[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]





                      COVERED BONDS: PROSPECTS FOR
                      A U.S. MARKET GOING FORWARD

=======================================================================

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                           DECEMBER 15, 2009

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-95








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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel















                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    December 15, 2009............................................     1
Appendix:
    December 15, 2009............................................    25

                               WITNESSES
                       Tuesday, December 15, 2009

Boyce, Alan, Chief Executive Officer, Absalon....................     7
Ely, Bert, Ely & Company Inc.....................................    10
Hoeffel, J. Christopher, Managing Director, Investcorp 
  International, Inc., on behalf of the Commercial Mortgage 
  Securities Association (CMSA)..................................    14
Phoa, Wesley, Senior Vice President, the Capital Group Companies.    12
Stengel, Scott A., Partner, Orrick, Herrington & Sutcliffe LLP, 
  on behalf of the U.S. Covered Bond Council.....................     9

                                APPENDIX

Prepared statements:
    Marchant, Hon. Kenny.........................................    26
    Boyce, Alan..................................................    28
    Ely, Bert....................................................    39
    Hoeffel, J. Christopher......................................    50
    Phoa, Wesley.................................................    62
    Stengel, Scott A.............................................    67

              Additional Material Submitted for the Record

Ely, Bert:
    Written response submitted for the record to a question posed 
      by Chairman Frank during the hearing.......................    77

 
                      COVERED BONDS: PROSPECTS FOR
                      A U.S. MARKET GOING FORWARD

                              ----------                              


                       Tuesday, December 15, 2009

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:02 a.m., in 
room 2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Maloney, Watt, 
Moore of Kansas, Baca, Scott, Green, Cleaver, Bean, Perlmutter, 
Foster, Carson, Minnick, Adler, Peters; Bachus, Royce, 
Hensarling, Garrett, Marchant, Jenkins, Lee, and Paulsen.
    The Chairman. This is a hearing on the subject of covered 
bonds, and I recognize for 2 minutes the gentleman from 
Illinois, Mr. Foster.
    Mr. Foster. Thank you, Mr. Chairman. I would just like to 
say very briefly that I think this is a great initiative, and 
it is wonderful to see the Republican Party claiming their 
historical support for European financial and social 
structures--but all kidding aside--if you look at the history 
of how different segments of the economies in different 
countries have performed in the last crisis, one of the high 
points is the covered bond, the performance of the covered bond 
market.
    I think particularly the--one of the segments that will be 
brought up in the testimony here is in fact a variation of 
these that is supported in Denmark has maintained very good 
liquidity across the whole crisis, as well as historically 
provided the best deal for consumers. This, I think, is a 
fundamental issue here. We have to look at what provides over 
time the best stability and the best deal for consumers, and I 
think that both of these lead to the covered bond market as the 
way forward.
    I'm also very interested in the possibilities for covered 
bonds to provide a path forward out of the situation with 
Fannie Mae and Freddie Mac, which no one likes. And I think 
that having a strong covered bond market out there will make 
all the decisions we're going to be faced with much, much 
easier. So, for all these reasons, I think this is a great 
initiative. I think this is an example where--another point 
that is made in some of the testimony that we ought to pay 
attention to is that the markets that have held up the best 
have been those--in terms of having small spreads, are ones 
where there's quite prescriptive legislation, because one of 
the variables that we have to address if we're going to go 
ahead and provide legislative support for this is the degree to 
which we should say here is exactly the simple form of covered 
bonds that we're going to legislatively support or whether we 
just provide--let a thousand flowers bloom and let a very 
broadly regulated market provide a variety of products.
    It's a very interesting lesson that it appears as though 
the market in times of stress prefers to have a rather tightly 
prescribed set of conditions. And as we try to bootstrap the 
covered bond market, I think that we may want to err on the 
side of being more prescriptive and saying, here is the simple 
form that we're going to start out with. And when we have a 
successful covered bond market in the United States, then 
perhaps loosen the rules to allow more elaborate products.
    So those are the things that I will be keeping my eyes on 
in the testimony. I read it all last night, and I found it 
very, very encouraging, and I yield back.
    Mr. Scott. [presiding] The gentleman from New Jersey, Mr. 
Garrett, is recognized for 5 minutes.
    Mr. Garrett. And I thank the chairman. I thank Chairman 
Frank for working with me during the last few months on this 
and helping to schedule today's hearing. I would also like to 
thank Chairman Kanjorski and Ranking Member Bachus for their 
continued support and hard work on this important issue. I 
appreciate the opening comments from Bill over there, as well.
    The United States continues to recover from the financial 
crisis, as you referenced, over the last year, and so it is 
essential that Congress examines new and innovative ways to 
basically unthaw or unlock the credit markets and encourage 
private capital to confidently reengage by turning cash now on 
the sidelines into active investments in our country's future. 
And one of those innovative ways that I believe could provide 
that additional liquidity to our credit markets is by 
establishing covered bonds in the marketplace here in the 
United States. Covered bonds are simply debt instruments issued 
by financial institutions and backed, or covered if you will, 
by a pool of high-quality loans. Covered bonds are kept on the 
balance sheet of the issuing institution, which is important, 
and investors have a dual recourse to both the assets used as 
collateral as well as the underlying institution.
    Covered bonds have been used, as I said, in Europe for 
hundreds of years to help provide additional funding options 
for the issuing institutions, and are a major source of 
liquidity for many European nations' mortgage markets. Covered 
bonds have performed extremely well during the financial 
crisis, largely because of the high underwriting standards used 
for loans in the covered pools. And so I do believe that a 
robust U.S. covered bond market would offer numerous benefits 
to investors and consumers in the broader financial sector.
    Investors would benefit by having a new, safe, innovative 
vehicle which will allow for more diversification in their 
portfolio. Consumers would stand to benefit greatly by the 
increase in liquidity to their credit markets. There will be 
more funding available for loans and thus lower rates for home 
mortgages, auto and student loans, and for small businesses.
    One of the problems that we experienced during our current 
crisis was the difficulty of modifying mortgage loans because 
the ownership of those loans had been transferred out through 
the securitization process. Not here. This is not a problem 
with covered bonds, because they are held in service by the 
lender. The lending institution thus has a greater ability to 
modify consumer mortgage loans, which will benefit the 
consumer.
    Finally, the broader financial markets will stand to 
benefit from a covered bond market. Covered bonds provide an 
additional low-cost, diverse funding tool for financial 
institutions. They will ensure more stable and longer-term 
liquidity in the credit markets, which reduces refinancing 
risk, as well as exposure to sudden changes in interest rates 
and investor confidence as well. And they also allow U.S. 
financial institutions to compete more effectively, I believe, 
against their global peers.
    Now to date, there have only been two issuances of covered 
bonds here in the United States. That was by Bank of America 
and Washington Mutual, which is now part of JPMorgan Chase. But 
over the last several months, there has been a tremendous 
increase in demand by investors for these bonds. In 1 week in 
September alone, there were 7 new issuances in a variety of 
different European countries, and that totaled over $20 
billion. And for the year to date, there has been a total of 
around $120 billion of covered bonds issued in Europe alone. 
Also, the European covered bond market was one of the first 
markets to rebound when the financial panic ebbed, and I think 
that's important.
    And so that is why during this committee's consideration of 
the Financial Stability Improvement Act, I offered an amendment 
that would create a detailed statutory framework to help 
facilitate the broader use of these funding instruments in the 
United States. A detailed statutory framework is common in the 
European countries where these bonds basically flourish, and is 
indeed in this country to provide the investors what they're 
looking for, and that is greater certainty in regards to exact 
recourse if the issuing institution fails.
    This legislation will spell out the variety of different 
asset classes which will be eligible to be included in the 
covered bonds. In Europe, the covered bond market is very 
narrowly tailored to just residential mortgage. However, in 
ours, we would include a wider array of asset classes, like 
commercial mortgages, as well as auto loans, small business 
loans, and public sector loans. And so we will be working there 
to increase liquidity to a broader consumer base and allow 
financial institutions to further spread their risk.
    So finally, this legislation also designates the Secretary 
of the Treasury as a covered bond regulator, because the 
Department of the Treasury, basically they have the unique 
knowledge and expertise in this area of the U.S. debt market 
which is needed here. And it also details the procedures that 
are to be followed in the case that an issuer of a covered bond 
were to fail or default, also all needed.
    So a U.S. covered bond market offers a wide variety of 
possible benefits to investors, to consumers, and to our 
capital markets as a whole. And so at a time when our credit 
markets are still experiencing a great deal of difficulty and 
our financial institutions are slow to reopen on a broader 
basis to our American public, we must consider these new and 
innovative methods, and so I'm pleased that this committee is 
taking a closer look into this unique funding, and I'm pleased 
that the chairman and the ranking member have been working with 
us to move this matter along.
    Thank you, Mr. Chairman, and I yield back.
    The Chairman. The gentleman from Georgia is recognized for 
3 minutes.
    Mr. Scott. Thank you, Mr. Chairman. First, let me thank you 
and the ranking member for holding this important hearing. Our 
economy is still struggling, despite the fact, the good news of 
Wall Street's recovering to a degree that many have said that 
we're out of the recession. The stock market has rebounded, and 
they're saying we're out of the recession, but nothing can be 
further from the truth for many, many of the communities in 
this country, for they're not only not out of the recession, 
their economic indicators point very dramatically that many of 
them are in fact in a depression.
    It's a struggle, with jobs, foreclosure rates continue to 
hit record highs. The employment rate continues to hover around 
10 percent, and in many communities, it's hovering at 40 and 50 
percent.
    As this hearing focuses on the potential role that covered 
bonds could have in U.S. markets, I am interested in 
identifying the possible benefits they could have for our 
market stability and our economy, particularly in some very, 
very depressed communities. Since the original lenders of 
covered bonds retain an ongoing interest in the performance of 
the loans, this type of loan could provide a sense of 
accountability for both the lender and the borrower. The bank 
must stand behind the mortgage it issues in this case, which 
could potentially decrease risky lending practices. This area 
is clearly in need of investigation and improvement.
    My home State of Georgia has the 7th highest foreclosure 
rate in the country. I have 2 counties that have among the 
highest of the top 20 counties in the country of foreclosure 
rates. With covered bonds, the collateral pool, the bonds 
against which the bonds are written may be swapped out for 
better assets if it begins to underperform. So we have to 
question if this practice could promote more careful lending. 
Covered bonds are used exclusively in Europe now, but they are 
nearly untested in the United States, and that's what makes 
this hearing so important this morning, that we can determine 
what the full potential is of covered bonds here in the United 
States economy.
    I yield back the balance of my time. Thank you, Mr. 
Chairman.
    The Chairman. The gentleman from Texas, Mr. Hensarling, is 
recognized for 2 minutes.
    Mr. Hensarling. Thank you, Mr. Chairman, and I'm certainly 
glad I could arrive early enough to get a good seat. I suppose 
that battle fatigue over the last 3 weeks may have taken its 
toll, but I'm glad the members who are here are here, and I 
think that the subject matter is one that certainly deserves 
our attention. I want to thank you, Mr. Chairman, for calling 
this hearing, and I certainly want to thank the ranking member 
of the Capital Markets Subcommittee for his leadership on this 
issue for a matter of months in attempting to ensure that we 
look at all possible avenues to bring private investment back 
into our mortgage markets. And certainly, I think that most of 
us have an open mind and a hopeful mind that covered bonds may 
pose a very promising option in that regard.
    As we have come off the recent debate of the last several 
weeks, I and many others still remain concerned about the role 
that the Government-Sponsored Enterprises, Fannie Mae and 
Freddie Mac, are playing in our mortgage markets, particularly 
given that we now have a trillion dollars of taxpayer funds 
that have been exposed to their operations. This is unwise, and 
this is unsustainable. And so I would hope that we would look 
at all different types of avenues to start leveling the playing 
field and transition Fannie and Freddie back to a competitive 
marketplace.
    I am concerned that too much action taken by the 
Administration and Congress has let too much private investment 
remain on the sidelines. I am hopeful again that if there is a 
statutory infrastructure, if you will, or foundation that can 
be placed under covered bonds, that again it is a hopeful and 
promising regime to get private investment and liquidity into 
our mortgage marketplace.
    Knowing that we have an important hearing soon, I yield 
back the balance of my time.
    The Chairman. The gentlewoman from Illinois is recognized 
for 3 minutes.
    Ms. Bean. Thank you, Mr. Chairman, for yielding and for 
holding today's hearing. I want to thank our panel for joining 
us today and sharing their expertise on this important topic. 
As the securitization market for residential and commercial 
mortgages has dried up over the last 2 years, this is a timely 
hearing as the committee looks for new mechanisms that will 
increase liquidity in a prudent manner.
    Toward that end, a well-structured U.S. covered bond market 
could be helpful in adding much-needed liquidity to our 
secondary mortgage market. This is an issue that I--along with 
others--have been looking at over the last year, recognizing 
that counterparts in Europe have been operating a covered bond 
market since 1770 and have relied on covered bonds as a stable 
and relatively safe source of funding for residential mortgages 
and other assets.
    As noted earlier, the FDIC and Treasury issued guidance 
last year to encourage financial institutions to issue covered 
bonds. To my knowledge, however, no financial institution has 
issued a covered bond in the United States under that guidance. 
So I look forward to hearing from our witnesses today about 
whether legislation is needed to establish a statutory 
structure for a U.S. covered bond market, and I'm interested in 
knowing if they feel that European nations who have successful 
covered bond markets have done so because they have established 
a statutory structure.
    I'm also interested in how covered bonds compare to 
traditional mortgage-backed securities in terms of curing 
troubled mortgages within the pool. One of the most frustrating 
aspects of the current foreclosure crisis is that some 
investors in mortgage-backed securities, depending on the 
tranche they hold, can veto loan modifications that would 
benefit both the borrower and the collective pool. My 
understanding is that is not an issue with covered bonds 
because the mortgages stay on the bank's books and the bank is 
required to remove troubled mortgages from the pool and replace 
them with performing mortgages.
    Establishing a U.S. covered bonds market could be very 
helpful to the residential and commercial mortgage market, and 
other asset markets like public sector loans and other consumer 
loans as well. I look forward to today's hearing and potential 
action by this committee to establish such a market.
    Thank you. I yield back.
    The Chairman. The gentleman from Alabama is recognized for 
2 minutes. No, I take it back. I'm now told there's a change 
here, that he gets 3 minutes.
    Mr. Bachus. All right. Thank you, Mr. Chairman. Thank you 
for holding this hearing, and I thank the ranking member of the 
subcommittee for introducing this legislation on covered bonds.
    The collapse of Fannie Mae and Freddie Mac and their 
subsequent trillion dollar Federal bailout have renewed calls 
to explore innovative private market alternatives to the 
government-sponsored model of mortgage financing. America is 
about innovation, competition, and the private market, and I 
think covered bonds could be part of our solution. As one of 
our witnesses at today's hearing, Mr. Scott Stengel of the U.S. 
Covered Bond Council, states in his testimony, ``covered bonds 
also represent a cost effective form of on balance sheet 
financing for financial institutions that in turn can reduce 
the cost of credit for families, small businesses and the 
public sector.'' And obviously, that is something we should all 
strive for.
    Covered bonds are also a private market solution to the 
need for market participants to have skin in the game. The 
issuers of covered bonds are responsible to their bondholders 
for the risk posed by the underlying loan pool. For example, if 
the underlying loans default, bondholders have a secured claim 
to the assets in the loan pool as well as recourse to other 
assets of the insolvent firm. Additionally, issuers of covered 
bonds are required to account for the risk posed by their bonds 
on their balance sheet. In June, Mr. Garrett introduced 
legislation providing a statutory framework for a U.S. covered 
bond market that promotes greater legal certainty for investors 
in these instruments.
    Chairman Frank should be commended for convening this 
hearing on Mr. Garrett's legislation, and other ideas for 
encouraging the development of a covered bond market in this 
country. Mr. Chairman, a functioning securitization market is 
necessary for successful housing market recovery. Covered bonds 
are one of several solutions this committee should explore as 
we move forward with proposals to revive stalled private 
mortgage credit markets.
    I look forward to hearing expert testimony from the 
witnesses and working with you. And I'm pleased that this seems 
to be a bipartisan effort and that members on both sides of the 
aisle realize that this could be a potential source of funding 
for our mortgage market and a safe source as well.
    I yield back the balance of my time.
    The Chairman. The time has expired, and we will now go to 
the witnesses. I begin with Mr. Alan Boyce, who is chief 
executive officer of Absalon. Let me say at this point that 
with unanimous consent, any member who wishes to enter matter 
into the record will be recognized, and the witnesses at the 
conclusion of their oral statements will be free to submit any 
other material, including the rest of their statements, into 
the record.
    Mr. Boyce?

   STATEMENT OF ALAN BOYCE, CHIEF EXECUTIVE OFFICER, ABSALON

    Mr. Boyce. Mr. Chairman, Ranking Member Bachus, 
Representative Garrett, and members of the committee, I very 
much appreciate the chance to testify today. In my testimony, I 
would first like to discuss the general benefits of covered 
bonds and then to discuss the importance of specialized and 
rigorous legislation to provide a framework for this market. I 
will conclude by briefly examining an additional proposal that 
can make the covered bond approach even more effective in 
helping homeowners and investors alike.
    Covered bonds offer several potential advantages. In the 
recent past, issuers of loans sold into asset-backed securities 
were less concerned than they should have been about the 
quality of these loans, since they were often completely off 
the hook within weeks of making the loan. By requiring the 
institution to retain the loan on its balance sheet, covered 
bonds substantially mitigate this problem.
    Covered bonds are simple and transparent, unlike the 
complex, idiosyncratic, and opaque asset-backed securitization 
structures of the recent past. Covered bonds can help banks 
more cleanly manage interest rate risk by matching long-term 
assets with long-term liabilities. Finally, covered bonds can 
offer a much needed, low-cost method of private financing, 
particularly in the context of an appropriate regulatory and 
legal framework. Substantial risks do of course remain.
    The overall 200-year success of the European covered bond 
market is due to its consistently conservative approach. The 
U.S. covered bond market should copy this and be started with 
high-quality assets and strict standards. This should start 
with a specialized rather than a general law-based approach. It 
is my view that in starting a covered bond program, covered 
assets should be limited to well-underwritten, conservative 
loan-to-value ratio, first-lien mortgages. This is the asset 
class where the benefits of this approach are the greatest. The 
legislation should also include strict lending standards, 
including specific loan-to-value ratio limits, and requiring 
full recourse.
    Strict asset liability management practices should be 
mandated through an appropriate balance of legislation and 
regulation. The European covered bond market came to a halt 
last year after the Lehman bankruptcy filing. While the credit 
quality of the underlying covered pool assets had deteriorated 
somewhat, the significant factor was the inability of issuers 
to raise new liabilities to pay off mismatched maturing covered 
bonds.
    Given the recent experience and future threats to covered 
bonds from asset liability management risks, the bond ratings 
agencies have proposed significant changes to their covered 
bond rating methodologies. I believe that this committee should 
work in concert with these efforts.
    Successful covered bond programs also have clear and 
definitive rules to deal with problems. The simplest problem 
arises when there is a bad loan in the covered pool. The best 
policy approach is to insist that cash be the only substitute 
for a bad loan. The rules for estate separation should be 
clearly defined with a strong covered bond regulator empowered 
to make quick decisions.
    The benefits of covered bonds are maximized when the term 
of the bond exactly matches the term of the underlying assets. 
When each loan is exactly balanced by a portion of an 
identical, transparent, and tradable bond, this is called the 
principle of balance. Instituting the principle of balance can 
allow for better-aligned interests between borrowers, 
intermediaries, and investors.
    Indeed, this system has worked extraordinarily well in 
Denmark since 1797, while the United States Congress was still 
meeting in Congress Hall in Philadelphia. Further, when 
combined with optional redemption mortgages, this system can 
significantly limit the threat of foreclosure during housing 
busts.
    Optional redemption mortgages like covered bonds are a 
fairly simple idea, but one that is unfamiliar to many in this 
country. Just as homeowners are allowed to refinance when 
interest rates drop, optional redemption mortgages offer the 
homeowner the option of refinancing when the value of his or 
her mortgage drops due to rises in interest rates. Optional 
redemption mortgages thus put households in the same situation 
as corporate treasurers who have the ability to purchase their 
own debt back at a lower value in the open market when the 
value of that debt falls. This feature would profoundly improve 
the overall situation facing the housing market during most 
housing price declines by directly and substantially reducing 
the number of homeowners who are underwater.
    Transitioning to a new and simpler and more stable system 
could be done efficiently and effectively by refinancing 
performing mortgage loans into new standardized principle of 
balance loans. Many other transition paths can also be 
considered.
    In conclusion, the U.S. Government has become the single 
payor supporting the mortgage market. As such, it has a 
profound ability to influence the design of the system moving 
forward. There should be added urgency to mortgage reform, 
given the threat from the embedded extension risk that exists 
in the current mortgage market. Covered bonds can be an 
important part of the solution. Introducing a legislated 
covered bond market is a big step in rebuilding the mortgage 
market in a sound and sustainable fashion. A few additional 
changes can make this an even more effective step, and I urge 
the committee to carefully examine the potential of the market 
in which standardized mortgages with optional redemption are 
funded through simple and transparent securities.
    [The prepared statement of Mr. Boyce can be found on page 
28 of the appendix.]
    The Chairman. Your time has expired, Mr. Boyce. Again, 
members of the panel should feel free to submit anything 
further that they wish.
    Next, Mr. Scott Stengel.

 STATEMENT OF SCOTT A. STENGEL, PARTNER, ORRICK, HERRINGTON & 
   SUTCLIFFE LLP, ON BEHALF OF THE U.S. COVERED BOND COUNCIL

    Mr. Stengel. Chairman Frank, Ranking Member Bachus, and 
members of the committee, I am grateful for your invitation to 
testify today on the crucial role that U.S. covered bonds can 
play in stabilizing our financial system and funding the needs 
of consumers, small businesses, and State and local 
governments.
    I am a partner with Orrick, Herrington & Sutcliffe and a 
member of the steering committee for the U.S. Covered Bond 
Council. The Council is comprised of investors, issuers, 
dealers, and other participants in the covered bond market, and 
we strive to develop policies and practices that harmonize the 
views of these different constituencies and that promote an 
efficient market for U.S. covered bonds.
    Recent reports have confirmed what we are seeing on the 
ground. Our Nation's economic recovery remains slow and uneven, 
and the foundations of our financial system are not yet fully 
repaired. In this volatile environment, credit remains tight 
for both families and small businesses, public sector resources 
are increasingly strained, and consumers are understandably 
cautious.
    In the Council's view, sustained economic growth begins 
with a stable financial system. This in turn requires an ample 
supply of long-term and cost-effective funding that is sourced 
from diverse parts of the private sector capital markets and 
that can be translated into meaningful credit for households, 
small businesses, and State and local governments. We believe 
that covered bonds are an untapped but proven resource that 
could be invaluable in meeting this need. We also believe that 
the time for U.S. covered bonds is now.
    At its core, a covered bond is simply a form of high-grade 
debt that is issued by a bank or other regulated institution 
and that is secured by a cover pool of financial assets which 
is continually replenished. Over the course of their 240-year 
history, covered bonds have been backed by residential mortgage 
loans, commercial mortgage loans, agricultural loans, ship 
loans, and public sector loans. And in the Council's view, 
loans for small businesses, students, automobile owners, and 
consumers using credit or charge cards also are appropriate.
    U.S. covered bonds can bring a stabilizing influence to our 
financial system in several ways. First with maturities that 
range from 2 to 10 years or more, covered bonds can infuse 
longer-term liquidity into the credit markets. Second, by 
providing more cost-effective funding for lenders, covered 
bonds can produce less expensive and more available credit for 
consumers, small businesses, and the public sector. Third, 
covered bonds can add funding from a separate investor base 
that would not otherwise make liquidity available through the 
unsecured debt or securitization markets. Fourth, covered bonds 
can deliver funding from the private sector even in distressed 
market conditions without relying on U.S. taxpayers for 
support. Fifth, because covered bond issuers continue to own 
the assets in their cover pools and have 100 percent skin in 
the game, incentives relating to loan underwriting, performance 
and modifications can be strongly allied. And sixth, as a 
straightforward financial instrument, covered bonds can 
increase transparency and uniformity in our capital markets.
    Covered bonds, however, are no silver bullet, and action is 
still needed to resuscitate securitization and the rest of the 
capital markets. But in our view, covered bonds represent a 
critical step toward restoring financial stability, and in this 
constrained credit environment, one that is urgently needed 
now.
    To function effectively, however, a U.S. covered bond 
market must be deep and highly liquid, and that requires the 
kind of legal certainty that only legislation can provide. 
Covered bonds developed in Europe under dedicated legislative 
frameworks, and this precedent, now found in almost 30 
countries, has set expectations. Covered bonds programs must be 
subject to strong public supervision that is designed to 
protect investors. And a separate resolution process must exist 
that provides a clear road map in the event of the issuer's 
default or insolvency, and avoids the waste inherent in a 
forced liquidation of collateral.
    While a covered bond regulator can supply more detailed 
criteria for cover pools and other aspects of covered bond 
programs, the features that give covered bonds their unique 
character can be supplied only by legislation. Without action 
by Congress, European banks will be left to capture the 
investor demand for covered bonds that is growing in the United 
States. The result will be an increasingly uneven playing field 
for U.S. banks of all sizes, and more expensive and less 
available credit for families, small businesses, and the public 
sector.
    The Council therefore fully supports the kind of 
comprehensive covered bond legislation that Congressman Garrett 
has offered, and I want to thank him for his leadership and 
Chairman Frank for holding this hearing, and I would be pleased 
to answer any questions that the committee may have.
    [The prepared statement of Mr. Stengel can be found on page 
67 of the appendix.]
    The Chairman. Mr. Ely?

           STATEMENT OF BERT ELY, ELY & COMPANY INC.

    Mr. Ely. Chairman Frank, Ranking Member Bachus, and members 
of the committee, I very much appreciate the opportunity to 
testify today about covered bonds and the prospects for a U.S. 
covered bond market going forward.
    In my written testimony, I provided a brief description of 
covered bonds, discussed the many benefits they will bring to 
the U.S. financial system, and described a legislative and 
regulatory framework for fostering growth of covered bonds in 
the United States.
    I am speaking today only for myself as a champion of 
covered bonds. While others have discussed covered bonds, I 
want to first stress the principal benefits of covered bonds, 
as follows:
    One, better credit risk management due to lenders retaining 
100 percent of the credit risk.
    Two, better borrower protection, because lenders will keep 
the loans they make. They will have to eat their own cooking.
    Three, if needed, loan modifications would be much less 
complicated, because the lender will own the loan outright.
    Four, highly efficient funding of loans financed with 
covered bonds, because their high credit ratings and low 
transaction costs will bring lower interest rates to borrowers.
    Five, reduced maturity mismatching by lenders, and an 
attendant reduction in interest rate risk due to the medium- 
and long-term maturities of covered bonds.
    Six, a substantial new supply of high-quality debt for 
investors to purchase. Given that $21 trillion of loans 
currently outstanding in the United States are potential 
candidates for covered bond financing, a highly liquid covered 
bond market of several trillion dollars could readily develop, 
approaching the size of the Europe covered bond market.
    Seven, covered bonds would appeal to investors 
internationally, which is important, given that non-U.S. 
investors currently provide $7.7 trillion of debt financing to 
U.S. borrowers.
    It is absolutely crucial to have a sound, efficient legal 
structure governing the issuance of covered bonds, which 
consists of three layers: One, a statutory foundation; two, a 
regulatory mechanism based on that statutory foundation to 
oversee the day-to-day functioning of the covered bond market; 
and three, bond indentures tailored to the unique circumstances 
of a covered bond issuer and the assets in a cover pool 
securing those assets.
    Essential to the development of a U.S. covered bond market 
is for Congress to enact a covered bond law which creates a 
sound, efficient legal framework for the issuance of covered 
bonds by banks and other entities.
    The statute must create legal certainty for covered bond 
investors, specifically the certainty that no matter what 
happens to the issuer, principal and interest will be paid on 
the covered bonds at the contracted time and that the covered 
bonds will not be stripped of their cover pool should the 
issuer default on the bond or be placed in a receivership or 
bankruptcy proceeding.
    That certainty is absolutely crucial to covered bonds being 
able to obtain and retain the triple-A rating that covered 
bonds almost always earn.
    However, the covered bond statute should not overreach or 
get too precise about the specific protections and processes. 
That is, the statute should not love covered bonds to death by 
being overly prescriptive.
    Instead, the more detailed prescriptions and processes 
governing covered bonds should be left to regulation, to a 
covered bond regulator, and to the indentures governing 
specific covered bond issuances.
    Moody's has written quite positively about these statutory 
provisions, stating recently that the latest proposal for 
covered bond legislation is robust and would provide very 
strong protection to future covered bond investors following 
initial default.
    Moody's goes on to say that the development of a covered 
bond market in the United States would be a positive 
development for the funding profile of U.S. banks, by providing 
an additional funding source for residential mortgage loans.
    The Treasury Department as the covered bond regulator would 
develop regulations to implement the statute and then enforce 
those regulations. Specific regulations could cover each 
covered bond class, such as maximum loan-to-value ratio and 
minimum credit scores for borrowers, and other criteria for 
loans eligible for a cover pool.
    The rules would also provide for an independent cover pool 
monitor to ensure that each cover pool was monitored on a 
continuous basis. This rule-making process also would enable 
Treasury to keep covered bond regulations up to date.
    Although seldom discussed in the legislative arena, each 
covered bond issuance would be governed in its most specific 
detail by a bond indenture. The administration of the indenture 
would be carried out by an independent bond trustee, who would 
perform its duties in accord with the covered bond statute and 
regulations and enforceable in the appropriate court of law.
    Finally, in the covered bond marketplace, issuers and 
investors will be the ultimate covered bond regulator; for 
covered bond issuance will not take off and function in the 
United States if covered bonds do not meet the needs of both 
issuers and investors.
    However, this marketplace will not develop until such time 
as Congress enacts a sound covered bond statute which provides 
for the efficient regulation and operation of the U.S. covered 
bond marketplace.
    Mr. Chairman, I thank you for this opportunity to testify 
to this committee today. I welcome the opportunity to answer 
questions posed by members of the committee.
    Thank you.
    [The prepared statement of Mr. Ely can be found on page 39 
of the appendix.]
    The Chairman. Mr. Phoa?

 STATEMENT OF WESLEY PHOA, SENIOR VICE PRESIDENT, THE CAPITAL 
                        GROUP COMPANIES

    Mr. Phoa. Good morning, Chairman Frank, Ranking Member 
Bachus, and members of the committee.
    Thank you for the invitation to testify today on the U.S. 
covered bond market. It is very encouraging to see the 
remarkable progress being made on financial regulatory reform.
    Covered bonds could, I think, help in this process by 
playing an important role in making the financial system more 
robust and less dependent on government support. They also have 
a useful role to play in investors' portfolios.
    I manage portfolios of the Capital Group Companies. You may 
know us because we manage the American Funds family of mutual 
funds. I would like to explain briefly how, in my opinion, 
covered bonds help us serve the needs of our clients.
    Investors have different needs. Workers saving for 
retirement have to build their savings, and for them, we try to 
purchase shares in good companies from around the world. 
Retirees need a reliable income to support them, and so we look 
for stocks and bonds that will generate the income they 
require.
    And almost everyone needs to protect a portion of their 
savings through difficult markets. So we must also find good 
sound investments whose value holds up in rough times. This 
means investing for safety, not just growth or income.
    In the past, when investing for safety, we and other 
investors have turned to government bonds and government-
sponsored securities. This has worked well, but it means 
sacrificing income and diversity and making our portfolios more 
sensitive to government policy decisions.
    We seek private sector alternatives. In Europe, the covered 
bond market has played this role for more than 2 centuries. The 
safety comes from good collateral rather than government 
support. We ourselves have invested in European covered bonds 
on behalf of European clients for 2 decades. They have earned 
the confidence of investors by holding their value through 
turbulent markets.
    Thus, firms which can tap this market have access to a 
broad and deep base of investors to help them continue lending, 
even in bad recessions.
    Covered bond financing also aligns the interest of issuers 
and investors, since firms continue to hold the collateral on 
balance sheet and remain exposed to any losses.
    I was therefore very encouraged when a U.S. covered bond 
market started to emerge in the years immediately before the 
crisis. Hence, my involvement in the U.S. Covered Bond Council.
    While only two U.S. financial institutions raised covered 
bond financing, a number of European banks also tapped the U.S. 
dollar markets. And it looked as if a diverse market was 
starting to evolve.
    Unfortunately, the global financial crisis intervened. As 
you know, this severely affected all parts of the private 
sector bond market, shutting firms off from debt finance. The 
European covered bond market actually weathered the crisis 
reasonably well, and European banks were able to resume issuing 
covered bonds well before they could issue any other kind of 
debt that was not government guaranteed.
    This includes many of the smaller banks, not just the 
larger firms.
    The nascent U.S. covered bond market did not fare as well 
for a number of reasons. It was very immature. The investor 
base was not yet fully developed. Liquidity deteriorated much 
more sharply than in Europe. And crucially, the uncertainty 
about decisions being taken by policymakers and regulators 
weighed heavily on investors' minds.
    The legal framework in the United States offered less 
clarity than the more specific principles enshrined in European 
covered bond legislation. We could not be completely sure 
precisely what would happen if an issuer failed.
    The FDIC and the Treasury Department did take some actions 
in 2008 to mitigate this uncertainty. But administrative and 
regulatory actions can't substitute for clear legislation.
    I think it is possible for this market to make a fresh 
start on a sound legislative basis. Today's environment, where 
there are plenty of savings looking for a conservative home, is 
quite conducive to the development of a robust and reliable 
market.
    To sum up, it's good for the economy and good for investors 
if we have a private sector financial system that can stand on 
its own 2 feet during the most severe recessions and continue 
lending freely on prudent terms to households and small 
businesses.
    A healthy, well-regulated, and supervised U.S. covered bond 
market, established on a firm legal basis, should make an 
important contribution towards this goal, as well as creating a 
useful asset class for us to invest in.
    Again, I appreciate the opportunity to testify before the 
committee, and I hope my remarks have been of some assistance.
    [The prepared statement of Mr. Phoa can be found on page 62 
of the appendix.]
    The Chairman. Mr. Hoeffel?

    STATEMENT OF J. CHRISTOPHER HOEFFEL, MANAGING DIRECTOR, 
  INVESTCORP INTERNATIONAL, INC., ON BEHALF OF THE COMMERCIAL 
             MORTGAGE SECURITIES ASSOCIATION (CMSA)

    Mr. Hoeffel. Thank you, Mr. Chairman. My name is 
Christopher Hoeffel, and I am the managing director at 
Investcorp, a provider and manager of altered investment 
products for both private and institutional clients.
    I am testifying today on behalf of the Commercial Mortgage 
Securities Association, or CMSA, where I serve on the Executive 
Committee and am immediate past president.
    CMSA represents the collective voice of all market 
participants in the commercial real estate capital markets, 
including lenders and issuers, investors, rating agencies, and 
servicers, among others.
    I currently am an investor in the commercial mortgage-
backed securities (CMBS) market, but I have more than 2 decades 
of experience as a commercial lender and a CMBS issuer and 
originator.
    CMSA would like to thank the committee for the opportunity 
to share our perspective on the creation of a U.S. covered bond 
market.
    Today, the commercial real estate finance markets remain 
severely constrained, despite extraordinary borrower demand. In 
fact, there is more than $1 trillion of commercial real estate 
loans maturing in the next several years. At the same time, the 
CMBS market, which accounted for $240 billion, or approximately 
half of all commercial lending in 2007, has provided only $1 
billion of new lending this year.
    As such, we applaud the committee's timely efforts to 
consider a covered bond framework. We also applaud Capital 
Markets Subcommittee Ranking Member Garrett and Subcommittee 
Chairman Kanjorski for introducing legislation to facilitate 
this market and for including commercial mortgages in CMBS as 
collateral.
    Overall, our members believe that covered bonds would be a 
helpful financing tool for the commercial property market. 
Certainly covered bonds would not replace CMBS as the capital 
source for commercial real estate; however, it would be an 
additive tool that provides liquidity, helps institutions raise 
capital to fund loans, and eases the credit crisis facing 
commercial real estate.
    In the current environment, covered bonds could be a 
helpful means of raising capital relative to CMBS, as today the 
cost of capital related to a covered bond deal may be less 
volatile than CMBS. Moreover, such conditions could assist 
financial institutions in aggregating collateral for a covered 
bond issuance, in contrast with the aggregation difficulties 
now being faced by the CMBS market.
    Additionally, a broader-covered bond market would be a 
valuable financing tool for smaller banks. Securitization is 
often not an option for some smaller banks that lack a critical 
mass of collateral in one asset category.
    But the ability to use diverse asset cover pools, made 
possible under a broad covered bond regime, could give smaller 
banks a useful new source of capital, enhancing their 
viability.
    Today, commercial mortgages in CMBS are already permitted 
in covered bond pools in most European jurisdictions. These 
jurisdictions accord the necessary and appropriate regulatory 
treatment, including capital requirements, with respect to 
covered bonds, to facilitate the market and to better serve 
consumers and businesses seeking access to credit.
    It follows that in order to be globally competitive, any 
U.S. covered bond regime should be closely aligned with the 
approach used by our European counterparts. Such a framework 
will give U.S. consumers and businesses access to the same 
sources of credit availability and support our overall economic 
recovery.
    Also, a covered bond market would attract new investors to 
the commercial real estate market. This would increase the 
potential sources of the capital available for consumers and 
businesses, enhance liquidity, and help to create stability and 
asset values.
    As the previous and current Administrations have rightfully 
pointed out, no recovery plan will be successful unless it 
helps restart the securitization markets. Covered bonds should 
be viewed in the same light, as an important component of any 
economic recovery plan.
    All available tools should be employed to strengthen the 
credit markets and to provide the certainty and confidence that 
private investors, who fuel lending, seek.
    However, all of these issues and efforts cannot be viewed 
or considered in a vacuum.
    Today, recovery efforts in the commercial real estate 
market, including TALF and PPIP, have been helpful, but they 
remain in a delicate stage. They have led to increased 
liquidity for certain commercial real estate securities, but 
there still remain serious impediments to new lending for 
several reasons, including aggregation issues and enormous 
uncertainty in the securitized credit markets.
    In this regard, our markets face unprecedented and 
retroactive accounting changes, including FAS 166 and 167, that 
will undoubtedly impact capital and liquidity.
    In conclusion, the ongoing credit crisis presents enormous 
challenges for the commercial real estate sector. With 
traditional sources of credit such as CMBS developing slowly 
due to technical and regulatory hurdles, financial institutions 
need all tools to raise capital for commercial real estate and 
other asset classes in a sound manner.
    Accordingly, we urge Congress to include in reform 
legislation a framework for covered bonds in order to promote 
global competitiveness and to give U.S. consumers and 
businesses access to the same sources of credit availability.
    Thank you for your leadership on these issues. CMSA stands 
ready to assist you.
    [The prepared statement of Mr. Hoeffel can be found on page 
50 of the appendix.]
    The Chairman. Thank you. Let me begin, Mr. Hoeffel, and I 
apologize for mispronouncing your name earlier.
    I was struck because there was this concern about 
commercial real estate. But you have found the combined efforts 
of the Treasury and the Federal Reserve to be useful?
    Mr. Hoeffel. They have been useful in creating demand for 
securities, so that there has been active secondary trading in 
commercial mortgage-backed securities, both investment grade, 
or triple-A and below. Credit spreads have come in.
    So it has been very valuable, I think, in clearing bank 
balance sheets, in creating liquidity, and in helping shore-up 
demand for the securities. It has not, however, inspired new 
lending. So there has been no incremental credit offering--
    The Chairman. I understand that, but to the extent that it 
has had an effect, it has been a beneficial effect. Because 
there have been people who have been very critical.
    Are these efforts ongoing? Would you have them stop them 
now?
    Mr. Hoeffel. I think that they have created investor 
demand, and they don't need to continue indefinitely. We have 
started to see a very few--
    The Chairman. Well, indefinitely, I would agree. Nothing 
should continue indefinitely, like this hearing.
    [laughter]
    The Chairman. But what about, would you stop them now? When 
would you stop them?
    Mr. Hoeffel. Well, I wouldn't stop them now because--
    The Chairman. Okay--
    Mr. Hoeffel. You said you're not going to stop them now. 
You need to carry through with the original term.
    The Chairman. I appreciate that. Thank you.
    Mr. Ely, again on some of the issues, I'm struck by, on 
page 7 of your written testimony, your proposal that the 
Federal Reserve Bank of New York should lend on a 
collateralized basis to the covered bond trust, etc. We haven't 
heard many calls for a greater role for the Federal Reserve 
Bank of New York. So I thought we would draw on this.
    They would be allowed to lend their funds, Federal Reserve 
funds, it says, ``to make timely payments on principal and 
interest.'' This would be if the trustee was somehow unable to 
do that temporarily? Is that the issue?
    Mr. Ely. Yes. First of all, I think it would be a rarely 
used borrowing power. An alternative that has been suggested 
as--
    The Chairman. Well, let's not talk about the alternative. 
Let's talk about what you propose.
    Mr. Ely. Okay.
    The Chairman. I want to see how it works.
    Mr. Ely. The situation would arise where for some reason 
the assets in the cover pool backing the covered bonds weren't 
generating enough cash flow in a period of time to cover the 
interest and principal payments due on the covered bonds that 
were secured by those assets. Only in effect, it would be a 
short-term bridging type of loan.
    The Chairman. Well, the Federal Reserve would be able to 
step in and lend the money to cover the shortfall?
    Mr. Ely. Yes. But it would obviously have a secured 
interest in--
    The Chairman. Yes. Then there are some who would say that 
was a bailout by the Federal Reserve, of short duration. But it 
would have to be collateralized.
    But the principle allowing the Federal Reserve to being 
sufficiently collateralized isn't a problem for me. That makes 
sense here.
    Mr. Ely. I would not consider it to be a bailout, but 
rather a short-term secured, interest-bearing loan--
    The Chairman. But they would step in, there would be a 
shortfall in the private sector's ability to make these 
payments. And the Federal Reserve Bank of New York would step 
in and advance money to carry them over that shortfall. 
Correct?
    Mr. Ely. Yes, it's a bridging loan.
    The Chairman. Okay. Thank you.
    And the only other point I would make is to note that I 
welcome the acknowledgement that sometimes we can look at 
European--the gentleman from Illinois said it, he said 
kiddingly, but it's a very important point, because there have 
been, during our most recent debate, people who said, ``Look, 
forget about Europe, this is America,'' and the notion that 
there is nothing to be gained from others' experience, or that 
we have no need to do things in parallel, I think, is gravely 
mistaken.
    So I am struck by the unanimity that the European 
experience has been a good one, that it is instructive for us, 
that it gives us lessons, and that this is a case where 
acknowledging that something has been done in Europe has some 
useful lessons for us, we ought to go forward.
    So I appreciate that.
    And I will tell you, Mr. Boyce, that the Majority Leader 
will appreciate your invocation of Denmark. He often notes that 
he is the only Dane serving in Congress. And this cultural 
reinforcement, I'm sure, if and when we get to legislation, 
will help us get him to schedule it.
    Mr. Ely. Mr. Chairman?
    The Chairman. Yes.
    Mr. Ely. If I could pick up on what you said about learning 
from Europe, I think it is important to pick up on their 
experience. The key thing is that in many ways, the European 
mortgage market is a more privatized market because of covered 
bonds. And I think that it has demonstrated that it can work 
very well--
    The Chairman. I agree, it is privatized and we would have a 
privatized one until and unless the private market got in 
trouble, and then the Federal Reserve Bank of New York could 
step in and help them out.
    The gentleman from New Jersey?
    Mr. Garrett. I thank the Chair. And my understanding is 
that the Speaker is traveling to Europe later this week for the 
specific purposes of examining the covered bond market.
    To the last point, Mr. Ely, can you inform me, though, what 
is the backstop, if you will, in the European model?
    Mr. Ely. I'm sorry?
    Mr. Garrett. What is the backstop in the European model? 
You suggested a reserve instead of the Federal financing bank 
here.
    Mr. Ely. There have been, as I understand it--and there may 
be others on the panel who can speak to this more 
specifically--that there have been some situations where there 
has been some ad hoc mechanism created to deal with short-term 
cash flow and market problems.
    Mr. Garrett. Does anybody else want to chime in on that? 
Yes, sure, Mr. Boyce?
    Mr. Boyce. The assumption was that in the event that the 
covered bond matured and the cash flows from the assets were 
insufficient, the assumption was that assets would be able to 
be sold, or that the covered bond issuer would be able to raise 
other liabilities.
    Last year, what happened was that sovereign governments of 
Ireland, the United Kingdom, The Netherlands, Belgium, and 
Germany had to rescue the financial institutions. That was the 
backstop.
    Mr. Garrett. Mm-hmm. But prior to that, there was not?
    Mr. Boyce. No.
    Mr. Garrett. Right. And so--because over there, there was 
no statutory framework for it, right? That was specifically 
touched upon, that point, as you say, ``The assumption was,'' 
or I guess you would say priced into the model of it, then, 
that's how they would assume that they would be covered. So 
that was in the pricing mechanism.
    So--and I'll have to delve into this a little bit deeper. 
But I guess you could also put that, if the statutory framework 
here was just the contrary here, as far as not having the 
backstop, then I guess that would just be part of the pricing 
of the project as well.
    Would it not?
    Mr. Stengel. Congressman Garrett, if I could speak to that?
    Mr. Garrett. Sure.
    Mr. Stengel. I agree completely. One concern that has 
existed, trying to transplant the covered bond system in the 
United States, is to make crystal clear here that there is 
neither an explicit or implicit guarantee from the government.
    I think what we found in Europe was silence in the 
legislative frameworks on what would happen when the issuer 
defaulted, a separate resolution process began for this cover 
pool.
    It was silent at that point. And I think some in the market 
thought that implied a guarantee from the government.
    And so by providing liability only, no credit risk--so the 
same kind of borrowing that banks can get from the discount 
window--the notion, at least in the Council's view, is that 
this kind of clear borrowing only for liability, only until 
cash comes in from the assets themselves, is critical.
    Mr. Garrett. Okay. Oh, yes, we have had that problem here, 
of course, in other areas where there was an implicit 
guarantee, that some people thought was an explicit guarantee. 
And then it turned out to be an explicit guarantee.
    Mr. Ely. And Mr. Garrett, if I could just add to that?
    Mr. Garrett. Sure.
    Mr. Ely. My proposal as I talked about it in my statement, 
is again just following up on Mr. Stengel's comments, that it 
is strictly a liability support, comparable to banks borrowing 
from the Fed discount window, with no loss intended for the 
taxpayer.
    Mr. Garrett. Okay.
    I will just run down the line, if anybody wants to make any 
comments. In our proposal, there is language there with regard 
to a wider array of asset classes, one being commercial 
properties. And you addressed that issue.
    The European model does not have that. Do you just want to 
comment on if there's a reason why you saw that is not in that 
model, and why that is a benefit to our model? I think you 
touched about the benefit here--
    Mr. Hoeffel. Well, there are commercial mortgages in the 
European model. In fact, I think one of the reasons--
    Mr. Garrett. I'm sorry. I should say it's not in the U.S. 
model, what has begun over here, I should have said.
    Mr. Hoeffel. Well, it hasn't been. And thank you, you have 
been very supportive in trying to add commercial real estate to 
the legislation, so we're thankful for that.
    Mr. Garrett. Right.
    Mr. Hoeffel. We see no reason not to include it. It has 
been a viable asset class in Europe, and in fact, it has been 
probably the prevalent source of commercial mortgage financing 
from banks in Europe.
    Mr. Garrett. Okay. And from anyone on the panel, what is 
the timeframe, assuming that we have a hearing today, and then 
a markup soon, and this legislation moves expeditiously through 
the House and the Senate, how quickly can this market actually 
blossom and grow into something of a sizeable nature?
    I have heard all sorts of, not just timeframes, but size of 
the market. But how quickly can this really grow here in the 
United States?
    Mr. Hoeffel. Congressman, I think the market needs to start 
quickly, and we need to enact this quickly in order for it to 
have the best benefit. Because right now, the traditional 
securitization markets are somewhere impeded. And covered 
bonds, we're not thinking are going to be a replacement for 
securitization, but an additional tool for banks.
    So to the extent that we can get the legislation out 
quickly, I think banks will take very good advantage of it in 
the near term.
    As securitization markets recover and we have some basis 
for new issuance, I think covered bonds will be another tool, 
but may not be the predominant tool.
    The Chairman. The gentleman from North Carolina?
    Mr. Watt. Thank you, Mr. Chairman. Since we have a 
classified briefing coming up, and Mr. Foster has been active 
in this area, I'm going to yield my time to him, if it's okay--
    The Chairman. The gentleman from Illinois is recognized for 
5 minutes.
    Mr. Foster. Thank you.
    The Chairman. I'm not going to make the classified 
briefing. I'll wait and read about it tomorrow.
    Mr. Foster. Thank you.
    You mentioned that the European covered bond market froze 
at least temporarily in the crisis last year. It's my 
understanding that the covered bond market in Denmark did not, 
and this is at least partially attributable to the principle of 
balance.
    I was wondering if any of you could elucidate on how the 
different segments of the covered bond market responded to the 
crisis?
    I guess, starting with Mr. Boyce.
    Mr. Boyce. The last covered bond issued in Europe last year 
was the week before the Lehman Brothers bankruptcy. The most 
severe pressure in the global financial markets was in October. 
Every day in the fall of 2008, the Danish mortgage market, 
which is funded by the issuance of standardized covered bonds, 
functioned.
    I would say that the European covered bond market has 
performed rather well recently, but it has come back earlier 
this year, and was still quite limited. And it was the 
announced purchase intentions of the ECB in May of the purpose 
of 60 billion Euros worth of covered bonds that really got 
their market going.
    So I would say that the lessons that we should take from 
that are that the transparency and asset liability mismatches, 
the two things that were the biggest vectors of problems in the 
European covered bond market, should be avoided when we set up 
ours.
    Mr. Foster. Thank you. And in terms of generating an 
efficient market, which ultimately yields a good deal for 
consumers and better mortgage rates, and so on, how do the 
different variations of covered bond markets compare 
historically and during the crisis?
    Whoever wants to answer.
    Mr. Phoa. We're happy dealing with different covered bond 
frameworks.
    What we require as investors is: first, enough disclosure 
and transparency, so that we can carry out our own due 
diligence within whatever framework; second, a market that 
however it is structured, is well-regulated and well-
supervised; and third, legislative clarity about what the 
rights and duties of the different parties are, if an issuer 
fails.
    Mr. Foster. Yes. But have there been differences within the 
different flavors of covered bond markets, in terms of the 
spread?
    Mr. Phoa. Yes, in Europe there has been considerable 
differentiation between spreads and behavior of markets, 
particularly between the U.K. jurisdiction, where there is no, 
or there had been no established covered bond legislation, and 
the European jurisdictions, such as Germany and France, where 
there had been a long-established legislative framework.
    Mr. Foster. Okay. So the lesson to be drawn there is that a 
strong legislative framework is important to preserving a good 
deal for consumers, especially in bad times?
    Mr. Phoa. Yes.
    Mr. Foster. Are there any other comments?
    Mr. Boyce. I can back that up. Before the financial crisis, 
I would say that all covered bonds in Europe traded at very 
tight spreads to each other, that the bond market did not 
significantly differentiate between specialized and general 
law, and between the types of collateral and the specifics of 
the law. Since then, I would say general covered bond law, 
covered bonds, have widened out by 30 or 40 basis points on 
average.
    Mr. Ely. If I could add to that, I think one of the things 
we have to keep in mind is that in Europe, you have a number of 
different countries, with varying covered bond laws.
    If Congress enacts one law and there is one regulator, 
given the potential size of a U.S. covered bond market, which 
could easily be several trillion dollars or more, just the 
sheer size of that market operating under one set of rules 
rather than a number of different sets of rules would provide 
liquidity and depth to the market, and, if you will, 
interchangeability among various covered bond instruments, that 
would go a long way toward maintaining the liquidity of the 
market, even in crisis times.
    Mr. Stengel. If I could add, from the Council's 
perspective, I think one primary factor has been the depth of 
the domestic market.
    German investors were willing to invest in German covered 
bonds, French investors in French covered bonds, and certainly 
one focus of the Council has been a development of a deep U.S. 
domestic market, and we find the demand is there.
    Mr. Foster. And could you talk briefly about a possible 
role for local community banks? How do they relate to the 
covered bond market in Europe, for example?
    Mr. Stengel. Lending from community banks in the United 
States is critical. And so there are a couple of places in the 
legislative framework where they have a role.
    One is a system for them to issue pooled covered bonds. 
They would issue their own, and then create diversity in the 
underlying pool, so that they could match it and mark it in 
size, and issue competitively.
    The Chairman. We do have the briefing, so I appreciate it. 
If you can elaborate on that in writing, it would be helpful.
    The time has expired. The gentleman from Texas is 
recognized for 5 minutes.
    Mr. Marchant. Mr. Chairman, my first question is, in a 
resolution such as bankruptcy or an FDIC proceeding or under 
the legislation that was just passed, a resolution from the new 
agency, what is the standing in recovered bond as opposed to 
preferred shares or other bonds that are issued by that entity?
    Mr. Stengel. Under current law, covered bonds are secured 
debt, so they would rank equally with other secured lenders in 
any bankruptcy or receivership. The one issue that's created 
under current law, however, is that there is a standstill, a 
stay, while either the bankruptcy court or the FDIC decides 
what to do with the broader resolution. And that kind of delay 
and that kind of uncertainty, the discretion given to managing 
the broader receivership or bankruptcy case, creates a lot of 
uncertainty for the investment community in what is supposed to 
be a high-grade and defensive investment. And so, the proposed 
legislative framework would lift out the covered bond program 
to be resolved separately with only one exception, and that 
being if the FDIC is appointed as conservator/receiver, having 
a reasonable period of time to transfer the entire program to 
another eligible issuer, much like Washington Mutuals was 
transferred to JPMorgan Chase.
    Mr. Marchant. So the legislation, as it is written or 
proposed, would alleviate the FDIC's concerns?
    Mr. Stengel. I believe so, and in two different ways. One, 
this is about maximizing the value of the collateral. And the 
FDIC's largest concern is losing the value of any equity or 
surplus collateral in that pool and by having it separately 
managed, having uninterrupted servicing of that pool, that's 
going to maximize the value. There's also a residual interest 
that's automatically created that represents that residual that 
would be in the form of a security that could be sold or 
otherwise monetized so the FDIC or creditors don't have to wait 
around while covered bonds pay off and the program winds down. 
They would have something immediately that could be monetized. 
So, I think both of those should assuage the FDIC's concerns.
    Mr. Marchant. My next question is, do all the bonds in the 
offering have the same status or are there tranches similar to 
mortgage bank security?
    Mr. Stengel. There are no tranches. It could be that a bank 
decides to set up multiple covered bond programs. One for 
residential mortgages, another for commercial mortgages, 
another for student loans. There would be no mixing of those 
collateral; they would all be separate. There could be multiple 
covered bond programs but all bonds have equal access to the 
assets in the covered pool that are securing them.
    Mr. Marchant. Mr. Phoa, in a mature covered bond market, 
what is the right spread over a comparable treasury?
    Mr. Phoa. That tends to vary a lot of the cycle. For 
example, a spread of say, 45, 50, 60 basis points might be 
observed during calm periods. And spreads will tend to widen 
during periods of market turbulence, but certainly much less so 
than spreads on unsecured debt. I think in Europe, we have seen 
spread volatility of covered bonds being a small percentage of 
that of unsecured debt.
    Mr. Marchant. And Mr. Ely, last question. Would it have the 
effect of taking the more conservatively unwritten loans out of 
the market and have them packaged with covered bonds, leaving 
the more risky loans to be underwritten and written by the 
government?
    Mr. Ely. No, I think that it is conceivable to establish 
covered bond programs that can deal with loans of all degrees 
of risk. What you would have is, obviously, for a covered bond 
would be an over-collateralization requirement that would have 
to be adjusted according to the risk, with a riskier pool of 
loans backing a covered bond issuance having a higher over 
collateralization requirement than would be the case with safer 
loans.
    So, my assessment is that covered bonds can deal, and have 
the potential to deal with loans of not only different types, 
but also different degrees of credit risk.
    Mr. Marchant. Thank you, Mr. Chairman.
    The Chairman. The gentleman from Missouri.
    Mr. Cleaver. Thank you, Mr. Chairman. This covered bond 
business is new for me, but I do have one question as I'm 
trying to digest all of the information that you're providing. 
Last summer, former Secretary Paulson actually endorsed this 
entire concept of covered bonds and I'm just wondering why, and 
maybe you can't even answer this question, why the initiative 
was not brought forth by the Administration? If the Secretary 
of the Treasury was strongly supportive of it, do any of you 
have any idea why that was not done? The Secretary made a 
speech about best practices and talked about this, so?
    Mr. Stengel. I think from the market's perspective, the 
market did try to act on the initiatives that were provided by 
both the Treasury and the FDIC. What was learned, not only 
through the crisis associated with Lehman and liquidity 
disruptions throughout our entire financial system, but what 
was found was, the legal certainty and the public supervision 
that is found in legislative frameworks is critical to this 
deep and liquid market that's needed for covered bonds.
    And so I think, at least from the Council's perspective, 
there has been a conclusion that without legislation, without 
the legal certainty provided, and without the public 
supervision provided through legislation, that this kind of 
market, which really needs to be deep and liquid, can develop. 
It can't start with just a couple of issuances and have 
sporadic issuance, have shallow trading; it needs to be deep 
and liquid in a very short order.
    Mr. Ely. Mr. Cleaver, my understanding is along that line, 
too, which is why other countries that didn't have a covered 
bond statute have moved in that direction, the U.K. being one. 
We have seen, for instance in Canada, a couple of the major 
banks either have issued or are about to issue covered bonds 
without a statute, but at the same time, Canada is working on a 
covered bond statute. So, the global experience seems to 
indicate, from the market's perspective, that in order to get a 
really good, sustainable market going, there has to be a strong 
legislative framework that establishes the certainty that 
investors in AAA bonds need to have.
    Mr. Cleaver. So, this is going to go global, you think?
    Mr. Ely. Yes.
    Mr. Boyce. Yes. Just to add to those comments. One of the 
things that was learned from last fall's crisis in Europe was 
that significant asset liability mismatches were a source of 
problems, so the rating agencies have all come out with very 
clear guidance and S&P is the last one that should come out 
soon requiring substantially minimized asset liability 
mismatches.
    Mr. Ely. And the good news is that, particularly when you 
have the strong legal environment, you can have long-term 
covered bonds of maturities of 10, 15, 20 years or more and 
that the long maturity of these bonds is what is key to 
minimizing maturity mismatch. But again, for that long-term 
debt to be out there, for the investors to buy it, you have to 
have the legal certainty that can only come from statutory law.
    Mr. Cleaver. All right. Thank you. That's all, Mr. 
Chairman.
    The Chairman. Would the gentleman yield? Mr. Boyce, I want 
to make sure I understood you. You're saying that the rating 
agencies learned as a result of their experience that a severe 
mismatch between assets and liabilities was a bad thing? Is 
that what they learned last year?
    Mr. Boyce. You are correct.
    The Chairman. Wow. The gentleman from New York.
    Mr. Lee. Thank you. I also am weaving my way through this 
and came down here to understand a little bit more about the 
covered bond market. I'm thinking that maybe I'll start with 
Mr. Stengel on this question and you can help educate me. And 
it has to do more with, obviously, secured creditors. In the 
bill that was passed last week, there had been an amendment 
inserted, the Miller-Moore amendment, with regards to a 
provision in that bill that would allow the FDIC to impose a 10 
percent haircut to secured creditors.
    My concern is over this, how this would play out in a 
covered bond market? And what impact would it have?
    Mr. Stengel. I think the market was very concerned about 
that particular amendment. It really threw off the playing 
field with which creditors have interacted with borrowers. I 
think we were grateful to see that was scaled back on the House 
Floor to debt that is under 30 days in length. So, very, very 
short term debt is now covered by that amendment, although that 
is still somewhat concerning to the capital markets.
    With covered bonds having very long maturities, 2 to 10 
years or more, and at least in the proposed legislation, by 
definition, at least one year, I don't think, at least the 
Miller-Moore amendment in its current form, would pose any 
issue for covered bonds.
    Mr. Lee. Do you think it's going to restrict investors 
coming into the market knowing that potential liability stick 
is out there?
    Mr. Stengel. I think the market, and again, just speaking 
for myself here, not the entire market, but I think there is 
market concern when the government suggests that secured 
creditors should not be entitled to all of their collateral. It 
really creates uncertainty and disruption in expectations. And 
so I think when Chairman Bair first made that suggestion some 
time ago, there was quite a quick market reaction to that 
suggestion. I think when the amendment was introduced, another 
reaction as well. And so, I think if that is going to be part 
of our law going forward, it's going to take some getting used 
to, but I think it is somewhat concerning for the market.
    Mr. Lee. I would completely agree. With that, I'll yield 
back. Thank you.
    The Chairman. The hearing is now adjourned. I appreciate 
the witnesses and any further information, obviously, with 
questions, if you want to elaborate on any of the answers, we 
would welcome that. This is a subject that the committee will 
be dealing with next year.
    [Whereupon, at 11:13 a.m., the hearing was adjourned.]






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                           December 15, 2009



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