Treasury, Banks Promote 'Covered Bonds'

Yesterday, the Treasury published guidelines for covered bonds, requiring banks to disclose details about the mortgage pools that are backed by the bonds and scrutinize the assets monthly to ensure the quality of the bonds.

Earlier this month, the Federal Deposit Insurance Corp. clarified several rules for covered bonds, stating that investors in covered bonds would have the right to get their money back within days if the bank issuing them were to fail.

"We must ensure that market mechanisms return to incentives that encourage sound underwriting and strong capital," FDIC Chairman Sheila C. Bair said. "I think that covered bonds can help achieve these goals, while bringing positive innovation to the U.S. market."

Federal Reserve Governor Kevin Warsh added that the Fed would consider accepting high-quality covered bonds as collateral if banks requested emergency funds.

Brad Brown and Chip Salter, both senior vice presidents at Bank of America, said in a joint telephone interview that covered bonds hold multiple benefits for everyone involved in issuing and financing mortgages.

Cash-strapped banks can use covered bonds to quickly raise money or to diversify the way they finance mortgages. "It's another arrow in the quiver that gives us options on funding," Salter said.

Debt investors are doubly protected if a borrower defaults on a mortgage, Brown said. Their first recourse is the bank issuing the covered bond. If that bank cannot make up for the losses, the investors still have a claim on the underlying collateral of the mortgage, which is the home.

Homebuyers looking for a mortgage will have an easier time because the moribund debt markets could be sparked by the development of a rigorous covered bond market, Salter and Brown said.