U.S. banks kick-start alternative way to provide mortgage loans

Representatives of the four largest U.S. banks and Henry Paulson, Treasury Secretary, agreed on Monday to kick-start a market for covered bonds, in the United States this is an alternative way to provide mortgage loans.

To explain how they work, basically, a bank borrows money to lend to homeowners and holds the mortgages on its books. It uses the proceeds of the mortgages to repay investors. Although covered bonds are all over Europe they actually originated from Germany.

Paulson said at the press conference where he was pushing the idea of the bonds “Covered bonds are a promising financing vehicle and we believe this market can grow in the United States” who also added “The key to the U.S. economy making a major improvement will be turning the corner on housing finance, the housing correction. We’re not going to be able to do that unless we have availability of mortgage financing and this is an attractive new source.”

The idea behind the bonds is to help the housing market, and create liquidity, which has ground to a halt in the traditional US way. Under this new way using Covered bonds the mortgage originators sell mortgages to financial institutions that package them into securities and then re-sell them. Although people have not wanted to invest in anything mortgage related over the last year.

Covered bonds are considered more secure than mortgage-backed securities because the purchasers of the bonds have a direct claim on the issuer’s balance sheet.

It is said that the investors will find the covered bonds more attractive and provide a better tool of gaining liquidity into the system.

Source: marketwatch

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