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Investments

US covered bond discussion is officially on hold

April 11, 2013

There was a time when the covered bond discussion felt important. There was even a chance a covered bond framework could happen.

The bonds, backed by corporate debt and high-quality mortgages, could play a role in the reformation of the nation's housing finance system, its supporters claim.

But now that conversation feels like it will be on hold for a long time.

Two reports out of Europe give an idea why, and both revolve around pending Basel III capital requirements.

Euromoney notes a feeling that securitization will gain in popularity on the Continent due to its role in Basel III capital ratios. "A bank could securitize a portfolio or part of a portfolio of loans or derivatives and sell the associated risk to a third-party investor, thereby gaining relief from penal capital charges, and freeing up space to lend."

And in the Euromoney sister publication, IFLR, there is coverage of support growing to include covered bonds as tier-1 capital, thus counting toward the Basel III requirements.

So why wouldn't this increase support for covered bonds in the United States? Wouldn't large financial institutions love to use a structured finance product to count towards capital directives?

Possibly, but it isn't necessary. For one, the United States is suddenly and quickly coming up to speed with meeting these voluntary standards. Some big names in policy are throwing support behind the measures.

And from a policy perspective, nothing will get fixed if it doesn't appear broken through the lens of Washington DC.

In a note from Goldman Sachs, analysts note the federal deficit is shrinking at a rapid pace. "In the first three months of calendar 2013--that is, since the increase in payroll and income tax rates took effect on January 1--we estimate that the deficit has averaged just 4.5% of GDP on a seasonally adjusted basis," said chief economist Jan Hatzius in an email alert. "This is less than half the peak annual deficit of 10.1% of GDP in fiscal 2009."

It's important to note that one thing that does count toward tier-1 capital is a financial firm's holdings of Treasurys. And currently, the government would not be interested in providing an alternative.

Until it is, the discussion on covered bonds will remain on hold.

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