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House committee clears framework for covered bonds

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The House Financial Services Committee voted 44-7 in favor of a bill to establish a regulatory framework for a U.S. covered bond market. Rep. Scott Garrett (R-N.J.) and Rep. Carolyn Maloney (D-N.Y.) introduced the United States Covered Bond Act of 2011 in March. Analysts said the bipartisan bill stands a good chance of reaching President Obama's desk. The bill would allow a U.S. covered bond market to pool residential and commercial mortgages into debt securities. Unlike the European system, however, the bill would include auto loans, credit cards, student loans and government-guaranteed small business loans. Issuers of covered bonds are on the hook against losses. Payment to investors is via swap agreements and are meant to cover the scheduled payments should the issuer become insolvent or there is a discrepancy in timing, where the interest being paid on the loans does not align with payments due to investors. A third party trustee represents covered bondholders. Adding these layers of additional recourse, as it compares to securitization, makes it pricier by comparison. "They have worked well in Europe since the 1700's, and they would be another form of getting longer term liquidity into the credit market, reducing refinancing risk, and generating less expensive and more available credit for borrowers of all kinds," Maloney said during a committee hearing Wednesday. "This will not solve all of our problems but could be another tool we could work with to help our economy and help our financing of credit markets and housing." The housing and mortgage industry supported the bill, including the National Association of Realtors, the Mortgage Bankers Association and the Securities Industry and Financial Markets Association. The committee passed an amendment introduced by Rep. John Campbell (R-Calif.). According to the amendment, regulators will set a maximum amount of outstanding covered bonds as a percentage of an issuer's total assets. The issuer's regulator will then review that cap for possible adjustments every quarter. "The number 4% has been thrown around," Campbell said. The committee denied two amendments introduced by Rep. Barney Frank (D-Mass.) that would grant the Federal Deposit Insurance Corp. powers to establish a covered bond oversight program and veto power for any program submitted by an eligible issuer. Frank said the FDIC raised concerns the covered bond program would put the still recovering deposit insurance fund at risk. "The FDIC has concerns not with the concept but with the extent to which the FDIC will be protected," Frank said. Garrett said such oversight would subject investors to prepayment risks he said do not belong in the definition of a working covered bond market. Lawmakers continued work to determine to what extent the FDIC would play in the new system. "Neither of us want to see the FDIC as a government backstop," Garrett said. "If the government is going to provide a guarantee let's make it clear and explicit not some backdoor method," Campbell added. Write to Jon Prior. Follow him on Twitter @JonAPrior.

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