To date, not many covered bonds have been issued in the United States, for several reasons.  First, the Federal Home Loan Banks (FHLB) can tap capital markets and provide cost-effective funding for mortgage assets.  In addition, as a source of financing, covered bond issuance today is not generally competitive with FHLB advances.  Second, Fannie Mae and Freddie Mac have traditionally securitized U.S. prime mortgage assets.  The GSEs' implicit government backing and their scale of securitization operations have made it difficult for banks to use covered bonds to finance their own prime mortgages.  Third, the United States does not have the extensive statutory and supervisory regulation designed to protect the interests of covered bond investors that exists in European countries.  To this end, the recent introduction of the FDIC policy statement on covered bonds and the Treasury covered bond framework were constructive steps.  Finally, the cost disadvantage of covered bonds relative to securitization through Fannie and Freddie is increased by the greater capital requirements associated with covered bond issuance.

Today's introduction of the Treasury Covered Bond Framework may be illustrative of the benefits of product innovation in globally connected financial markets.

Treasury's discussions with market participants suggest that a covered bond framework may attract investor interest and facilitate greater access to mortgage credit. High-quality assets might be financed if banks are allowed to manage pools of loans, substituting new loans into the pool as others become delinquent.  Newly issued covered bonds backed by high quality mortgage loans and issued by strong financial institutions may find a growing investor base in the United States.

The Federal Reserve has long accepted a broad range of high-quality collateral from depository institutions at its discount window. Highly rated, high-quality covered bonds would generally fall within that broad range as eligible collateral.  Private lenders also are likely to find such bonds attractive as collateral for credit extensions.

Today we are also looking more broadly for ways to increase the availability and lower the cost of mortgage financing to accelerate the return of normal homebuying activity. We are working with FDIC, the Federal Reserve, the OCC and the OTS to explore the potential of covered bonds, which is one promising financing vehicle to do just that. Covered bonds provide funding to an issuer, generally a depository institution such as a commercial bank or thrift, through a secured debt instrument collateralized by a pool of residential mortgage loans that remain on the issuer's balance sheet. Interest is paid to investors from the issuer's cash flow. In the event of a default, covered bond investors' primary recourse is the pool of mortgage loans, and secondary recourse is an unsecured claim on the issuer. Covered bonds have been widely used in Europe to finance residential and commercial real estate, and municipal bonds. At the end of 2006 the European covered bond market was over 1.9 trillion Euros.

And, as Treasury seeks to encourage new sources of mortgage funding in the United States, improve underwriting standards and strengthen financial institutions' balance sheets, covered bonds have the potential to serve these purposes and reduce the costs for first-time home buyers, and for existing homeowners to refinance.