the thinking behind the conference:

"Although the crisis in financial and housing markets has been commanding most of the attention in the business press, this crisis, like all crises will eventually come to an end.  We need to be ready for that day.  Identifying our mistakes—as well as the success stories—and putting those lessons to work will be crucial for improving our public policies and business policies in real estate markets."

Key Messages

Here are some of the key messages that stood out to me from various presentations:

Thomas Hoenig, President and CEO, Federal Reserve Bank of Kansas City, delivered welcoming remarks   1. In contrast to the huge amount of support and muscle the federal government is providing to giant financial institutions that engaged in dubious practices, the strong regionals and middle tier lenders—who never got into the mud—are not being rewarded for their discipline and "stick to the fundamentals" approach.

   2. Financing the residential real estate market likely needs some executions with strong capital relief,  but there is room (and interest) in diversifying sources of capital funding.

   3. While subprime credit losses have already been large, big waves of Option ARM and Alt A resets still loom on the horizon for 2010 and 2011.

   4. Commercial real estate financing generally started with more equity cushion than residential loans, but rating agency actions and future cash flow declines brought on by our economic downturn may make delinquencies grow—and refinancings tougher to execute.

   5. Across the board, it is clear that generalizations about national data sometimes obscure geographic or unique market segment insight.

   6.  Government often lags behind in offering solutions, and it doesn't always factor in the disincentives caused by well-intended remediation policies.

Audience's Reaction to Covered Bonds

Robert DeYoung, Chaired Professor, University of Kansas School of Business, moderated a panel discussion on financing in residential real estate marketsAs I made my presentation on the potential for covered bonds in U.S. financing,  I was struck (as usual) my how little most financially sophisticated Americans yet know about this product.   A basic description of what covered bonds are and how they work was news to most in the audience.

At the same time, as they began to get the picture, I was struck by the visible attraction that almost everyone seemed to feel toward a funding product that generally supports good borrowers, good assets, and good lenders—with no slicing-and-dicing or financial alchemy allowed.

The topic for the panel on which I served was "Financing in Residential Real Estate Markets."  My presentation on covered bonds came before the panel discussion.

In my opening, I told the audience something like this:

If anyone thinks all of their current capital funding options and government supports and guarantees are permanently in place for the long term, covered bonds have little value to offer you.  In that case, feel free to skip this presentation.  

On the other hand, if anyone thinks the GSE rate subsidies and guarantees could change ... or the pace and economics of FHLB advances could change ... or the FHA appetite for risk could change ... or RMBS accounting treatment could change ... then a look at "new" and diversified funding vehicles such as covered bonds should command your full attention.

To my great relief, no one opted for an unscheduled coffee break!

Conference Organizers

William Keeton, Assistant VP and Economist, Federal Reserve Bank of Kansas City, moderated a panel discussion on financing in commercial real estate marketsThe financial conference was organized by Co-Chairs Robert DeYoung (Capitol Federal Professor at KU School of Business) and William Keeton  (Assistant VP and Economist at the Federal Reserve Bank of Kansas City).  

Welcoming remarks were delivered by Thomas Hoenig, the Kansas City Fed's President and CEO.  He recently authored a thought-provoking paper titled "Too Big Has Failed," which is very much worth a read.