[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 202ï¿½09512ï¿½091800, or 866ï¿½09512ï¿½091800 (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

