American covered bond law depends on the reform of the GSEs, sadly that isn't going to happen anytime soon.
One of the most informative and, at the same time, depressing takeaways from the Euromoney North American Covered Bond Forum last week was the impasse in the world's biggest housing market.
We know the narrative. Fannie Mae and Freddie Mac combined represented a similar share of the US housing market that covered bonds do in Europe. Like covered bonds they are private sector, provide excellent funding to the underlying mortgages and generally traded like government credits, off the rates desk, not the credit desk at the investment banks. Unlike covered bonds, they failed in the crisis and the US government chose to take them under their wing.
It is of course absurd that in the global champion of free markets the residential mortgage market is mainly government supported credit. Equally absurd is that this 'temporary' phenomenon, the conservatorship of the agencies by the US government, is now rapidly approaching it's 10th anniversary.
The fact that the agency that runs Fannie Mae and Freddie Mac is also their regulator and that the rating agencies and US debt ceiling rules conveniently gloss over the de facto governmental character of their debt just adds to the craziness.
But, as Sandra Thompson of the Federal Housing Finance Agency pointed out in the Euromoney North American Covered Bond Forum, it is in no one's interest to change the status quo. Too many people, buyers, sellers and everyone who makes a living in between them, have too much to gain from the current set up. The US government gets a healthy dividend and doesn’t have to consolidate the debt. This is the real reason why every attempt to reform US housing finance in the last 10 years - Scott Garret's covered bond Bill included - have failed.
What will break the impasse?
Jerry Marlatt of Mayer Brown made the point when I spoke to him on stage in Vancouver that there is absolutely nothing to stop a bank replicating the contractual covered bond structures pioneered by Washington Mutual (other of course than the stigma. Washington Mutual, like Depfa and Northern Rock before them were victims of the curse of the GlobalCapital 'Covered Bond of the Year award'). Whether any banks currently have the economic incentive to do so is another question – like so much progress in the covered bond market, abundant liquidity stymies the development.
Another possible driver of US covered bonds would be the private label securitisation market. Many draw parallels between the securitisation market now and that in 2005 – 6. A repeat of what happened next would surely generate a hole that covered bonds could fill.
The other potential route out of the morass comes from the rating agencies. The vast debts of Fannie and Freddie, although guaranteed by the US government are not consolidated into the debt according to the agencies models. Would America still be triple A rated if it were? Probably not. That would certainly focus a few minds on reform.
American housing needs are too large and covered bond technology too good for this market not to come into existence one day. Those of us who watch and hope have seen several false dawns before, but one day we will have an American covered bond market.