[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
LEGISLATIVE PROPOSALS TO CREATE A COVERED
BOND MARKET IN THE UNITED STATES
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
MARCH 11, 2011
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-17
U.S. GOVERNMENT PRINTING OFFICE
65-675 WASHINGTON : 2011
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, [email protected].
HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
KENNY MARCHANT, Texas BRAD MILLER, North Carolina
THADDEUS G. McCOTTER, Michigan DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JOE DONNELLY, Indiana
BLAINE LUETKEMEYER, Missouri ANDRE CARSON, Indiana
BILL HUIZENGA, Michigan JAMES A. HIMES, Connecticut
SEAN P. DUFFY, Wisconsin GARY C. PETERS, Michigan
NAN A. S. HAYWORTH, New York JOHN C. CARNEY, Jr., Delaware
JAMES B. RENACCI, Ohio
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
Larry C. Lavender, Chief of Staff
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
DAVID SCHWEIKERT, Arizona, Vice MAXINE WATERS, California, Ranking
Chairman Member
PETER T. KING, New York GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois BRAD MILLER, North Carolina
JEB HENSARLING, Texas CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin
JOHN CAMPBELL, California ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan JOE DONNELLY, Indiana
KEVIN McCARTHY, California ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico JAMES A. HIMES, Connecticut
BILL POSEY, Florida GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK, AL GREEN, Texas
Pennsylvania KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
C O N T E N T S
----------
Page
Hearing held on:
March 11, 2011............................................... 1
Appendix:
March 11, 2011............................................... 33
WITNESSES
Friday, March 11, 2011
Andrews, Stephen G., President and Chief Executive Officer, Bank
of Alameda..................................................... 11
Daloisio, Ralph, Managing Director, Natixis, on behalf of the
American Securitization Forum (ASF)............................ 9
Ely, Bert, Ely & Company, Inc.................................... 6
Skeet, Tim, Chairman, Committee of Regional Representatives,
International Capital Market Association....................... 8
Stengel, Scott A., Partner, King & Spalding LLP, on behalf of the
U.S. Covered Bond Council...................................... 4
APPENDIX
Prepared statements:
Garrett, Hon. Scott.......................................... 34
Andrews, Stephen G........................................... 36
Daloisio, Ralph.............................................. 44
Ely, Bert.................................................... 68
Skeet, Tim................................................... 84
Stengel, Scott A............................................. 104
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Letter from the Honorable John Walsh, Acting Comptroller of
the Currency, dated March 10, 2011......................... 120
Letter from Bert Ely providing additional information for the
record, dated April 12, 2011............................... 122
Written statement of the Federal Deposit Insurance
Corporation (FDIC)......................................... 130
Written statement of the National Association of REALTORS
(NAR)...................................................... 146
LEGISLATIVE PROPOSALS TO CREATE
A COVERED BOND MARKET
IN THE UNITED STATES
---------- Friday, March 11, 2011
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:07 a.m., in
room 2220, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Schweikert,
Campbell, Pearce, Hayworth, Grimm, Stivers; Waters, Maloney,
Donnelly, and Carson.
Chairman Garrett. This hearing of the Subcommittee on
Capital Markets and Government Sponsored Enterprises will come
to order. Today's hearing, of course, is titled, ``Legislative
Proposals to Create a Covered Bond Market in the United
States.'' Without objection, all members' opening statements
will be made a part of the record.
And at this time, I will yield myself 2 minutes for my
opening statement.
I would like to welcome everyone here to the smaller
committee hearing room, which is not reflective of anything to
do with the importance of the topic that we are discussing
today.
As our Nation continues to recover from the recent
financial crises in certain credit markets--as we know,
Congress must examine new and innovative ways to encourage the
return of private investment to our capital markets. We must
also consider cleaner ways to enable the private sector to
provide additional mortgage, consumer, commercial, and other
types of credit as well.
I believe establishing a U.S. covered bond market would
further these shared policy goals. So, today we are here to
examine legislative proposals to establish a covered bond
market here in the United States.
This past Tuesday, my good friend, the gentlewoman from New
York, Mrs. Maloney, and I introduced H.R. 940, the U.S. Covered
Bond Act of 2011. The legislation sets the foundation, if you
will, for a U.S. covered bond market. And it does so by
creating a regulatory framework and then detailing the exact
process that occurs if an issuer fails.
One reason that I am particularly interested in covered
bonds is the fact that they can be a purely private means, if
you will, of finance in this area without government guarantees
or subsidies. Many proposals will help alleviate the current
strains on our credit market, and alternatives will focus on
government loans or guarantees. But I believe that the current
bond legislation offers an alterative, a way for the government
to provide additional certainty to private enterprises and
generate increased liquidity through innovation of a new
marketplace, if you will, without putting the taxpayers on the
hook.
There are many potential benefits for a wide variety of
interested parties that can be derived from the U.S. covered
bond market. There are about four of them I can list. First,
consumers will experience lower loan rates because of the
additional liquidity in the marketplace and the various asset
classes as well. Second, consumers will also be able to more
easily have their loans modified, which we see is an issue
right now because the loans will still be on the balance sheets
of the originating institutions.
Third, investors will have a new and transparent and secure
vehicle to invest in. And this will allow for additional
diversification within their portfolios. And finally, the
broader financial markets will benefit. How? By having an
additional low-cost, diverse funding tool for financial
institutions.
So covered bonds will ensure a more stable and longer-term
liquidity in the credit markets, which reduces financing risk
as well as exposure to the sudden changes in interest rates and
investor confidence. And finally, they will allow U.S.
financial institutions to once and for all to compete more
effectively against their global peers.
I look forward to hearing from the witnesses at our table
today.
And right now, I yield Ranking Member Waters.
Ms. Waters. Thank you, Mr. Chairman, for convening this
hearing today to examine the potential for creating a covered
bond market in the United States. Today, we convene to discuss
covered bonds and Representative Garrett's covered bond bill,
H.R. 940.
Covered bonds offer a way for financial institutions to
raise funds by selling a bond that is backed by their
institution's assets, which were pledged as collateral. The
assets under cover per pool remain on the balance sheet of the
issuer. And the covered bonds provide dual recourse to both the
cover pool and to the issuer.
Covered bonds represent a potentially promising alternative
to securitization. We know that securitization failed us in
many ways leading up to the 2008 financial crisis, particularly
as originators used securitization as a means to originate bad
loans and then quickly transfer them off their books. This lack
of ``skin in the game'' was a cause of the financial crisis and
is something we addressed in the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
We also are seeing title problems in foreclosures stemming
from banks not following proper legal protocols when
structuring securitization deals. These problems are creating
significant legal reverberations as banks' ability to foreclose
on borrowers is questioned. For these reasons, I am interested
in exploring covered bonds more fully. I am also interested in
learning more about the potential limits of covered bonds,
including whether the issuers will be able to accomplish the
same environment of lending with this more capital-intensive
system.
I do not believe that covered bonds could constitute a full
replacement for the government-sponsored enterprises. For
example, each ratings makes in a recent report their buying
capacity to covered bonds amounts to about 11 percent of the
market securitization gap spending.
I am also interested in learning more about the concerns of
regulators, particularly whether covered bonds present risk to
the FDIC when they try to resolve failed institutions. Given
the main resolution responsibilities provided to the FDIC under
the Dodd-Frank Act, we must ensure that their ability to
protect the deposit insurance fund is protected.
Again, I want to thank you, Mr. Chairman, for convening
this hearing. And I look forward to exploring covered bonds
more fully. I yield back.
Chairman Garrett. I thank you for your statement. I thank
you for those questions, as they are on point with what we need
to discuss. I appreciate you bringing those up.
The gentleman from California, Mr. Campbell, for 2 minutes.
Mr. Campbell. Thank you, Mr. Chairman. There is wide
agreement that we will be winding down Fannie Mae and Freddie
Mac. But there is not yet agreement, or a decision, and a lot
of what we will be doing in this subcommittee and in this
committee is discussing what we are going to replace it with.
I happen to be one of those people who believes that we
cannot replace it with nothing. And without getting into
details on my reasoning, that we cannot leave something with as
gigantic an impact on the economy as the entire housing market
open to the vicissitudes of the general ups and downs of credit
markets without some support and stabilization mechanism.
I have been very vocally supportive of what is called the
public utility model. I know the Treasury Secretary hates that
term. But he prefers more a reinsurance of government,
reinsurance policy where instead of having a government
guarantee, as Fannie and Freddie did that was implicit and
unlimited, that we have ones instead that are explicit, but
very limited.
However, that being said, I am here today because I am open
to being convinced otherwise that the covered bond option is a
better, stronger or equal option to that. And so, I look
forward to the testimony and to the entire discussion today.
Thank you, Mr. Chairman. I yield back.
Chairman Garrett. And I thank you.
The gentlelady from New York for 2 minutes.
Mrs. Maloney. Thank you. I will place my opening statement
in the record, in the interest of time. And we have a very
strong panel. I am looking forward to hearing your statements.
But I particularly thank the chairman, really, for his
commitment on looking for ways to increase the flow of credit
and provide liquidity to the securities markets. He has worked
on this issue with great commitment over several years. And I
am pleased to support him in his latest effort on covered
bonds, which are successful in Europe. I look forward to
gaining more insight into how those should be regulated. In the
way it has been drafted now, there would be no government
guarantee, but has the promise of really providing liquidity to
our markets and helping.
So I will place my statement in the record and look forward
to the comments from the panel. Thank you.
Chairman Garrett. And, as I said before you came in, thank
you so much for joining with me in this legislation.
Mrs. Maloney. Thank you. I look forward to it. I think it
is very promising. I think it is exciting. It may be part of
the answer.
Chairman Garrett. Thank you. I appreciate it.
The gentleman from New Mexico, for 2 minutes.
Mr. Pearce. Thank you, Mr. Chairman, for having the
hearing. I will place my comments into the record also, but
appreciate the opportunity to come and listen in on the
hearing.
Chairman Garrett. Does the gentleman from New York seek
time?
Mr. Grimm. Just 1 minute, Mr. Chairman. First of all, I
thank the panel for coming today. I appreciate the opportunity
to have a discussion and certainly look for more solutions as
we reflect on what has happened in the housing market and we
look for the innovation and the creativity that the United
States really should be driving in the marketplace and
elsewhere.
So I will place my full statement in the record because I
am eager to get to the questions and get the debate started. So
thank you, Mr. Chairman. I yield back.
Chairman Garrett. And I thank you.
If that is all the statements, I now look to the panel and
Mr. Stengel to go first for 5 minutes. And your complete
statement, obviously, will be made a part of the record. We
thank you for joining us today.
STATEMENT OF SCOTT A. STENGEL, PARTNER, KING & SPALDING LLP, ON
BEHALF OF THE U.S. COVERED BOND COUNCIL
Mr. Stengel. Thank you. Chairman Garrett, Ranking Member
Waters, and members of the subcommittee, 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
in contributing to our economic recovery. I am a partner with
King & Spalding 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 a
vibrant market for U.S. covered bonds.
When I last testified before the full committee in December
2009, the economic recovery was slow and uneven. Fifteen months
later, little has changed. Almost 17 percent of Americans
remain unemployed or underemployed. Nearly one out of every
four homeowners is still underwater on a mortgage.
A record percentage of commercial mortgage loans are
delinquent. And for Fiscal Year 2012, 35 States and the
District of Columbia are projecting budget shortfalls.
In the Council's view, sustained economic growth begins
with a stable financial system. While the Dodd-Frank Act has
revamped the regulatory landscape, there is still an unmet need
for long-term and cost-effective funding from the private
sector capital markets that can be translated into meaningful
credit for households, small businesses, and the public sector.
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
senior debt that is issued by a regulated financial institution
and that is secured by a dynamic cover pool of financial
assets. What distinguishes covered bonds from other secured
debt is a legal framework for managing and maximizing the value
of this cover pool after the issuer's default or insolvency.
And if the cover pool is adequate, continuing scheduled
payments on the covered bonds.
Over the course of their 240-year history, covered bonds
have been backed by a wide array of asset classes that benefit
from stable, long-term liquidity and that are significant to
national economies. U.S. covered bonds can stabilize our
financial system and contribute to the economic recovery in
several ways.
First, with maturities that extend out to 10 years or more,
covered bonds can infuse longer-term liquidity into the credit
markets as a complement to the shorter-term funding that is
supplied through the Federal Home Loan Banks and the
securitization and repo markets.
Second, by providing more cost-effective liquidity 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 this liquidity
available through other markets.
Fourth, covered bonds can deliver funding from the private
sector even in distressed market conditions without any
explicit or implicit government guarantee.
Fifth, because the issuers continue to own the assets in
their cover pools and have 100 percent ``skin in the game''
incentives related 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 the
capital markets. To function successfully, 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 in this precedent now found in almost 30
other countries have set expectations.
The twin pillars of such a framework are: one, public
supervision by a covered bond regulator that can protect the
interests of investors, free of any conflict of interest like
the FDIC's duty to the Deposit Insurance Fund; and two, a
separate resolution process that is clear and unequivocal and
that is designed to avoid a forced acceleration of the covered
bonds and a wasteful fire sale of the cover pool.
These two pillars, which afford the legal certainty
required for investors to dedicate funds to this market, cannot
be replicated by regulatory action alone. Without action by
Congress, European and other non-U.S. issuers will be left to
fill the void.
In 2010, they targeted over $27 billion in U.S. dollar
covered bonds to investors in the United States, and over $55
billion more is expected in 2011. The result is an increasingly
uneven playing field for U.S. institutions of all sizes and
more expensive and less available credit for families, small
businesses, and the public sector.
The Council, therefore, fully supports covered bond
legislation of the kind introduced by Chairman Garrett and
Representative Maloney as H.R. 940. And I want to thank them
for their leadership. I would be pleased to answer any
questions that members of the subcommittee may have.
[The prepared statement of Mr. Stengel can be found on page
104 of the appendix.]
Chairman Garrett. Thank you for your testimony.
Mr. Ely?
STATEMENT OF BERT ELY, ELY & COMPANY, INC.
Mr. Ely. Chairman Garrett, Ranking Member Waters, and
members of the subcommittee, I very much appreciate the
opportunity to testify today about covered bonds and H.R. 940,
which will create the legal framework for a vibrant U.S.
covered bond market.
Covered bonds offer important attributes which are often
overlooked or misunderstood. They include the following: First,
covered bonds will not be explicitly or implicitly backed by
the Federal Government. Clearly, H.R. 940 does not provide an
explicit Federal guarantee of covered bonds issued under the
provisions of this bill. Further, no provision in H.R. 940 even
suggests an implicit Federal guarantee of covered bonds.
There is widespread and legitimate belief among investors
that when a GSE bond default threatens, the implicit Federal
guarantee of that debt, by virtue of the issuer's GSE status,
will become explicit, as has been the practical effect of the
Fannie Mae and Freddie Mac conservatorships. Covered bond
issuers will not have GSE-like Federal charters.
Further, Federal regulation of covered bond issuance is no
more a government guarantee of covered bonds than is the
regulation of securities insurance by the SEC. The covered bond
regulator will merely ensure that covered bonds will at all
times be purely private sector credit instruments of the
highest possible credit quality.
Second, covered bonds will enhance the ability of lenders
to offer 30-year, fixed-rate mortgages because covered bonds
can be issued with medium- and long-term maturities at a fixed
rate of interest. Therefore, banks will be able to profitably
hold 30-year, fixed-rate mortgages in portfolio because the
interest rate spread on such loans will be locked in at the
time the mortgage is made.
Third, covered bonds do not represent GSE reform. While
covered bonds will become an important element of American
housing finance once a strong covered bond statute is enacted,
the issuance of covered bonds will have no direct bearing on
the eventual resolution of Fannie and Freddie. Instead, covered
bonds should be viewed as putting another horse in the housing
finance horse race, which will bring sound, low-cost financing
to American residential finance as well as to other classes of
financial assets suitable for covered bond financing.
Fourth, community banks will be able to issue covered bonds
due to the bill's pooling provision. This provision will enable
community banks and even larger banks, each too small to sell
their covered bonds directly to investors, to join together to
sell the covered bonds they issue into a covered-bond pool that
in turn will sell covered bonds to investors. In effect, the
covered bonds issued by the pool will be secured by the covered
bonds sold into the pool by its participants. The covered bonds
sold by a participating bank into the pool will in turn be
secured by the assets in that bank's cover pool.
Fifth, authorizing non-bank firms to issue covered bonds,
as the bill provides, will broaden the range of covered-bond
issuers, which in turn will provide greater depth and liquidity
to the covered bond secondary market, bringing the efficiencies
of covered bond financing to a broader range of borrowers.
Sixth, covered bonds will be a money maker for the FDIC. In
just 20 days, the FDIC assessment base will expand from total
domestic deposits to total global assets minus tangible equity
capital. In effect, FDIC assessments will become a tax on bank
liabilities, including covered bonds, whether insured by the
FDIC or not.
Assuming a 10-basis-point annual premium rate, the FDIC
will collect $1 million dollars annually for every billion
dollars of covered bonds outstanding. Yet, the FDIC's
additional realized losses due to those outstanding covered
bonds will be minimal.
Widespread use of covered bond financing will deliver
numerous benefits to the U.S. economy, specifically the safety
and efficiency of financing home mortgages and other types of
credit. Better lending will be one of the principal benefits of
covered bonds because covered bonds will be backed by loans
that lenders make and then keep on their balance sheet rather
than selling those loans into the securitization marketplace.
Lenders keeping the loans they make will eliminate the
moral hazard inherent in the securitization process. When a
lender keeps the mortgages it makes by funding them with
covered bonds, it will retain 100 percent of the credit risk
and 100 percent of its lending mistakes. It will eat its own
cooking.
This is far preferable to the 5 percent retention mandated
for home mortgages by the Dodd-Frank Act. Covered bonds will
enhance bank safety and soundness by providing the means for
banks to safely fund high-quality assets, such as
conservatively underwritten mortgages. For example, instead of
selling the fixed-rate mortgages it originates, thereby
weakening its relationship with those borrowers, a bank will be
able to keep those mortgages, which will deepen its
relationship with its borrower-customers. This stronger
relationship will enhance the bank's franchise value.
Other benefits include: stronger borrower protections--for
a default situation, loan modifications will be much less
complicated; highly-efficient bank funding because covered
bonds will have high-credit ratings and low transaction costs;
reduced maturity mismatching by lenders; a reduction in
interest-rate risk; and a substantial new supply of high-
quality debt for investors to purchase, especially
international investors.
Mr. Chairman, I thank you for the opportunity to testify
today. I welcome the opportunity to answer questions posed by
members of the subcommittee.
[The prepared statement of Mr. Ely can be found on page 68
of the appendix.]
Chairman Garrett. Thank you for that. I only came up with
three good reasons for covered bonds, so I appreciate that.
Mr. Ely. My written statement has even more.
Chairman Garrett. Even more--I can only imagine.
From the International Capital Markets Association, Mr. Tim
Skeet, for 5 minutes.
STATEMENT OF TIM SKEET, CHAIRMAN, COMMITTEE OF REGIONAL
REPRESENTATIVES, INTERNATIONAL CAPITAL MARKET ASSOCIATION
Mr. Skeet. Chairman Garrett, Ranking Member Waters, and
members of the subcommittee, I am pleased and honored to be
here today to share some thoughts on behalf of the
International Capital Markets Association in Europe on the
proposal for the creation of a covered bond market in the
United States.
There is, as we all know or perhaps as we have all
discovered, a lot of complexity in financial markets and the
instruments found therein. But covered bonds are not complex by
their nature. They are not risky by their nature. This is a
simple product, which, as my paper indicates, has done well in
Europe. And it serves the banks, the regulators and the
European taxpayers well. The paper I brought charts the
performance of this asset class and points to its essential
ingredients.
It also sets out how this asset class did not need the
benefit of government guarantees or subsidies, just solid
legislation and prudence. I am here today to say how much we in
Europe welcome the work going on, on covered bonds in the
United States. That is not to say that the United States needs
a carbon copy of what we have in Europe. Indeed, it is right
that you design a market for your own needs.
Nevertheless, there are good lessons to be learned from the
European experience. We have learned simply to keep it simple,
go for quality assets and make investors feel confident.
Covered bonds worked in Europe despite the crisis on account of
three irrefutable characteristics that meant that the market
functioned. And today, it represents the strongest and the most
reliable source of term funding for European banks.
Those three characteristics are: high-quality collateral; a
robust legal framework; and solid supervision. We also note it
has not just been the European investors that have supported
the market for covered bonds. As we already heard, U.S.
institutional investors have been doing their homework, and
they increasingly like what they see--bullet maturities, cash-
flow certainty and an enviable track record of no defaults.
This is close to what we once referred to as a rates-type
product in the market.
We note that there is work to be done on detailed
regulations and limits, on getting a regulator up to speed and
so on. This is serious work. In Europe, for instance,
regulators already recognize that banks cannot simply be funded
by pledging collateral. Some considerable thought has gone into
encumbrance levels, particularly like a Basel III and the
concept of the net stable funding ratio.
In the United Kingdom specifically, limits on covered bond
issuance have been set and have been monitored for years. Work
continues on this and across Europe, also on the standards of
collateral transparency. This work is relevant here also.
Covered bonds in Europe have, moreover, allowed a lot
smaller, and in some cases weaker, financial institutions to
fund themselves on a term basis, illustrating the simple fact
that stable funding contributes to a reduction in the
probability of a default, and it makes the overall system a
safer and more stable place.
As investors do a lot more of their own due diligence and
homework, they look for certainty, and they look for safety.
This bill gives them the basis for legal certainty, but it does
not completely remove, it just diminishes, the credit risk. In
Europe, we view covered bonds as part of the solution, not part
of the problem. We believe that it can and should work also
here in the United States.
Moreover, we believe that they are straightforward and
deliverable, give U.S. investors a chance to buy covered bonds
issued by U.S. institutions, allow U.S. private sector money
back into the U.S. mortgage market and not just be there for
the Europeans and the Canadians, as we have seen. Covered bonds
are not the complete answer to the future of mortgage finance
in the United States. But it could and it should be one
practical element in the solution. This product, covered bonds,
can play a part.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Skeet can be found on page
84 of the appendix.]
Chairman Garrett. I thank you for your testimony.
And now, from the American Securitization Forum, and also
representing the 5th Congressional District in the State of New
Jersey as well, Mr. Daloisio is recognized for 5 minutes.
STATEMENT OF RALPH DALOISIO, MANAGING DIRECTOR, NATIXIS, ON
BEHALF OF THE AMERICAN SECURITIZATION FORUM (ASF)
Mr. Daloisio. Thank you, Chairman Garrett, Ranking Member
Waters, and distinguished members of the subcommittee for the
opportunity to testify before you today. Can we restart? All
right. Thank you.
I promise I won't move. I will stay in the 5th District.
Thank you, Chairman Garrett, Ranking Member Waters, and
distinguished members of the subcommittee for the opportunity
to testify before you today on behalf of the 330 institutional
members of the American Securitization Forum and in particular,
its 60-plus pension funds, mutual funds, and insurance company
members, which collectively manage trillions of dollars of Main
Street's financial assets.
Assuming a legislative U.S. covered bond market is
established, our members will have a leading and lasting role
in this new financial instrument, much like they did over 25
years ago with the creation of the first asset-backed security.
As we gather today, there is a vibrant market in covered bonds,
which has raised over 2.5 trillion euros in secured financing
for over 140 credit institutions from 29 countries. These
issuers benefit from a deep and liquid market, more stable
asset liability management and lower financing costs that are
transmitted to their customers, individuals, companies, and
small businesses.
Despite the benefits obvious to so many other sovereign
banking systems, American banks are noticeably absent from this
market. Meanwhile, U.S. institutional investors have become
active investors in covered bonds beginning last year when they
purchased over $30 billion issued by foreign banks. Half of
this issuance came from Canadian banks, which crossed our
financial borders to tap investor demand for high-quality,
private-sector, fixed-income investments. In the absence of a
comparable alternative from our domestic banks, those dollars
have left our country to the benefit of other financial
systems.
Chairman Garrett, your effort last year to legislate into
existence a U.S. covered bond market was the right idea at the
right time, which has now been validated by the flow of U.S.
dollars into exactly these types of investments. As you
recognize, without the right kind of legislation, there will be
no U.S. covered bond market.
Earlier attempts in 2006 by Washington Mutual and Bank of
America remain the only isolated cases of U.S. covered bond
issuance. The financial crisis highlighted the weakness in the
contractual legal framework under which those covered bonds
were issued and discouraged investor participation.
The Treasury Department and the FDIC collaborated in July
2008 to set policy and guidelines to promote the development of
U.S. covered bonds. But not one dollar of issuance followed.
It should be clear by now that a U.S. covered bond market
can only be seated by a specific enabling act of legislation,
which has, at its cornerstone, a dedicated legal framework for
the treatment of covered bonds in the event the issuer becomes
insolvent. This is the case in every country that supports a
vibrant covered bond market. The lack of such a legal framework
in the United States is the single best explanation for a
nonexistent U.S. covered bond market.
The final policy issued by the FDIC in 2008 to encourage a
U.S. covered bond market remains unchanged and insufficient.
Current FDIC insolvency authorities afford the FDIC actions
adverse to investor interests, including the authority to
liquidate the cover pool at a loss to investors. Covered bond
holders need legal certainty that the insolvency of the issuer
will not result in a market liquidation of the cover pool and
an early return of their investments at par value or less.
Accordingly, legislation is required to curb FDIC
authorities over covered bonds in order to bring those
authorities in line with the legal frameworks in use elsewhere
around the world. The systemic benefits of enabling banks and
non-banks to issue covered bonds under a legislative framework
would appear to vastly outweigh the concerns such as the fear
that covered bonds could increase the risk of loss to the
FDIC's Deposit Insurance Fund and therefore, to the U.S.
taxpayer.
Covered bond investors are not entitled to receive more
than the return of their original investment at the contracted
rate of interest. In an issuer's insolvency, if there were a
deficiency between the cover pool and the covered bonds,
covered bond holders would be treated as unsecured creditors of
the issuer for the amount of the deficiency.
This unsecured claim would run pari-passu with other
unsecured claims, while depositors would have a more senior
rank. Moreover, any excess cover pool collateral existing after
the scheduled repayment of the covered bonds would revert to
the insolvency estate, not to the covered bond holders.
Also, the Dodd-Frank Act strengthened the DIF by granting
the FDIC the ability to achieve goals for DIF fund management
that it had sought for decades. In our view, the contrary
concerns are far more troubling, namely, the concern that we
failed to encourage the necessary resurgence in private sector
finance to accelerate an orderly exit from the excessive fiscal
and monetary support measures that remain, including the
continued overreliance on the GSEs and FHA to finance our
mortgage system when most other developed nations finance those
privately. A new market like covered bonds can enable the
process of replacing public sector subsidies with private
sector initiatives and prime the process for resolving the
GSEs.
Thank you for your time and attention to my testimony. And
I look forward to your questions.
[The prepared statement of Mr. Daloisio can be found on
page 44 of the appendix.]
Chairman Garrett. I thank you for your testimony.
Mr. Andrews, for 5 minutes.
STATEMENT OF STEPHEN G. ANDREWS, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, BANK OF ALAMEDA
Mr. Andrews. Mr. Chairman, Ranking Member Waters, my name
is Steve Andrews. I am pleased to appear before you today at
this important hearing covering the United States Covered Bond
Act of 2011.
I am a community banker. I guess I am sitting with a bunch
of capital market guys. We jealously guard our community bank
franchises, and we jealously guard our relationships with our
constituents.
Community banks are conservatively run. I am pleased to
present testimony today and raise a couple of concerns that I
have as a community banker about the possible development of a
covered bond market in the United States. And to cut to the
chase, I am going to speak to you today as a community banker,
a banker, not a capital market individual who is interested in
his investors.
I think, in my opinion, that we have a covered bond market
today, and that is called the Federal Home Loan Banking system.
That has been around for a long time. It is operated very, very
well. I am not sure or certain that we need to import from
Europe or from other places a system that differs when we have
a tool in place today. And I see that this new system would
largely benefit the largest banks.
By contrast, the Federal Home Loan Bank today is alive. It
is vibrant. It is doing its job. During this downturn when we
saw the financial crisis, they stepped up. As you all are
aware, they have the ability for the balance sheet to expand
and contract to provide the very liability that we are talking
about here today through advances.
They provide the liquidity. They stepped up for the
community banks and all the small banks during this crisis and
became a lender. The correspondent banks, the banks that you
will see these assets go to, they didn't. They stayed away from
the community banks.
The Federal Home Loan Bank, during the height of this
mortgage crisis, 2007, 2008, provided member institutions $250
billion in advances. When the credit markets were frozen, both
large and small banks were able to provide themselves through
the Federal Home Loan Bank. In sum, the Federal Home Loan Bank
manages mortgage collateral differently.
They take haircuts. They don't take collateral pools. They
know their customers. A community bank can go to the Federal
Home Loan Bank, customize in advance to fit their needs. It is
not a cookie-cutter, take a 10-year bond, take a 7-year bond.
They customize that. And for that, they are more flexible than
the covered bond market.
I am not here today to bash the big banks. The big banks
certainly have their place in the Federal Home Loan system, and
they also provide by their usage low-cost, cheap deposits,
which we all benefit from.
My understanding of the covered bond market is that it is a
recosted obligation. And we have heard that described before as
what remains on the balance sheet of the institutions. Covered
bonds provide funding to a bond issuer, and the issuer retains
a pool of assets related credit risks on its balance sheet.
Therefore, in contrast to the mortgage-backed securities where
secured assets are off the balance sheet, the issuer pool
assets remain on the balance sheet.
Interest on covered bonds are paid the investors from
issuers' general cash flows, while the pool of assets serve as
collateral on those products. If the assets become
nonperforming, typically what transpires is they are told to,
or they by contract will bring another replacement asset. The
issuer must always be overcollateralized. And so, they have an
overcollateralization going on. That is the covered bond
market.
Where the majority of these purchases have maturities that
are shorter--7, 10, 15 years--we have heard talk that they can
match and help our market. We have 30-year mortgages. I see,
unfortunately, the lion's share of the benefits of the covered
bond market going to the largest banks.
As I sit here today, the debate in Congress has been on
``too-big-to-fail.'' And now we are going to push all these
mortgages onto the balance sheets of the biggest banks, which
we already have systemic risk issues with. To me, that is
interesting.
In Europe, it is touted. I don't see that Europe doesn't
have problems. I have heard the acronyms of the PIGs. I have
heard issues over there. It is not an elixir or a magic bullet.
Those markets froze up just as ours did during that time.
The United States has over 7,000 banks--7,000 banks--while
Germany and other European countries have three, four, and
maybe a spattering of small banks. These are different models.
Our financial systems are slightly different. The latter
financial market was fewer, larger banks are more conducive to
this.
We have talked about the ability of smaller community
banks; they might be at a disadvantage because of pooling. If
you throw an intermediary into this process, we can't compete.
Big banks have deal flow. Small banks don't have deal flow.
They don't have a ton of loan mortgages hitting their balance
sheet every day. But they are the fabric of the communities,
which are your constituents. They need a process of which to
make these loans.
I think that there will be a competitive disadvantage to
the community banks on pricing by the pool, not to mention,
when you pool together, there is a little bit of a
consolidation that is going on. I think that we have a system
that works today with the Federal Home Loan Bank.
In addition, what I didn't hear from anyone here is, what
about the borrowers? What about our low- to moderate-income
borrowers? They are going to get frozen out. These products
typically require large downpayments and short maturities. I
think we need to address our borrowers as well.
In the FDIC, it does have concerns. If you read through
that process, they are concerned about resolving these large
banks when they go.
I see that my time is up on the red dot there. So I am
happy to address questions when they come available.
But in closing, I would like to say that, in summary, I
don't want to see a 30-year mortgage harmed. I think we have a
robust Federal Home Loan Bank handling the intermediary role
that it was designed to do by Congress.
I think that small banks need to be at the table. They need
to be able to play. They need to be able to get advances from
the Federal Home Loan Bank at a reasonable cost.
And I think we need to deal not just with the investors. We
need to deal with our borrowers. Our borrowers need to chase
the American dream.
In Europe, homeownership is about 50 percent. I want my
children, my grandchildren to have ownership. I want them to be
able to chase the American dream. A covered bond market has
very strict underwriting guidelines. And that is why you see
homeownership so small in European countries.
Thank you for your time.
[The prepared statement of Mr. Andrews can be found on page
36 of the appendix.]
Chairman Garrett. Thank you, Mr. Andrews.
And thank you to the entire panel.
Let us begin with questions. I will probably just go from
the left to the right and run down some points I would like to
make or ask about.
Maybe I will start off; the ranking member is not here
right now, but she raised some good points during her opening
statement. One of them, and I go to Mr. Stengel on this, raised
the concerns that the FDIC has raised, specifically regarding
the impact of covered bonds on the DIF. Do you want to just
chime in on that to respond to that concern?
Mr. Stengel. Sure. Thank you, Mr. Chairman. I grew up as a
bankruptcy lawyer, so if there is anyone who is empathetic to
the concerns of the FDIC, I would like to think that I am at
the top of the list.
Whether resolving any distressed organization, any failed
organization is very, very difficult. Our regulatory system is
balkanized. Unlike most other countries that have one or two
regulators focused on banks during their lives and in the
resolution, we have divided that up in the United States. And
so, we have an institution, the FDIC, that is focused solely on
resolution, similar on the--for banks.
And I think that creates an institutional bias that is
built in as a matter of statute for focused on concerns about
resolution. So I would divide their concerns into two buckets.
One would be a desire to control all aspects of a resolution,
to control anything that touches upon the resolution of a bank.
Again, the likely economic incentives for the FDIC--it is very
understandable that would be something that they would want.
They sought broader powers under Dodd-Frank, which they
got. They have sought to seek--to regulate securitization, for
example, secured borrowings, which they have sought to do and
to take similar actions. And so, I think on the covered bond
legislation that has been proposed, their desire to control the
resolution of the covered bond program levered them to allow
that to happen as part of the private market and under this
legislation, again, an understandable concern, one that, in my
mind, from the covered bond markets perspective, is misplaced
for a couple of reasons.
One, in the United States, we have incredibly debtor-
friendly laws, creditor-unfriendly laws compared to other
jurisdictions. And that has historically put us at a
disadvantage. And so, the FDIC has very broad powers. They are
vaguely defined. And the FDIC also has government-funded
litigation to back those up.
And so, that puts private investors at a disadvantage. And
investors in covered bonds have said, ``We are not comfortable
with the FDIC and the optionality that the FDIC has.''
Mr. Ely. Mr. Chairman, if I could just add to that? I have
been a student of FDIC finances for over 25 years. I have
looked closely at their numbers, particularly under the new
assessment scheme. Covered bonds will actually generate a
substantial profit, or, if you will, additional income for the
FDIC. For the DIF, that income will far exceed any additional
loss that the FDIC might suffer because of covered bonds.
Chairman Garrett. Okay. As long as you are speaking, let me
ask you another question. Mr. Andrews raised a couple of
interesting points, I thought. One point he raised was with
regard to the Federal Home Loan Bank and what have you. Can you
just, not rhetoric, but just sort of address that issue?
Mr. Ely. There will still be a role for the Federal Home
Loan Banks. In effect, covered bonds will be another form of
bank funding. The whole idea of covered bonds is to put another
channel of financing out there for depository institutions of
all sizes.
Some have speculated that the Federal Home Loan Banks might
be more competitive in the shorter maturities, whereas covered
bonds would be more appropriate for longer-term maturity debt.
But there is room for both, covered bonds and the Federal Home
Loan Bank system, going forward. And again, to emphasize, the
pooling provision in the legislation would enable commmunity
banks to access the covered bond market in the same way that
larger banks can, but through a pooling process.
Chairman Garrett. Yes, and I can go into this in a lot of
detail, and I would like to, but--Mr. Skeet, you are here as
well. Talk to us a little bit more. I would appreciate the
international flavor that you bring to this as far as what is
going on in Europe and what have you. But one of the aspects of
it is--I have heard some stories--the absence or lack of
absence, if that is a word, of the backing in Europe, vis a vis
that we are trying to do here. Can you touch upon that? Some
say that in Europe you had a covered bond market that was
successful to varying degrees, but because there was implicit
guarantee?
Mr. Skeet. Right.
Chairman Garrett. We are trying to say here--
Mr. Skeet. I hope--
Chairman Garrett. --in our legislation there is no
explicit, there is no implicit, there is no guarantee.
Mr. Skeet. And that is the right road to take. I think I
have been clear, and we have made clear in the statement that
we have submitted, that there are no guarantees. During the
height of the crisis, some of the national regulators did offer
guarantees. I think there was one case, in the case of Ireland,
and we know what happened in Ireland, where explicit guarantees
were given. That was the exception, not the rule.
Guarantees were not given. And the investors and the work
they have done do not factor in government support.
Chairman Garrett. So it is not priced--
Mr. Skeet. So there is no--
Chairman Garrett. --it is not priced into it?
Mr. Skeet. It is not, no. Look at the way that this market
has come back. It has come back phenomenally strongly, post-
crisis. And we have not had a default of any covered bond. We
have had banks go down, but we have not suffered any of the
consequences of that through the covered bond market.
Now, there are no implicit guarantees. What there is, and
we mustn't confuse the two things, there is explicit
legislation. And there is good supervision provided by arms of
the state. But that is not the same as any form of guarantees.
Nor do the investors factor that in.
That is the very important point that needs to be made. And
people fudge that. The fact that you have given a law to
provide a framework doesn't mean you have given State support.
Could I perhaps just take up another point that was being
raised here about the--
Chairman Garrett. Yes.
Mr. Skeet. --size of the issuers? Because in Europe, we do
have much smaller financial institutions that have been able to
tap into the covered bond market. For instance, in Norway, we
have a lot of very small regional savings banks that
collectively come together and have successfully issued in
various markets. This includes a transaction that came to the
United States market late last year.
And that actually proves that you can have, through the
covered bond instrument, the ability for the smaller
institutions to compete and get the same pricing terms as the
larger institutions. I think that is an important point to make
as well.
Chairman Garrett. I am curious as how that works as far as
replenishing the pool when you have that pooling. But my time
is up.
So, I yield now to the gentlelady from New York.
Mrs. Maloney. Thank you very much, Mr. Chairman.
And thank you to all the panelists.
I would like to ask anyone on the panel who would like to
discuss it, how covered bonds could facilitate housing finance,
which is the challenge in the country now.
Mr. Andrews. I would like to respond to that first, if I
may.
Mrs. Maloney. Yes.
Mr. Andrews. I think that it is a little bit of an issue.
Today, as I mentioned in my testimony, the American dream is
homeownership. It always has been. My father returned from
World War II. That was the dream: to own a home.
When I look to the European markets, I see 50 percent and
less of homeownership. I see all the loans with large
downpayments, strong credit underwriting to protect the
investor. And, as I mentioned earlier, this is also a housing
issue.
This is getting people in homes and having them stay in
homes. It is not just about an investor never losing a dime. We
have a big issue in front of us. And I think when you start to
require tremendously large downpayments, you have very strong
underwriting criteria, you freeze out a lot of the market. You
freeze out a lot of the American dream for your own
constituents. So I don't see that as favorable.
Mrs. Maloney. Yes.
Could the others comment on how it would affect the
financing of the housing market and also, the fear covered
bonds would produce?
Mr. Ely. If I could address that. First of all, covered
bonds, because they are so well secured and generally AAA
rated, would bring banks, including community banks, a
relatively low cost of funding, certainly comparable to what
they would be able to get from the Federal Home Loan Banks for
longer maturities.
Second of all, covered bonds can be issued for relatively
long maturities, which makes them highly desirable to enable
banks to hold on-balance-sheet 30-year, fixed-rate mortgages,
keeping in mind that most 30-year mortgages get paid off long
before 30 years have expired. So I see covered bonds as a way
to bring back onto bank balance sheets mortgages that banks now
feel compelled to sell because they can't fund them safely.
That becomes very powerful in terms of lenders keeping all
of their risk, and underwriting appropriately. That becomes a
very powerful positive of covered-bond funding.
Mrs. Maloney. So are you saying, Mr. Ely, that covered
bonds would not be sold in the secondary market?
Mr. Ely. Covered bonds certainly would be sold by
investors. That is one of the reasons to bring on a large
covered bond market, so that you develop liquidity so investors
could sell. But the key here is that the mortgages would stay
on a lender's balance sheet, the individual covered bond
issuer, and then once the bonds are in the market, they could
be bought and sold the same way any other type of debt
instrument can be.
Mrs. Maloney. Okay.
Mr. Stengel. If I could just supplement that with one
point, and it is probably fairly elemental, so my apologies for
sharing it with you in that way. No bank--and Mr. Andrews
probably knows this as well as anyone--will extend a loan
unless it knows where it is going to get the funding and the
liquidity.
And so, for every single loan that is made, a mortgage
loan, a credit card loan, a student loan, an auto loan, for
every loan, there has to be a place where the bank can turn the
other way and get funding. That can come from deposits.
It can come from securitization. It can come from the GSEs.
It can come from other sources. But ultimately what we are
doing with this legislation and what the Covered Bond Council
has supported is another tool in that toolbox for banks to turn
around and pull liquidity out of the capital markets and turn
around and make cost-effective loans to borrowers.
Mr. Skeet. Could I just add, though? We don't regard this
as the same means of financing mortgages in Europe. It is only
a part of what we do.
Mrs. Maloney. Could I also comment on the fact that the
bill goes into great detail in how the covered bonds are
treated when a bank fails, a large portion of the bill. And
since the current pool is held on the bank balance sheet, could
you talk about how the regulators would work to ensure that the
covered bonds are successful as possible? Could you speak on
the regulation of and how you see it? I think that is a big
part of the bill.
Mr. Stengel. I think a key portion of this legislation is
that covered bonds are issued by regulated financial
institutions, so concerns about safety and soundness in
issuance. No institution, under the proposed legislation, would
be allowed to issue covered bonds without regulatory approval.
So it would be a highly regulated product.
What makes covered bonds different than ordinary secured
debt is the limited risk of prepayment because the pool is
managed rather than having a fire sale foreclosure of a large
pool of loans. If you would go into the market with a billion
dollars worth of mortgage loans that the buyers knew had to be
sold within 90 days, you would get cents on the dollar. And
that is basic economics. And so, what this legislation does is
create a framework to manage that pool, continue making
scheduled payments on the bonds if the pool will support it and
maximize value and decrease losses.
Mr. Andrews. If I could retort, to a degree?
Mrs. Maloney. Yes.
Mr. Andrews. What happens there is that those banks will
not be holding those nonperforming assets on their balance
sheet. What they will actually be doing is when the loan
becomes nonperforming, they will pull that out of the pool.
They will substitute a good loan that meets the underwriting
criteria of the pool contract, and then they will fire sale
that nonperforming asset. So I respectfully disagree to that
point.
Mrs. Maloney. My time has expired. Thank you.
Chairman Garrett. Before I turn to the next questioner, who
will be Mr. Schweikert, I would, without objection, enter into
the record statements, just the statements with regard to this,
from the OCC and the FDIC and statements in support of the
legislation from the National Association of Realtors and the
National Multi Housing Council. Without objection, it is so
ordered.
Mrs. Maloney. Clarification--are the FDIC and the OCC
supporting it or objecting?
Chairman Garrett. I don't know. That is why I said the
first two are the statements.
Mrs. Maloney. Okay. Just the statements, but not taking a
position.
Chairman Garrett. They are couched in terms that they are
in support of it, but they might not appreciate that.
Mrs. Maloney. Okay.
Chairman Garrett. The gentleman from Arizona, Mr.
Schweikert, for 5 minutes.
Mr. Schweikert. Thank you, Mr. Chairman.
Mr. Stengel, just on the last point that was made, I
noticed you sort of bounced up in your chair. Can you share
what your thought was?
Mr. Stengel. Sure. I think Mr. Andrews was confusing what
happens during the life of a bank, what happens with any loan
on a bank's balance sheet and then what happens to the cover
pool if the bank were to go into insolvency. And so, certainly,
during the life of a covered bond program, nonperforming loans
are pulled out. They are kept on the bank's balance sheet so
they can be worked out.
One of the advantages is this is 100 percent ``skin in the
game'' for banks. But the resolution process that I was
discussing was talking about what happens if the issuer were to
enter into receivership. If that pool then, instead of being
liquidated, billions of dollars worth of loans liquidated at a
single moment, it instead managed and collections brought in
and its value maximized.
Mr. Schweikert. Okay. Mr. Chairman, Mr. Stengel, actually,
walk me through a mechanic like what we have suffered through
the last couple of years. My real estate market goes to hell in
a handbag. I have institutions in your community that are
participants. What happens to the unwind?
Mr. Stengel. I think what you will see in that process,
again, if an individual bank were to fail, so if banks aren't
failing, banks are working with their borrowers directly.
Again, you don't have loans that have been securitized. Banks
are working with their borrowers directly to manage those
defaults on the individual loans.
If a bank that had issued covered bonds were to fail, the
loans on its books in the normal receivership process, the bank
would be put into receivership. The FDIC has to do something
with that pool of loans on the bank's balance sheet. Normally,
those are going to be sold.
They are going to be sold to another institution. They are
going to be liquidated in the market. Again, they are pledged
as collateral for the benefit of bondholders. What this
legislation does differently is instead of having to force a
fire sale, a liquidation sale of those loans pledged as
collateral, instead they are managed so that there is value
realized, not only by the bondholders, but also the residual
ownership interest that is retained by receivership for the
benefit of other creditors.
Mr. Schweikert. All right.
Mr. Andrews. Can I respond as well and give you the
scenarios you are asking for?
Mr. Schweikert. Sure.
Mr. Andrews. Okay. So you have this credit-quality bond
covered pool. During that meltdown, collateral values plummet
across the Nation. Loans go bad. So what they do by contract in
that covered pool is they pull those bad loans out. They put in
their good ones.
When the receiver, the FDIC, comes in, they only have the
poor assets. The investor doesn't get stung. It is the Deposit
Insurance Fund that gets stung and all the players that play
into that Deposit Insurance Fund. And so, what you have heard
from the capital markets is the investors--
Mr. Schweikert. Help me with one thing, because didn't you,
a moment ago, walk me through that you would be doing that swap
and you would be liquidating the nonperforming assets?
Mr. Andrews. That is just what I said. So earlier when you
have a pool which is pristine and it starts to go bad because
the economy has tanked, that pool needs to be
overcollateralized and remain pristine. So they swap out the
nonperforming asset, and they put in a good one. Where does
that nonperforming asset go? It goes on the balance sheet of
the bank, and they start getting a pile upon pile of
nonperforming assets.
Mr. Schweikert. That means you are liquidating those
assets--
Mr. Andrews. Then they have to liquidate them. And they
fire sale them. Or if it is so great, like a WaMu situation,
the FDIC comes in and asks, ``What do we have here?'' Well, we
have a bunch of junk.
Mr. Schweikert. Mr. Chairman, and forgive me, but the other
alternative is even more devastating. If you are in that market
upheaval, at some point then, do you have the taxpayers step
in? Do you also, it also brings down the institution.
Mr. Andrews. The taxpayers step in. And there are potential
for those things. Who comes out a winner here is Wall Street
and the investor.
Mr. Schweikert. And, in many ways, forgive me for cutting
in, but you also have the taxpayers being the loser in that
scenario. And I know I am running out of time, but one
mechanic. Okay, let us say the loans have been bundled and
securitized. Walk me through the same scenario where--
Mr. Ely. If I could address that point, you can probably
see that the securitization market today is tremendously trying
to work out and modify mortgages. This is an issue before you
all the time because there are so many different players
involved in protecting their interests.
The thing with covered bonds is that the bank that made the
loan still has it. If the mortgagee is in trouble, it moves out
of the cover pool, but it still is on the bank's balance sheet.
That leaves the bank without any competing and conflicting
interests, who then has to modify the loan.
I disagree with Mr. Andrews that these problem loans would
lead to a fire sale. The bank is going to, like any other
problem loan it has on its books, try to work that out to
minimize its loss.
And I would suggest that in the current banking environment
where the bank still has 100 percent of the loan, it is going
to be a much easier and more straightforward process to resolve
that loan problem. That is not the case when mortgages are
securitized.
Mr. Schweikert. Thank you.
Mr. Chairman, I know I am out of time. But I would love
someone to address what happens when the bank doesn't still
retain 100 percent of the loan--and hopefully someone else on
the panel will ask that. There you go.
Mrs. Maloney. They are required to, aren't they?
Chairman Garrett. I will yield now to Mr. Campbell for 5
minutes.
Mr. Campbell. Thank you, Mr. Chairman.
And if you indulge me, I am going to go to covered bonds
kindergarten here. And I am going to use Mr. Andrews because
you are here. So prior to 2008, Mr. Andrews makes 30-year,
fixed-rate home loans. And he can either retain them in the old
model of the 1970s and so forth, or he sells them off and, to a
collateral pool, is what happened prior to that.
Okay, so now we have this covered bond alternative. So he
sells that loan and covered bond. The cover is the pool of the
loans, his and other banks, presumably. And, when I am wrong, I
will give you an opportunity to tell me I am wrong. But, all
right, then, if that is not the cover, what is the cover?
Mr. Ely. What is in the cover pool are the assets that are
securing the bonds. Those assets are loans that are on that
bank's balance sheet. There is not a pooling of the loans.
Mr. Campbell. Okay. The bank owns the loans, and it issues
covered bonds. Then he does that for his liquidity and so forth
out there? But the only thing covering that is the same loans
that would have covered it had it been sold into a CMBF in the
mortgage-backed securities market of some sort. Right? There is
no additional collateral?
Mr. Ely. May I offer a distinction?
Mr. Andrews. You could substitute loans if they go bad.
Mr. Campbell. Okay.
Mr. Andrews. So we could sit here on our balance sheet and
pull out this one and pull up that one. And that is exactly
what WaMu is doing.
Mr. Campbell. So why do you do that? Why would you go to a
covered bond? And then I will come back to you on that one. Why
would you go to a covered bond market if there were a mortgage-
backed securities market available?
Mr. Andrews. We personally wouldn't. We could hold 30-year
mortgages on our books today all day long. If we were worried
about interest rate risk, say, we are making loans today at 4
percent--
Mr. Campbell. Let us say you couldn't.
Mr. Andrews. --we would get an interest rate swap.
Mr. Campbell. Let us say you couldn't. Let us say you could
go on, either, you needed liquidity, so, on these things. So
you either went to mortgage-backed security or a covered bond
market?
Mr. Andrews. Or the Federal Home Loan Bank.
Mr. Campbell. Okay.
Mr. Skeet. Can I just interject? The U.K. banks, Mr.
Chairman, they look at both instruments. And they want to have
access to both instruments. This is not either/or. This is not
an exclusive. All we are talking about is an additional
instrument for which you have investors in the United States.
It is in addition to what you have already have.
And I think the U.K. banks in particular want access to the
old ABS market. They think it is a good market. However, they
use covered bonds because it is actually cheaper. This is a
better, cost-effective, longer-term source of funding for them.
And it is important liquidity. Lack of liquidity had been
killing our banks.
Mr. Campbell. Okay.
Mr. Skeet. This is a good way to get term liquidity back.
Mr. Campbell. Mr. Daloisio?
Mr. Daloisio. Congressman Campbell, thank you. The
distinction I would like to offer for the subcommittee, between
what Mr. Andrews offers, which is a hypothetical, and what we
have experienced, is this. The assertion is that the economy
goes bad, and as a result, the loans go bad. That is really not
the cause-effect relationship that we just experienced in the
prior crisis.
The cause-effect relationship we experienced in the prior
crisis was the underwriting went bad, the loans went bad, and
the economy went bad. The underwriting went bad because there
was an ability to transfer risk without a proper disciplined
market mechanism for the supervision of that risk for a number
of reasons we don't need to get into.
If banks had the incentive to ensure that the risk that was
being retained in the whole loans that they have on their
balance sheet was no different than any other risk that they
are managing in those mortgage loans, there could not be that
cause-effect relationship. So we would have had--if we had a
covered bond paradigm, it is my opinion that we may very well
have created the situation where the underwriting discipline
was reinforced because the banks continued to own that risk
and, therefore, the loans did not go delinquent, and therefore,
the economy did not go south.
Mr. Campbell. Okay. Let me ask this, then. My concern,
going forward, is that, and to Mr. Andrews' point, we will have
69 percent homeownership, probably 65 or 66, whatever we are
now. And the banks get excited about certain segments of the
loan market for a while, and they will lend to anybody. And
then they pull back. They do that in home loans. They do it in
car loans. They do that in commercial loans. They do in all
kinds of segments.
And we can't let the entire home market be subject to the
fact that you are right about the concentration of banking now.
That large banks, it is true we don't like home loans for the
next 3 months, so we pull back and tank the whole economy along
with it because people can't sell homes and the liquidity, etc.
I am not sure I see where this solves that problem, where
this creates any--it provides a new option. But I am not sure
it provides a lot of stability when the banking sector decides
to pull back from a particular market.
Mr. Daloisio. If I could just add, I am not sure why a bank
would pull back from a market.
Mr. Andrews. They do it all the time. Because their
delinquencies go up. And they decide this is a bad place to be
and then the bank down the street sees that they have pulled
out and they do it all the time.
Mr. Stengel. I guess I would propose that the banks are
pulling back--to be said that they are pulling back in home
loans today, that is because they don't have liquidity on the
back end to fund the new loans that are been made. The Basel
III proposals are requiring banks to hold an enormous amount of
liquid assets on their balance sheet.
There are many factors at play right now that are going
into reduced lending. And I think one of those factors is a
lack of liquidity, a lack of funding for banks where they feel
comfortable they have long-term funding and they can turn
around and make a long-term loan. The last thing we want is
banks making bigger loans based on 90-day short-term funding.
That is the volatility we ran into in the crisis.
Mr. Campbell. My time has expired. But trust me, they will
go completely out of an entire segment, large--
Mr. Skeet. If they don't have the money, they can't--
Mr. Campbell. --completely out of an entire segment of the
economy for a while.
Chairman Garrett. If the gentleman is ready, I will yield
to Mr. Carson.
Mr. Carson. Thank you, Mr. Chairman.
This question is for Mr. Tim Skeet on behalf of the
International Capital Market Association. Much has been made of
the performance of European covered bond markets during the
initial stages of the global financial crisis of 2008 to 2009.
How much of that success can be attributed to the fact that in
most cases, those administering the European covered bond pools
were prohibited from buying U.S. ministered assets, which
really act as the original source of financial contagion?
Mr. Skeet. Obviously, we did suffer in Europe from European
institutions buying U.S. products. If you take a look at
certain parts of the European market, I think it was clear that
many European investors bought products that they simply didn't
understand, and where they hadn't done due diligence correctly.
We do have an opportunity here with this new product, the
covered bonds from the United States, whereby investors who are
doing a lot more of their homework would be able once again to
buy American assets, but feel happy about it and feel safe
about it. So I think we have European investors who want to buy
U.S. mortgage-backed products, even though if it is ABS, they
probably would be unhappy, they will look at this when it is
created. I don't know whether that answers your question, but--
Mr. Carson. I yield back.
Chairman Garrett. To the gentleman from New York, Mr.
Grimm. Thank you.
Mr. Grimm. Thank you, Mr. Chairman.
I guess for me, the heart of the debate lies with the
disparity somewhat between the facts, as Mr. Andrews states
them in the passion--and I appreciate that, and, again, it is
four to one. So I am been there myself many times.
All right.
Mr. Andrews, why do you see that the community banks will
not have access and be squeezed out? And we are hearing that
the pools will be available. I am not so sure. I think on that
one part, I probably tend to lean towards your concern that
something tells me that--
Mr. Andrews. You should.
Mr. Grimm. --the intentions are going to be great that
community banks will have complete access, but when the rubber
meets the road, they might not. So if you can expound on that
for a second.
Mr. Andrews. Okay, certainly. Community banks have access
right now to the Federal Home Loan Bank for this very purpose.
They are an aggregator of sorts for us to have liquidity, to
make these loans and transactions. What I foresee in the
covered bond market as it develops, it will all migrate to the
big deal flows, the big four banks.
I think what we have today is we have a huge hangover from
systemic risk and ``too-big-to-fail.'' And what we are doing is
we are pushing this train of Freddie and Fannie and all these
players, all the volume they had, those trillions of dollars we
are talking about, right onto the balance sheets of the largest
banks. They are going to out-price the little guys, and they
won't be able to compete. And that, to me, is a bunch of
issues.
Mr. Grimm. But this would not replace the Federal Home Loan
Bank. That would still exist. That option would still be there
for the community banks, but not--
Mr. Andrews. I am not saying it would replace it, as long
as Congress continues to charter it. But there will be an issue
in a sense that the big banks will back away. They will back
away from using the Federal Home Loan Bank because now they
have their own conduits. And believe me, they provide revenue
sources to the Federal Home Loan Bank. And that will increase
the advanced pricing that we enjoy as a community bank.
And we don't have the same ability to access capital
markets, being a small player, either for liquidity or for
capital.
Mr. Grimm. If I may, I will let Mr. Ely respond to that, as
far as the Federal--Mr. Andrews' legitimate concern with the
Federal Home Loan Bank and the bigger players no longer being
involved because they are all on the covered bond market.
Mr. Ely. There may be some pull-back but it is interesting
that in the White Paper that the Administration presented on
GSE reform, they proposed putting limits on the ability of the
Federal Home Loan Banks to lend large amounts of money to large
institutions.
But even so, first of all, the Federal Home Loan Bank
balance sheets have shrunk a lot as advances have been paid
down. Federal Home Loan Bank operations and their wholesale
business, the way it is going, they will be able to continue to
operate very efficiently and serve the smaller community banks
very efficiently because their operating expenses are so low as
it is. So I don't think that you would see a situation where
the cost of Federal Home Loan Bank advances to community banks
would rise in a meaningful way.
But again, it is important to stress the pooling provision
in the covered bond bill and the experience in Europe. In fact,
smaller depository institutions, smaller lenders can, in fact,
participate in the covered bond market. Thank you.
Mr. Skeet. Yes, if I could just reinforce that. We do have
smaller banks use this market. This market is not simply for
very, very large, jumbo-type transactions. Increasingly, the
market is flexible. They are much smaller sized transactions
being brought to the covered bond market in Europe by much
smaller financial institutions.
Mr. Grimm. Time is running out. If I could, Mr. Stengel,
why is the FDIC opposed to creating a covered bond regulatory
framework? Because I still don't know why they are opposed to
it. If you could explain.
Mr. Stengel. Sure. I really do think it is an institutional
bias. If I were the Chairman of the FDIC sitting before you
now, I would be concerned about wanting to control all aspects
of a resolution of a bank. So I wouldn't like securitization. I
wouldn't like Federal Home Loan Bank lending and their priority
status. I wouldn't like any repo funding. And I wouldn't like
any secured credit at all.
And I think it is largely driven by an institutional bias
with a focus on the risk to the Deposit Insurance Fund. And
again, that is natural. It is understandable. But I think,
again, it is my--
Mr. Grimm. Is it legitimate?
Mr. Stengel. It is myopic. It fails to recognize that what
we need is long-term, stable liquidity for banks so they don't
end up in the FDIC's lap in the first place.
Mr. Ely. If I could add to that, I think the FDIC is not
making a proper evaluation of the risk covered bonds pose to
the Deposit Insurance Fund, particularly in light of the Dodd-
Frank change in the FDIC assessment base, which is going to
bring an enormous amount of revenue into the Deposit Insurance
Fund from assets that are funded by covered bonds.
Mr. Campbell. Mr. Chairman, since the FDIC is not here, you
might want to read the first two sentences of their conclusion
that clarifies where they are.
Chairman Garrett. I will yield 15 seconds to the gentleman
from California to do that. In the completion of that, I will
yield, without objection, an additional 15 seconds to the co-
sponsor of the legislation to follow-up on the question that
the gentleman from New York raised with regard to the pooling
issue.
Mr. Campbell. ``The FDIC supports a vibrant covered bond
market that would increase liquidity of financial institutions
and enables sustainable and robust asset organization. However,
any legislation should avoid promoting development of a covered
bond market that provides bipolar risk to covered bond
investors and give rights to investors that are superior to
that of any other secured''--I just thought that their position
should be put in their words.
Chairman Garrett. Mr. Grimm, any--
Mr. Grimm. I yield back.
Chairman Garrett. Okay.
The gentlelady from New York?
Mrs. Maloney. Thank you, Mr. Chairman.
I would like to ask Mr. Andrews, certainly, the purpose we
have is to provide liquidity for those Americans, community
banks and banks. And I would like you to respond to the
statement made by many that the pooling aspect of the bill
would allow community banks to be--in response to Mr. Ely's
question on Home Loan Banks--on what they could do.
And what are the limits on this, in terms of how large
these covered pools can be? Are there any limits upon it? But
Mr. Ely's--pooling aspect--why is that such a--community banks
be part of this new--
Mr. Andrews. When you talk about capital markets, capital
markets are interested in big players with big deal flow. For
instance, today a small community bank could go out and access
the capital markets to a degree to bring in capital. And it
couldn't go out and access to bring in debt as well. And that
is what we are really talking about here, is bringing in more
debt financing in lieu of deposits funding the same way that
Wall Street did.
And so, I think it is a little bit academic in the sense
you are saying, you can all--you good little banks can get
together and pool and do this. Maybe that can happen, maybe it
won't. But I think practically what is going to happen is all
this business will end up on the books of the large banks. And
they will price out the little guys. You see that in every
industry.
Community banks do have access to liquidity through the
Federal Home Loan Bank. But it is difficult for them to tap
capital markets because they are not significant enough in
size. And the argument being made here is, we will let all
these little guys pool together, and once they pool together,
they can price as competitively as we do. And I say, no, that
is not going to be the case.
Mr. Stengel. Could I offer just very quickly? I would
just--2 seconds on the Federal Home Loan Banks. The distinction
between the Federal Home Loan Bank funding and covered bonds
really falls into two categories. One is the breadth of the
asset classes. U.S. covered bonds can fund a much broader range
of asset classes. They can also fund a maturities with the
Federal Home Loan Banks offer--don't offer.
And if I can remind the members, and this shouldn't be
lost, the Federal Home Loan Banks are GSEs with an implicit
Federal subsidy. We have every implicit subsidy that Fannie Mae
has and Freddie Mac has. So, of course, they can provide more
economical pricing for the community banks. And that is not
necessarily bad. But let us not forget that the Federal Home
Loan Banks are not GSEs.
And if I could--
Chairman Garrett. Let me try to get back to regular order
here. We can do another round, I guess.
To the gentleman from New Mexico, Mr. Pearce?
Mr. Pearce. Thank you, Mr. Chairman.
Mr. Andrews, Mr. Ely points out that loans on the books was
one of the problems. In other words, the issuing institutions
really didn't have much stake in seeing that the loan
performed. Is that something that you see as a problem, or is
that something you don't object to, keeping a loan somewhat on
your books?
Mr. Andrews. Community banks do carry mortgage loans on
their books. And if they get concerned about interest rate
risk, they can always do an interest rate risk swap.
Mr. Pearce. So it is not a concern?
Mr. Andrews. Or they can use Federal Home Loan Bank to--no,
it is not a concern, other than having the additional capital.
Mr. Pearce. Right. Okay.
Mr. Andrews. And so, it is easier for banks to sell it and
get a fee than provide more capital.
Mr. Pearce. Yes. Right. I just wanted to clarify that.
And, Mr. Stengel, you mentioned that we really didn't have
anything to worry about, that the market would come from--on
the covered bonds would come from--or be issued by regulated
institutions, highly-regulated institutions. Didn't all the
collateralized debt obligations in the MBS--didn't those
originate in highly-regulated institutions? Just yes or no.
Mr. Stengel. No, sir. I would say most of them--
Mr. Pearce. They did not?
Mr. Stengel. --originated with institutions that are not
necessarily as highly regulated as insured depository
institutions.
Mr. Pearce. Okay. All right. I find that curious.
Mr. Daloisio, that is kind of hard to say with a West Texas
accent.
[laughter]
You said that in the process of the transferred risk the
underwriting went bad, and then the economy went bad. Now,
somewhere in there, the underwriting, the market just assumed
the underwriters were not even going to look, that the truth
was we had an entire bonds issued with no performing loans
anywhere in them. That is the reason that four or five
institutions made a bunch of money selling short.
And so, it appears that it is far more complex than just
the transfer of risk, the underwriting went bad, and the
economy went bad. It looked like an organized, a disorganized
structure that simply never checked itself, that bad loans were
made with never the potential of paying back. In 2 years, you
are going to sell that house, and you don't really have to make
any initial payments, no principal, no interest.
And so, to say that simply a transfer of risk was, or the
originating thing, I would include as a hunger in the market
for these instruments that allowed tremendous profits to be
made as long as the game was going up. And then when the game
went the other way, we tagged the taxpayer with the downside.
And so, you stand by your statement that it was simple process,
transfer of risk, underwriting went bad, the economy went bad?
Mr. Daloisio. I do believe it is that simple because I do
think the incentives to relax the underwriting standards were
enabled by the ability to more readily transfer the risk into a
capital market system, which started to operate on, more so on
the basis of what seemed to be an ever-increasing rise in home
prices and an ever-lengthening favorable past historical
experience.
Mr. Pearce. Okay. I will accept that.
Mr. Stengel, you have mentioned that there is no liquidity,
that the lack of liquidity, the lack of funding. And I find
just the opposite. I find the local community bankers tell me
that they have quite a bit of money to lend.
Because, number one, if they make one bad loan, they stand
to lose their entire institution. And, number two, now the
compliance reviews are more rigorous than the safety and
soundness reviews and that things that used to be simple
exceptions are now written up as $50,000 fines. And they are
saying, why in the world would we do a home loan when one small
thing on a flood insurance program, which, one, collected flood
insurance--we started 3,000 feet above sea level and we go
higher than that.
And so, down on the coast--and yet, one bad statement in
there is a $50,000 fine. They are saying, why should we, why
should we bear the risk. What do you base your statement on
that small banks have no liquidity?
Mr. Stengel. On your comments about the regulatory exams,
that may well be the case. And so, I think your concerns may
well be founded and, certainly, worth investigating. On the
question about liquidity, the liquidity that exists today are
all deposits where people have put into banks because they are
afraid of investing their money elsewhere because the economic
recovery has been fragile.
And I think what you are going to see is when the economy
turns, the deposits are going to get yanked out as people look
for better yields. So today, I think there is probably plenty
of liquidity. I suspect the banks have deposits they don't want
because they can't make any money with them and that when the
economy turns, we are going to need these tools, we are going
to need securitization. And we are going to need all of those
tools to keep our economy growing.
Mr. Pearce. And do you think the policy of paying interest
on these areas is maybe contributing, in other words, just the
banks can borrow at, more or less and get 2 percent, is that
maybe contributing also, you have more risk guarantees?
Mr. Stengel. I would be reticent to comment about--
Mr. Pearce. Okay.
Mr. Grimm. Can we just thank Mr. Pearce for those in the
coastal regions with the Fed problems? We do appreciate that.
[laughter]
Chairman Garrett. Thank you.
Mr. Stivers for 5 minutes, please.
Mr. Stivers. Thank you, Mr. Chairman. And I want to kind of
go a little backward and back to the beginning of why we are
here. We are here because the GSEs, thankfully, helped fuel the
crisis that we are in. And now a lot of folks in Washington are
saying, gee, should we have an implicit government guarantee
through the GSEs, should we look for a different model? So one
of the reasons that we are here is because covered bonds are a
different model.
And I know Mr. Skeet talked earlier and said that you don't
think covered bonds are the only solution. What kind of
capacity could the covered, could a buyer-covered bond market
create? Would it create enough of a capacity to replace what
the GSEs are doing today? And we can start with Mr. Skeet.
If anybody else wants to comment--
Mr. Skeet. Just very briefly, no, we don't think it will
replace the GSEs. It is an additional tool. It is a logical
tool. It is a tool that makes sense.
Remember that, again, you asked earlier about limits,
whether or not you can issue. The U.K. guidance is about 20
percent of total assets. You can do a quick calculation. That
is the upper limit that the regulator in the United Kingdom
feels comfortable with the bank issuing. Beyond that, they will
stop you or up the amount of capital you need to hold.
You do the calculation. That is a good capacity. You can do
a lot of term funding. But remember, the Net Stable Funding
Ratio is an important ratio for all financial institutions here
on after because regulators care about, not just deposits and
the amount of deposits, but do you have 5- and 10- and 15- and
20-year money out there. That is part of keeping banks safe and
sound for the future.
Mr. Ely. If I could just add to that, Mr. Stivers. The U.S.
residential mortgage market for owner-occupied housing is now
$10 trillion outstanding. A covered bond market would develop
because investors would get used to it, what you put out there.
It is conceivable that the covered bond market might grow to 5
or 10 percent of that.
Then let us say you owe $500 billion or $1 trillion of
paper. That is still small, even in the European market. But it
would be a very significant market, a highly liquid market and
covered bonds become an important, not the sole source, but an
important source of funding for home mortgages, particularly as
Fannie and Freddie shrink and more specifically, as their
balance sheets shrink.
Mr. Stivers. Thank you. I think you pretty much agree. And
I know it is an important tool. But we all need to understand
we have a lot more work to do. And maybe Mr. Skeet is right and
it is 20 percent. So it is $2 trillion. But it is not going to
fix it completely. But it is a good tool, I think.
I do have a question about the overcollateralization. So
essentially, the 20 percent rule is basically how they, how the
European market manages that. You have 100 percent of loans to
cover the 20, whatever, 100 percent of the loans you haven't
securitized to cover the 20 percent of loans you allowed to
issue covered bonds against. Is that essentially correct?
Mr. Skeet. It is getting quite complicated because of the
way this Net Stable Funding Ratio has been introduced. Because
if you look at that, the overcollateralization portion of a
covered bond has to be 100 percent funded from the senior
unsecured market, whereas the mortgages themselves outside the
pool have to be funded 65 percent. So there are various
calculations that need to be done.
The world will become a lot more complicated in the future.
But, of course, I think it will become a safer and more stable
place if we are allowed to do that.
By the way, the FSA is a little bit vague about how it
monitors the collateralization levels. It is specifically the
U.K. that has done the most work on this. What they are
monitoring on an ongoing basis is the overall level of the
collateral that is in the pools against the covered bonds. If
it gets beyond a certain level, they get uncomfortable and they
will increase the capital charge for those banks.
So it is not a file and forget. This is constant
monitoring. It is proper supervision.
Mr. Stivers. Great. Mr. Andrews brings up some good points.
And Mr. Skeet talked about, I think you talked about in Norway,
how some smaller banks have come together. But I believe you
said they came together under a larger bank who, it was on the
larger bank's balance sheet.
Mr. Skeet. They created a third-party bank, if you like,
which specifically took the--
Mr. Stivers. Okay.
Mr. Skeet. --assets from there.
Mr. Stivers. As a conduit.
Mr. Skeet. It was a properly constituted bank. But it was
set up for the sole purposes of taking in the assets of these
lesser institutions.
Mr. Stivers. --finance.
Mr. Skeet. --of the financing and then issuing. And they
issued in the United States market, interestingly enough.
Mr. Stivers. Great. That was the only other question I had.
Thank you. I yield back the balance of my time, Mr.
Chairman.
Chairman Garrett. And I thank you for your questions, sir.
If the panel is still ready, we are going to--we have just
noticed that we are going to have votes called. We have many
members who have not had an opportunity to ask questions, so if
you are ready, we are going to switch into lightning round
here. Each member will be allowed 1 minute of questions and
quick answers. And then by that time or during that time, we
may actually be called to votes. But I will say thank you to
the panel right now.
So just very quickly on a couple of points, I entered into
the record earlier today the FDIC's comments and statements
with regard to this. They propose significant changes. And I
guess the question on that is if they were to be adopted, what
would happen with regard to the investor interests of
purchasing these?
Mr. Stengel. There would be no market.
Mr. Skeet. I agree with that. There would be no market.
Chairman Garrett. Okay. You can say a little more than
that.
[laughter]
Mr. Skeet. Let me just say that investors need certainty.
What the FDIC proposed does not give certainty. In Europe, as
in the United States, I believe that many of the investors will
be highly concerned about the nature of the instrument and
their rights thereunder.
Chairman Garrett. Okay, 26 seconds. There we go. So in the
pooling arrangement in the European model where you have--the
last question just came. What is the responsibility there for
the member banks to that created bank? Do they have an
obligation, as Mr. Andrews properly raised, to go back to those
member banks and to say, you have to repool, take out--
Mr. Skeet. Yes, they do. And they have to put capital in
and contribute capital as--
Chairman Garrett. That central bank, I will call it, if
that bank fails, can you, do you still have the liability back
to those individual banks?
Mr. Skeet. Yes, you will do.
Chairman Garrett. Okay, thank you very much.
Mr. Carson. Thank you, Mr. Chairman.
This question is for Mr. Daloisio. Some have suggested that
the covered bond market should replace the mortgage-backed
securitization model for financing home loans. If this were to
happen, sir, would you recommend the GSEs like Fannie and
Freddie?
Mr. Daloisio. In my professional opinion and as a citizen
of this country, I think I would prefer to see governmental
resources be used to stimulate markets that don't exist as
opposed to markets that could be operated properly by the
private sector, which have existed for quite some time,
particularly alternative energy I would use as an example. I
think that would be a far more efficient use of the public
resources. I think the public sector system for financing
mortgages is fully replaceable by the private sector.
Mr. Carson. I yield back.
Chairman Garrett. Mr. Schweikert for 1 minute, please.
Mr. Schweikert. Thank you, Mr. Chairman. Back to where I
was trying to tap before, what happens, is there a model, in
your mind, of the institution, let us say, our community bank,
not retaining all the liability or not retaining mortgage or
pumping them up into a securitization market? Tell me your
vision on that flow working.
Mr. Ely. That is the model for many community banks. They
sell their 30-year, fixed-rate mortgages to Fannie or Freddie
or, if they are jumbos, they try to securitize those jumbos.
The key thing about covered bonds is that a mortgage doesn't
get sold. The lender keeps it. So instead of moving the
mortgage to the source of funds, you are bringing the funds to
the lender and leaving the loan and the covered bond funding on
the lender's balance sheet.
Mr. Schweikert. Mr. Chairman, I am probably almost out of
time. Any method you see within there to provide that enhanced
liquidity of having a securitization participation, such a
thing? Or is it, do they just need to stay completely separate?
These are different ways of funding mortgages. So if there has
ever been sort of a model or a discussion of a sort of a
bifurcation.
Mr. Ely. I am not aware of it.
Mr. Schweikert. Okay.
Thank you, Mr. Chairman.
Chairman Garrett. The gentlelady from New York.
Mrs. Maloney. Given this covered bond, in Europe, how did
they perform during the financial crisis and the credit crunch
in 2007, and 2008 when bank balance sheets were under pressure?
And I do know that we have had previous hearings on it, but
they did not perform well in the United States during the
crisis. Any comments of why it didn't perform in the United
States and how it performed in--so we can get a sense of--
Mr. Skeet. Very, very briefly, Mr. Chairman, in the paper
that I submitted prior to this hearing, we set out how we
learned a lot about what happened. And there are some
statistics in there. Every single asset class, including, as we
now know, sovereign assets, were hit by the crisis, that the
most recent problems have been sovereign-related and not any
specific instrument.
Covered bonds probably were the least affected. Yes, they
were effective. Yes, there was illiquidity. All of that is
correct. It came out the fastest from this particular crisis.
That is the important aspect. We have done very well in
Europe, but we are not complacent. And that is why, precisely
why, we are tightening up the rules, the transparency and the
legislation, even though it is several hundred years old.
Chairman Garrett. Thank you.
Mr. Campbell, for 1 minute.
Mr. Campbell. One of the causes of the financial collapse
is a lot of people made a lot of money and transferred the risk
onto other places, which ended up being the taxpayer. The FDIC
is concerned that we are doing that here again with covered
bonds.
And Mr. Andrews' scenario where there is this pool, and as
things get bad, they get pulled into the bank, replaced with
good loans, and then the bank finally has all the bad loans and
goes down, the FDIC has to step in. But the covered bondholders
are fine because they have all the good loans, and the bank has
all the bad loans. Why is that not a concern?
Mr. Stengel. I would just make two points. The first is
when you talk about the DIF, let us remember who funds it. The
taxpayers who fund it are the banks. The top 10 banks from 43
percent; the next 100, 39 percent.
Mr. Campbell. I get that. But the scenario I just described
can occur.
Mr. Stengel. It can. And the banks are paying insurance
premiums right now to cover it for post, the after-crisis and
before. So the banks are self-insuring against that risk.
Mr. Ely. Mr. Campbell, I have done some financial modeling
on this in terms of what the risk is to the FDIC. I would be
glad to submit that analysis for the record. But basically, the
additional loss that the FDIC would experience as the deposit
insurer would really be quite modest, especially related to the
premium income on covered bonds as of April 1st.
Chairman Garrett. Thank you.
Mr. Pearce, for the last word?
Mr. Pearce. I would like to wrap up with Mr. Ely.
Mr. Skeet, I don't mean to overlook you and ignore you, but
I represent New Mexico, which has a lot of Hispanic
descendants. And that whole thing with the Spanish Armada still
hasn't quite settled out yet.
[laughter]
Mr. Skeet. The Armada--I think we won that battle.
Mr. Pearce. Okay. We will look for it.
Mr. Skeet. That is done and gone.
Mr. Pearce. Mr. Ely, Mr. Andrews expressed that all the
money is going to migrate to the big deals. And I worry about
that, too, that the further away the institutions get from New
Mexico, the rates of return on their investments in New Mexico
look microscopic. We don't have high-priced properties. And we
don't have high-priced anything. So can you give the assurance
to Mr. Andrews and myself that won't happen?
Mr. Ely. Yes, I will certainly try.
Mr. Pearce. Instead of--
Mr. Ely. The key thing is that community banks can
participate in the covered-bond marketplace. And they will be
able to do so. As Mr. Skeet has indicated, there is history in
Europe to that effect. I see no reason why that wouldn't be the
case in this country.
In many ways, I think covered bonds will actually
strengthen community banking because community banks will be
better positioned than they are today to not just make these
mortgages, but to keep them and maintain the customer
relationship and not just sell the mortgage, but as they also
do many times they sell the servicing rights. So there is a
complete detachment of the customer, the borrower, if you will,
from the bank.
What covered bond funding will do is allow for the
preservation of that customer relationship. And I would argue
that one of the benefits of covered bonds will be to actually
strengthen community banking in this country by enabling banks
to hang onto loans rather than feel compelled to sell them
because it is not necessarily a piece of cake today to go out
and assume interest rate risk on a 30-year, fixed-rate
mortgage, which is why most community banks sell off all their
30-years.
Mr. Pearce. Mr. Andrews, do you want to wrap up? I am out
of time. Thanks.
Chairman Garrett. I thank you.
And I thank all the members of the panel. I very much
appreciate all of you coming here today and your testimony and
your views.
Without objection--and it doesn't look like there will be
any objection--the hearing record will remain open for 30 days
for members to submit questions to these witnesses and to place
their responses into the record. And with that, this hearing is
adjourned. Thank you very much.
[Whereupon, at 11:41 a.m., the hearing was adjourned.]
A P P E N D I X
March 11, 2011
[GRAPHIC] [TIFF OMITTED] T5675.001
[GRAPHIC] [TIFF OMITTED] T5675.002
[GRAPHIC] [TIFF OMITTED] T5675.003
[GRAPHIC] [TIFF OMITTED] T5675.004
[GRAPHIC] [TIFF OMITTED] T5675.005
[GRAPHIC] [TIFF OMITTED] T5675.006
[GRAPHIC] [TIFF OMITTED] T5675.007
[GRAPHIC] [TIFF OMITTED] T5675.008
[GRAPHIC] [TIFF OMITTED] T5675.009
[GRAPHIC] [TIFF OMITTED] T5675.010
[GRAPHIC] [TIFF OMITTED] T5675.011
[GRAPHIC] [TIFF OMITTED] T5675.012
[GRAPHIC] [TIFF OMITTED] T5675.013
[GRAPHIC] [TIFF OMITTED] T5675.014
[GRAPHIC] [TIFF OMITTED] T5675.015
[GRAPHIC] [TIFF OMITTED] T5675.016
[GRAPHIC] [TIFF OMITTED] T5675.017
[GRAPHIC] [TIFF OMITTED] T5675.018
[GRAPHIC] [TIFF OMITTED] T5675.019
[GRAPHIC] [TIFF OMITTED] T5675.020
[GRAPHIC] [TIFF OMITTED] T5675.021
[GRAPHIC] [TIFF OMITTED] T5675.022
[GRAPHIC] [TIFF OMITTED] T5675.023
[GRAPHIC] [TIFF OMITTED] T5675.024
[GRAPHIC] [TIFF OMITTED] T5675.025
[GRAPHIC] [TIFF OMITTED] T5675.026
[GRAPHIC] [TIFF OMITTED] T5675.027
[GRAPHIC] [TIFF OMITTED] T5675.028
[GRAPHIC] [TIFF OMITTED] T5675.029
[GRAPHIC] [TIFF OMITTED] T5675.030
[GRAPHIC] [TIFF OMITTED] T5675.031
[GRAPHIC] [TIFF OMITTED] T5675.032
[GRAPHIC] [TIFF OMITTED] T5675.033
[GRAPHIC] [TIFF OMITTED] T5675.034
[GRAPHIC] [TIFF OMITTED] T5675.035
[GRAPHIC] [TIFF OMITTED] T5675.036
[GRAPHIC] [TIFF OMITTED] T5675.037
[GRAPHIC] [TIFF OMITTED] T5675.038
[GRAPHIC] [TIFF OMITTED] T5675.039
[GRAPHIC] [TIFF OMITTED] T5675.040
[GRAPHIC] [TIFF OMITTED] T5675.041
[GRAPHIC] [TIFF OMITTED] T5675.042
[GRAPHIC] [TIFF OMITTED] T5675.043
[GRAPHIC] [TIFF OMITTED] T5675.044
[GRAPHIC] [TIFF OMITTED] T5675.045
[GRAPHIC] [TIFF OMITTED] T5675.046
[GRAPHIC] [TIFF OMITTED] T5675.047
[GRAPHIC] [TIFF OMITTED] T5675.048
[GRAPHIC] [TIFF OMITTED] T5675.049
[GRAPHIC] [TIFF OMITTED] T5675.050
[GRAPHIC] [TIFF OMITTED] T5675.051
[GRAPHIC] [TIFF OMITTED] T5675.052
[GRAPHIC] [TIFF OMITTED] T5675.053
[GRAPHIC] [TIFF OMITTED] T5675.054
[GRAPHIC] [TIFF OMITTED] T5675.055
[GRAPHIC] [TIFF OMITTED] T5675.056
[GRAPHIC] [TIFF OMITTED] T5675.057
[GRAPHIC] [TIFF OMITTED] T5675.058
[GRAPHIC] [TIFF OMITTED] T5675.059
[GRAPHIC] [TIFF OMITTED] T5675.060
[GRAPHIC] [TIFF OMITTED] T5675.061
[GRAPHIC] [TIFF OMITTED] T5675.062
[GRAPHIC] [TIFF OMITTED] T5675.063
[GRAPHIC] [TIFF OMITTED] T5675.064
[GRAPHIC] [TIFF OMITTED] T5675.065
[GRAPHIC] [TIFF OMITTED] T5675.066
[GRAPHIC] [TIFF OMITTED] T5675.067
[GRAPHIC] [TIFF OMITTED] T5675.068
[GRAPHIC] [TIFF OMITTED] T5675.069
[GRAPHIC] [TIFF OMITTED] T5675.070
[GRAPHIC] [TIFF OMITTED] T5675.071
[GRAPHIC] [TIFF OMITTED] T5675.072
[GRAPHIC] [TIFF OMITTED] T5675.073
[GRAPHIC] [TIFF OMITTED] T5675.074
[GRAPHIC] [TIFF OMITTED] T5675.075
[GRAPHIC] [TIFF OMITTED] T5675.076
[GRAPHIC] [TIFF OMITTED] T5675.077
[GRAPHIC] [TIFF OMITTED] T5675.078
[GRAPHIC] [TIFF OMITTED] T5675.079
[GRAPHIC] [TIFF OMITTED] T5675.080
[GRAPHIC] [TIFF OMITTED] T5675.081
[GRAPHIC] [TIFF OMITTED] T5675.082
[GRAPHIC] [TIFF OMITTED] T5675.083
[GRAPHIC] [TIFF OMITTED] T5675.084
[GRAPHIC] [TIFF OMITTED] T5675.085
[GRAPHIC] [TIFF OMITTED] T5675.086
[GRAPHIC] [TIFF OMITTED] T5675.087
[GRAPHIC] [TIFF OMITTED] T5675.088
[GRAPHIC] [TIFF OMITTED] T5675.089
[GRAPHIC] [TIFF OMITTED] T5675.090
[GRAPHIC] [TIFF OMITTED] T5675.091
[GRAPHIC] [TIFF OMITTED] T5675.092
[GRAPHIC] [TIFF OMITTED] T5675.093
[GRAPHIC] [TIFF OMITTED] T5675.094
[GRAPHIC] [TIFF OMITTED] T5675.095
[GRAPHIC] [TIFF OMITTED] T5675.096
[GRAPHIC] [TIFF OMITTED] T5675.097
[GRAPHIC] [TIFF OMITTED] T5675.098
[GRAPHIC] [TIFF OMITTED] T5675.099
[GRAPHIC] [TIFF OMITTED] T5675.100
[GRAPHIC] [TIFF OMITTED] T5675.101
[GRAPHIC] [TIFF OMITTED] T5675.102
[GRAPHIC] [TIFF OMITTED] T5675.103
[GRAPHIC] [TIFF OMITTED] T5675.104
[GRAPHIC] [TIFF OMITTED] T5675.105
[GRAPHIC] [TIFF OMITTED] T5675.106
[GRAPHIC] [TIFF OMITTED] T5675.107
[GRAPHIC] [TIFF OMITTED] T5675.108
[GRAPHIC] [TIFF OMITTED] T5675.109
[GRAPHIC] [TIFF OMITTED] T5675.110
[GRAPHIC] [TIFF OMITTED] T5675.111
[GRAPHIC] [TIFF OMITTED] T5675.112
[GRAPHIC] [TIFF OMITTED] T5675.113