Paulson aims to create new source of mortgage financing

Regulators can provide the guidance that lenders are asking to be set in law, said a Treasury official working on the issue who declined to be identified. Banks want a standardised definition of a covered bond, which requires the lender to make good on payments if homeowners default, and guidelines on bondholder protections.

Paulson is promoting the debt as an alternative to mortgage-backed bonds, the securities that sparked more than $426 billion in writedowns and credit losses as delinquency rates soared. Covered bonds also offer a way to diminish the role of Fannie Mae and Freddie Mac, the troubled firms behind more than two-thirds of new US mortgages, according to the Treasury.

"If they'd asked for" legislation, there would be "a question whether they could even get it done this year," said Wayne Abernathy, an executive director at the American Bankers Association in Washington and a former Treasury official.

"There is a need today for additional types of forms of providing liquidity and forms of providing funding for housing.''

Covered bonds offer banks a way to raise money for new mortgages without either selling the loans or packaging them into securities. Instead, a bank issues bonds that are backed by a dedicated and regularly updated pool of loans.

European model: In Europe, covered bonds represent a $3 trillion market that's a primary source of financing for home loans and municipal debt. The securities have been used in the US since 2006, after introductory offerings by Seattle-based Washington Mutual Inc. and Bank of America Corporation of Charlotte, North Carolina.

While a law would be helpful for issuers, it isn't required, the Treasury official said last week. The department hasn't yet signaled its next move.

"What we may see from them first is more like a game plan,'' laying out "here's what we think a covered bond is," said Michael Durrer, partner at law firm Sidley Austin LLP in London who has worked with both of the US covered bond issuers.

A take-off in covered bond issuance may reduce the role of Fannie Mae and Freddie Mac, which own or guarantee almost half the $12 trillion of US mortgages outstanding. Paulson told lawmakers last week the firms "touch" 70 per cent of new loans. Mortgage originations totaled $525 billion in the second quarter, according to a Mortgage Bankers Association estimate.

Fannie, Freddie: Washington-based Fannie Mae has slumped 55 per cent in the past month, and McLean, Virginia-based Freddie Mac is down 61 per cent, on concern the companies lack sufficient capital to cover writedowns and losses. Paulson July 13 asked Congress for the power to make unlimited loans to the firms, and make equity purchases, to combat a collapse in confidence.

Covered bonds are a "promising financing vehicle," Paulson said in a July 8 speech. They offer a way to "increase the availability and lower the cost of mortgage financing to accelerate the return of normal home-buying activity," he said.

The Treasury hosted a private meeting last month between regulators and market participants to work out concerns about guidelines for issuance. If US bond issuers, dealers and investors all jump into the market at once, each will avoid the risk of going first, the Treasury official said.

Bernanke's view: Federal Reserve Chairman Ben Bernanke expressed doubt this month whether covered bonds can take off without action by Congress. "It's not yet known whether this can be successful without legislation," he told lawmakers July 10.

The Federal Deposit Insurance Corporation, rebuffing requests by banks, issued a final rule on covered bonds on July 15 that will allow investors to access their collateral more quickly in the event of a bank failure. The regulations alleviate some of the industry's concern about how regulators will treat covered bonds when a bank goes under. —