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S. HRG. 111–768 

COVERED BONDS: POTENTIAL USES AND 

REGULATORY ISSUES 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING COVERED BONDS, THEIR POTENTIAL USES, AND 

REGULATORY ISSUES 

SEPTEMBER 15, 2010 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KAY BAILEY HUTCHISON, Texas 

JUDD GREGG, New Hampshire 

EDWARD SILVERMAN, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

DEAN V. SHAHINIAN, Senior Counsel 

LEVON BAGRAMIAN, Legislative Assistant 

JONATHAN N. MILLER, Professional Staff Member 

DEBORAH KATZ, Legislative Fellow 

MARK OESTERLE, Republican Chief Counsel 

MICHAEL PIWOWAR, Republican Senior Economist 

ANDREW J. OLMEM, JR.,Republican Senior Counsel 

CHAD DAVIS, Republican Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

BRETT HEWITT, Hearing Clerk 

WILLIAM JOHNSON, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)
C O N T E N T S 

WEDNESDAY, SEPTEMBER 15, 2010 

Page 

Opening statement of Chairman Dodd .................................................................. 1 

Prepared statement .......................................................................................... 33 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 3 

Senator Corker .................................................................................................. 4 

Senator Johnson 

Prepared statement ................................................................................... 33 

WITNESSES 

Scott Garrett, Representative in Congress from the State of New Jersey ......... 5 

Prepared statement .......................................................................................... 34 

Julie L. Williams, First Senior Deputy Comptroller and Chief Counsel, Office 

of the Comptroller of the Currency ..................................................................... 8 

Prepared statement .......................................................................................... 35 

Responses to written questions of: 

Senator Shelby ........................................................................................... 126 

Senator Vitter ............................................................................................ 130 

Michael H. Krimminger, Deputy to the Chairman, Federal Deposit Insurance 

Corporation ........................................................................................................... 10 

Prepared statement .......................................................................................... 41 

Responses to written questions of: 

Senator Shelby ........................................................................................... 131 

Senator Vitter ............................................................................................ 136 

Scott A. Stengel, Partner, Orrick, Herrington and Sutcliffe LLP, on behalf 

of the U.S. Covered Bond Council, Securities Industry, and Financial Markets Association .................................................................................................... 12 

Prepared statement .......................................................................................... 46 

Responses to written questions of: 

Senator Shelby ........................................................................................... 137 

Kenneth A. Snowden, Associate Professor of Economics, University of North 

Carolina at Greensboro ........................................................................................ 13 

Prepared statement .......................................................................................... 53 

Ric Campo, Chairman and Chief Executive Officer, Camden Property Trust, 

on behalf of National Multi Housing Council and the National Apartment 

Association ............................................................................................................ 15 

Prepared statement .......................................................................................... 63 

Responses to written questions of: 

Senator Shelby ........................................................................................... 194 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Prepared statement of the American Society of Civil Engineers ......................... 197 

(III)

(1) 

COVERED BONDS: POTENTIAL USES AND 

REGULATORY ISSUES 

WEDNESDAY, SEPTEMBER 15, 2010 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 10:05 a.m., in room SD–538, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. Well, good morning, everyone. The Committee 

will come to order, and let me first of all welcome all of you to the 

Committee room. It is good to see my colleagues once again after 

the August break and the rather hectic year we have had with all 

the legislative efforts. So it is pleasant to see everyone, and this 

morning we are going to have a hearing on covered bonds, the potential uses and regulatory issues. 

Just as background to this—and I will make a brief opening 

statement. We are waiting for Congressman Garrett to come up. 

He is the individual in our conference who raised this as an 

amendment during the conference consideration. Senator Corker 

expressed a great deal of interest in this subject matter, as did others, and there was some opposition to including his language in the 

bill at the time from a number of the regulators and others. So I 

was uneasy about putting something in where there was that much 

debate about the subject matter, but agreed to have a hearing exclusively on the subject matter, which we will do here today, and 

we have got some wonderful witnesses who can shed, I hope, some 

very worthwhile light on the subject matter. 

And so I am grateful to Congressman Garrett for raising the 

issue, grateful to Senator Corker for calling for us to have a hearing on it so we can examine the issue; and while we do not intend 

necessarily to resolve the matter in the next few days, it is an important subject, and this is a vehicle that is used by a lot of our 

European allies. It is a common vehicle used, and there are a lot 

of positive things about covered bonds, but there are some questions obviously others will have as well about their usage. 

So let me open with some comments. I will turn to Senator Shelby, and by that time, we hope Congressman Garrett can be here. 

Then we will hear his testimony and get right to our panel. 

Today the Committee will hear testimony on covered bonds, as 

I have indicated, a potentially significant alternative means for 

raising capital for housing finance. Covered bonds have been issued 
2 

widely in Europe for many years, but not in the United States. The 

purpose of today’s hearing is to learn more about covered bonds, 

exploring whether they could contribute to sustained economic 

growth and whether it is in the public interest to encourage their 

broader use in our own country. 

The hearing grew out of a discussion, as I mentioned a moment 

ago, on covered bonds that came up during the latter part of the 

Senate–House conference on the so-called ‘‘Dodd-Frank Act.’’ I am 

pleased to have worked with Ranking Member Shelby and Senator 

Corker, as I have mentioned, in organizing this hearing. As the 

Banking Committee has not previously held a hearing on covered 

bonds, and the subject has raised issues among Federal regulators, 

we determined to explore the matter more carefully before acting. 

When speaking of covered bonds in the United States context, we 

generally mean a debt security issued by a bank and backed by 

cash-flows from mortgages or public sector loans. The bond is 

backed by the bank’s promise to repay and by the assets pledged 

in collateral. Covered bonds can provide an additional option to the 

two dominant funding mechanisms in the U.S. marketplace, which 

are securitization and the traditional portfolio lender model, where 

a bank holds mortgages on the balance sheets and funds them with 

deposits. 

Proponents of covered bonds point to their greater transparency 

because these assets remain on a bank’s balance sheet so investors 

can analyze their value more easily than in the case of some other 

asset-backed securities. Proponents also note that issuers of covered bonds have a long-term interest in the underlying loans because they keep them on their balance sheet, which increase investor confidence. 

While American banks are not prohibited from issuing covered 

bonds to raise capital, few currently do so. Some potential investors 

are concerned about the treatment of covered bonds if the issuer 

goes into conservatorship or receivership. They believe that legislation and agency rulemaking are needed to provide clarity about 

how covered bonds would be regulated. Any such measures would 

define the rights and responsibilities of investors, issuers, and regulators. They feel that this would stimulate the growth of a later 

domestic covered-bond market. 

It is important that Congress, I think, look for alternative means 

and measures that could stimulate the economy. The Committee is 

holding today’s hearing to learn more about this alternative and 

whether it could contribute to safe and stable and sustained economic growth. 

We are pleased to have before us experts who will provide testimony about the history of covered bonds, their uses and potential 

benefits, as well as their interaction with existing mortgage financing mechanisms. The panel also includes Federal regulators who 

can share their perspective on the regulation of banks that would 

issue covered bonds, including the impact on the Deposit Insurance 

Fund. 

On the first panel, I am pleased to welcome Congressman Scott 

Garrett. Here you made it. I am glad you got over here. I was going 

to filibuster for a while until you got here, something we do with 

some regularity around here these days. Welcome to the Senate 
3 

side, Congressman. Nice to see you again as well, by the way. We 

spent an awful lot of time together, it seems, not long ago. Anyway, 

delighted you are here. 

Congressman Garrett has a strong interest in this area—spoke 

eloquently about it during our conference with the House on the financial reform bill—and has introduced legislation on covered 

bonds. 

On the second panel, we will hear from Julie Williams, Chief 

Counsel and the First Senior Deputy Comptroller, Office of the 

Comptroller of the Currency; Michael Krimminger, who is Deputy 

to the Chairman of the Federal Deposit Insurance Corporation; 

Scott Stengel, on behalf of the U.S. Covered Bond Council; Professor Kenneth Snowden, from the University of North Carolina at 

Greensboro; and Mr. Ric Campo, on behalf of the National Multi 

Housing Council and the National Apartment Association. 

Last, let me just say just as what I see as kind of the issues, and 

I will just pick seven issues here that it would seem to me to help 

our panelists—I do not expect you all to answer every one of these, 

but these are the questions we thought were legitimate to be raised 

here. 

One, is legislation needed? A pretty basic question, but one that 

I think should be raised. What entities would be eligible to issue 

covered bonds? What agencies should regulate covered bonds? 

What assets would be eligible for covered bonds? What standards 

should apply to issuance, joint rulemaking, cap on assets held in 

covered bonds, limit of percentage of covered bonds as to total liabilities, minimum collateralization? What are the consequences of 

a failure of a covered-bond issuer or a bond default? And what securities disclosures would apply? 

Now, there may be more issues, but those are six or seven we 

thought were legitimate questions to be raising about this subject 

matter. 

So, with that, let me turn to Senator Shelby for his opening comments, and then unless my two colleagues want to be heard on the 

matter, we will go right to Congressman Garrett. Richard. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. 

Mr. Chairman, I appreciate that you are fulfilling the commitment that you made during the financial regulation conference to 

hold this hearing. The fact is our housing policies have failed on 

a grand scale. Fannie and Freddie are in Federal hands, while millions of homeowners continue to struggle with mortgages that are 

underwater. Taxpayers have lost over $200 billion and are likely to 

lose billions more in the future. Despite this, the proponents of reform legislation chose to ignore many of the problems in the mortgage market, I believe. I believe this was a serious mistake and 

think this Committee must remain engaged in the hard work necessary to come up with solutions that protect taxpayers and homeowners alike. 

A thorough examination of the use of covered bonds I think is a 

positive first step. A covered bond, Mr. Chairman, as you have 

mentioned, is a financial instrument that merits this Committee’s 

close scrutiny. When implemented under certain regulatory and 
4 

economic circumstances, they have proved to be a valuable private 

sector tool for providing mortgage liquidity in certain markets. 

However, what works in some markets does not always translate 

well to our economy. Additionally, as is noted in the testimony of 

members of the second panel, and contrary to popular perception, 

covered bonds have been tried in this country before, and they did 

not achieve a high level of success. Nonetheless, the Committee 

should thoroughly study this unique area of mortgage finance. Only 

then can we conduct our own analysis of this particular approach 

and determine whether covered bonds should become a part of our 

housing finance landscape. 

But I believe before we proceed with the testimony, Mr. Chairman, I want to reiterate my belief that, notwithstanding the recent 

passage of the Dodd-Frank bill, this Committee has a great deal of 

work yet to do. Our housing finance markets have been crippled, 

and the bureaucratic structure that has been erected as a result of 

decades of ill-advised housing policies has only made it worse. 

Mr. Chairman, I think the American people are fed up. They are 

fed up with bailouts, excessive debt, and oversized Government. 

They are certainly fed up with an anti-State mentality that demands a new Federal program for every identifiable problem in the 

housing sector. Therefore, Mr. Chairman, I believe we must completely reevaluate our current approach to housing policy and find 

the political courage to make some significant changes. My hope is 

that this hearing is the beginning of that process. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Yes, Senator Corker. 

STATEMENT OF SENATOR BOB CORKER 

Senator CORKER. I want to break the Corker rule and just very 

briefly say that I want to go back to comments I made last November or December and say that this type of hearing is exactly the 

reason that I think this is a great Committee. And I think at the 

time of conference we did not have the information we needed. A 

commitment was made by you to have this hearing and we are 

having it, and I appreciate that. And, again, I think it is part of 

the thoughtful approach that we have used on most issues. I know 

last year was a very tumultuous year, a lot of emotions frayed. But, 

Scott, I want to thank you for championing this issue and pressing 

it as you have. I know that you have already passed a piece of legislation in the House. We did not know as much as we needed to 

know about it and had some questions, and I think it is appropriate that we are having a hearing, and I think this is a first step 

toward addressing some of the issues that Senator Shelby has 

raised. 

So I want to thank you for having the hearing. 

Chairman DODD. Thank you, Senator, very much. 

Jack, any comment? 

Senator REED. For the record, Mr. Chairman, I would like to follow the Corker rule. 

[Laughter.] 

Senator SHELBY. Now, the Corker rule is unwritten, isn’t it, Mr. 

Chairman? 
5 

Chairman DODD. It is an unwritten, rigid rule. And I suspect 

that as this gavel may move back and forth here that the people 

are going to want to apply it with greater regularity. 

Senator SHELBY. And the Corker rule is very much in vogue 

when we have got a full panel of members. 

Chairman DODD. Oh, very much in vogue. 

Senator SHELBY. Of members. 

Chairman DODD. Yes, absolutely, want to talk. First of all, on the 

subject matter I am sure not a lot of them know what a covered 

bond is yet, too. That may slow them down on opening statements 

along the way. 

Anyway, Congressman, welcome to the Senate. We are anxious 

to receive your testimony. 

STATEMENT OF SCOTT GARRETT, REPRESENTATIVE IN 

CONGRESS FROM THE STATE OF NEW JERSEY 

Mr. GARRETT. Well, first of all, thank you, Chairman Dodd and 

Ranking Member Shelby. Thank you very much for inviting me 

here and for holding this hearing as well, and thank you, Senator 

Corker, for being a strong and articulate advocate for covered 

bonds as well. I appreciate your assistance on this very important 

issue. 

As our Nation continues, in essence, to recover from the recent 

financial crisis and certain credit markets remain locked, Congress 

really must—and I think the Chairman agrees—examine new and 

innovative ways to encourage the return of private investment to 

our capital markets. So we must also consider creative ways to enable the private sector to provide additional consumer and commercial and public sector and other types of credit as well. So establishing this U.S. covered-bond market would further all these 

shared goals. 

One reason I am really particularly fascinated with covered 

bonds is the fact that they can be a purely private means of finance—and this is important—without any Government guarantees or subsidies. Many proposals to help alleviate the current 

strains in our credit markets focus on Government loans or guarantees. However, I believe that covered-bond legislation offers a way 

for the Government to provide additional certainty—and some are 

looking for it—to private enterprises and generate increased liquidity through the innovation of a new marketplace without, again— 

and this is important—putting the taxpayers on the hook. 

Now, there are many potential benefits for a wide variety of interested parties that can be derived from a U.S. covered-bond market. I think the Chairman was touching on some of these. 

Consumers will experience lower loan rates because of the additional liquidity in the various asset classes. 

Consumers will also be able to more easily have their loans modified because the loans will still be on the balance sheets, on the 

books of the originating institution. 

Investors will have a new transparent and secure vehicle to invest in, and this will allow for additional diversification within 

their portfolios. 
6 

And, finally, the broader financial market itself will benefit by 

having an additional, low-cost, diverse funding tool for all financial 

institutions there. 

Covered bonds will ensure more stable and longer-term liquidity 

in the credit markets, which reduces refinancing risks as well as 

exposure to sudden changes in interest rates and investor confidence. And they will allow U.S. financial institutions to compete 

more effectively against their global peers. 

In the House, we have worked in a very constructive bipartisan 

fashion to push the ball forward on comprehensive covered-bond 

legislation. I just left Chairman Kanjorski and Ranking Member 

Bachus, and I have introduced three different versions of coveredbonds legislation. The most recent is H.R. 5823, the Covered Bond 

Act of 2010. 

Now, a week before the August recess, we successfully marked 

up this legislation and reported it out of Committee with a unanimous vote. It is my hope that we can pass this legislation out of 

the House over the next several weeks. 

Some have asked why we need covered-bond legislation. You 

raised seven points. Simply, to get the market off the ground and 

provide investors with the needed confidence to invest in the market and resolution procedures of a bond when an issuer fails needs 

to be spelled out specifically in statute. Otherwise, without the certainty of a legally binding process, there is not significant enough 

appetite from the investment community to make covered bonds 

cost-effective to the issuers to offer. Also, a regulatory regime needs 

to be put in place to ensure proper oversight of the marketplace. 

Throughout this process, there have been some people who have 

said, ‘‘Well, let us wait and see; maybe next year with housing finance reform.’’ But the proposal we are discussing today is broader 

than just housing finance. Covered bonds offer a complementary 

source of funding that can spur much needed lending to consumers, 

small businesses, and State and local governments. The reason 

why I have been so active in pushing covered bonds this year is because I believe we have to do it right now. We hear almost daily 

about the liquidity concerns throughout various asset classes. The 

House Financial Services Committee held a recent hearing about 

the lack of liquidity in the marketplace. The Senate just passed a 

bill already approved by the House with the intent of providing 

more liquidity. 

Also, we have spoken to local and State officials about the problems municipalities face with increased funding costs for their 

projects. The President has continuously stressed the need to help 

these segments of the economy. More importantly, this is something we can do, we can do it now, and we do it without any cost 

to the taxpayer. 

Another reason to move quickly on establishing a covered-bond 

market in the U.S. is because billions of U.S. investment dollars 

are moving overseas and north of the border. So far in 2010, there 

have been a dozen covered-bond deals issued by foreign banks to 

U.S. investors totaling over $18 billion. This is private capital that 

could have been invested here in the United States with the help 

of our legislation. 
7 

Private industry realizes that we are currently missing out on an 

opportunity as well. Now, I have formal letters of support for the 

U.S. Covered Bond Act from the National Association of Realtors, 

the Mortgage Bankers Association, the ABA, the National Multifamily Housing Council, and so on. 

Now, finally, I do not want to pretend to believe that covered 

bonds are some sort of magic bullet that will help solve all of our 

funding needs. However, what I do know is this: that they will help 

solve some—some—of our funding needs. What I do know is that 

during this time of economic uncertainty, lack of liquidity, and rising budget deficits, during all this time we must consider innovative approaches to help attract private investments—not Government investments—into our capital markets. I believe that this legislation can help us out in that regard. 

I will end where I began. I want to thank the Chairman so very 

much and the Ranking Member as well for this invitation, for taking up this issue, and for considering this important piece of legislation. 

Thank you, Senators. 

Chairman DODD. Thank you, Congressman, very, very much, and 

I congratulate you on your efforts in the House and getting things 

moving along in this area. 

Let me turn to my colleagues if they have any questions of our 

colleague in the House. Jack, any questions at all? 

Senator REED. No. I just want to commend the Congressman not 

only for his work here today but for his major contribution to the 

conference committee on financial reform. Thank you, Congressman. 

Chairman DODD. Yes, and I should have said that as well. 

Mr. GARRETT. Well, that was made more fun because of the Senators. 

[Laughter.] 

Chairman DODD. I know. I know how much you like to have us 

come over to the House side. 

Mr. GARRETT. We do. 

Senator CORKER. I know we do not typically question, you know, 

people who are elected officials, and so I am not going to do that. 

But you might want to get some editorial comment as to what— 

I know what passed in the House was not perfect in your eyes. 

Would you share with us a couple of things that you think might 

make the bill you passed in the House more perfect? 

Mr. GARRETT. How would we make the bill—— 

Senator CORKER. I know you had to make some compromise in 

the House that you did not really want to make. Could you share 

with us a couple of the things that you think would make the bill 

that passed in the House better if we passed it in the Senate? 

Mr. GARRETT. Well, I will just touch on one. One aspect is with 

regard to asset classes in the legislation. Our background on this 

looks to Europe. They use this for their asset classes. We take a 

broader approach to that. And some say maybe we are taking too 

broad an approach. So we agreed to come to agreement, come to 

a compromise on that, and rein that in somewhat. But I think we 

did it in a constructive manner to allow the regulators some degree 
8 

of flexibility going forward as the marketplace expands and develops and they have the understanding of the operation there. 

But I do believe going forward, just as I said in my testimony, 

that this really is not an issue just in the mortgage/housing finance 

situation. This can be an avenue for increased liquidity and increased credit and a whole slew, if you will, of different asset classes as well. So that is one area that we could take a look at. 

Senator CORKER. And right now it is mortgages only. Is that correct? 

Mr. GARRETT. Oh, no. We have limited it, but we have not extended it to a carte blanche avenue in the bill. 

Senator CORKER. OK. Thank you, Mr. Chairman. 

Chairman DODD. Congressman, thank you very, very much. 

Mr. GARRETT. Thank you. 

Chairman DODD. Let me invite our panel to come up and join us. 

I have already introduced, I think, the panel so I will ask you to 

come up and assume the seats in the order in which I introduced 

you. 

While our witnesses are taking their seats, the staff has pointed 

something out to me that we do not do often enough, in my view. 

In the case of Mr. Krimminger and Ms. Williams, these are people 

who have dedicated a good part if not all of their professional life 

to the service of our country. Julie Williams has worked for almost 

30 years for the Federal Home Loan Bank, the OTS, and the OCC. 

Where are you? There you are at the end down there. Very fond 

of people who—young people with gray hair. I have a bias to that 

coloration. And Michael Krimminger has worked for almost 20 

years as well for the Government, and we thank you both for your 

service to our country, day in and day out just trying to do a good 

job on behalf of the Nation. We are very fortunate to have your 

service, and I thank you for it as well. 

We will begin with you, Ms. Williams, and then I would just ask 

you all, because it is a large panel, to try and keep your remarks 

to about 5 minutes or so, so we can engage in the questions that 

all of us will have for you. And then any supporting documents or 

materials you would like for this Committee to have as part of this 

record, I will just ask unanimous consent that all documents that 

our witnesses provide be accepted as part of the record. Without 

objection, it is ordered. 

Ms. Williams. 

STATEMENT OF JULIE L. WILLIAMS, FIRST SENIOR DEPUTY 

COMPTROLLER AND CHIEF COUNSEL, OFFICE OF THE 

COMPTROLLER OF THE CURRENCY 

Ms. WILLIAMS. Thank you. Chairman Dodd, Ranking Member 

Shelby, and Members of the Committee, my name is Julie Williams, and I am the Chief Counsel and First Senior Deputy Comptroller at the Office of the Comptroller of the Currency. The OCC 

appreciates the opportunity to testify today regarding the potential 

of covered bonds as a new funding mechanism for financial institutions and the issues presented in designing a covered-bond legislative framework. 

Covered bonds are a promising funding option for financial institutions. They could serve as an alternative to securitization and 
9 

other current funding techniques and could be a new source of 

funds for lending and an alternative source of liquidity. 

For the banking system, covered bonds could provide a funding 

source that is longer term and more stable and potentially less expensive than currently available alternatives. The structure of covered bonds might require less collateral and may also accommodate 

a broader range of types of collateral than current options. 

Covered bonds also may attract types of investors that would not 

otherwise invest in bank debt. Institutions also have a strong incentive to maintain prudent underwriting standards for loans in a 

covered-bond collateral pool because those loans remain on the institution’s books. 

That said, a complex combination of factors will determine the 

relative attraction of covered bonds compared to alternative funding sources. Because covered bonds remain on an institution’s balance sheet, an institution must hold more capital than would typically be required if the assets were securitized. Thus, capital requirements could constrain the growth of covered bonds. And new 

accounting rules, upcoming changes in capital requirements, and 

the ‘‘skin in the game’’ provisions in the Dodd-Frank Act are all 

factors that could affect the relative advantages and disadvantages 

of covered bonds versus other funding alternatives. 

The legal framework for covered bonds in the U.S. also will be 

a key factor in whether covered bonds flourish, and various legislative efforts have emerged recently to provide enhanced legal certainty regarding the elements of a covered-bond regime in the U.S. 

My written testimony provides detail on the issues that we would 

suggest Congress consider in designing a legislative framework for 

covered bonds. We also offer some suggestions on how those issues 

could be addressed, and I will summarize those points. 

First, what type of entity is eligible to issue covered bonds? We 

believe that limiting eligible issuers to entities already subject to 

Federal supervision will ensure that dedicated financial supervisors 

can monitor and control the growth of covered-bond programs, 

react to emerging issues, and promote safe and sound programs in 

the institutions they supervise. 

Second, what agency or agencies are appropriate to regulate U.S. 

issuers and programs? We support a framework where Federal financial regulators operating under a single uniform set of standards would be designated as the covered-bond regulators for their 

respective regulated entities. 

Third, what types of assets should be eligible to collateralize the 

covered bonds? We suggest that a new covered-bond program start 

with a relatively conservative scope, with regulators authorized to 

expand the eligible asset classes as more experience is gained with 

covered-bond programs. 

Fourth, what specific standards should be applicable to covered 

bonds and covered-bond issuers? These could include, for example, 

minimum eligibility criteria by asset class, limits on size of 

issuances, and overcollateralization standards. Here legislation 

could provide direction on key issues and charge regulators with 

adopting the detailed standards to implement those directions. 

Fifth, what are the consequences of a default of a covered-bond 

issuance or the failure of a covered-bond issuer? How a U.S. legal 
10 

framework resolves how a covered pool is treated in the event of 

a default or insolvency of a covered-bond issuer and the role of the 

FDIC will critically affect the appeal of covered bonds to investors. 

And, last, what reporting and securities standards should apply 

to covered bonds? We support transparency and availability of information to investors as important components of a comprehensive 

covered-bond regime. 

I appreciate the opportunity to appear today to discuss these 

issues. I would be happy to answer any questions. Thank you. 

Senator REED [presiding]. Thank you, Ms. Williams. 

Mr. Krimminger, please. 

STATEMENT OF MICHAEL H. KRIMMINGER, DEPUTY TO THE 

CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION 

Mr. KRIMMINGER. Good morning, Chairman Dodd and Members 

of the Committee. On behalf of the FDIC, I want to thank you for 

the opportunity to testify about covered bonds. I am Deputy for 

Policy to Chairman Bair and have had the privilege to work on 

many of the issues that we will discuss this morning. 

Early on, the FDIC recognized covered bonds as a potential 

source of bank liquidity, but one that should be balanced within 

the U.S. financial system. To do this, in 2006, the FDIC worked to 

clarify our policies with the first U.S. banks to issue covered bonds. 

Later, in mid-2008, the FDIC adopted a Covered Bond Statement 

of Policy to further solidify that foundation. 

However, the intervening financial crisis has prevented new covered bonds so far. While there is some question whether a legislative framework is essential, the FDIC does support balanced legislation. We believe legislation should embody three key principles. 

First, it should clarify the rights and responsibilities of investors, 

issuers, and regulators. 

Second, it should not transfer investment risk from covered-bond 

investors to the public or to the Deposit Insurance Fund. 

And third, it should be consistent with longstanding U.S. law 

and policy for secured creditors. In short, covered-bond investors 

should not be given rights that are unavailable to any other investors. 

My written statement provides a detailed explanation of these 

principles. I will concentrate today on the need to provide protections for the Deposit Insurance Fund and to preserve the priorities 

of U.S. laws. 

We have worked with the sponsors of H.R. 5823, the United 

States Covered Bond Act of 2010, and appreciate the evolution of 

that legislation to address some of our concerns. However, a few 

key concerns remain. Of course, we will continue to work with the 

sponsors and other members to address these continuing concerns 

with that legislation. 

I think the importance of the Deposit Insurance Fund to stability 

in our banking system is very apparent today. Key statutory protections for this Fund are, one, the FDIC’s ability, or duty, I should 

say, to use the least costly way to resolve banks, and two, the ability to fulfill this duty by getting the best value for a failed bank’s 

assets, such as a covered-bond program. 
11 

To maintain these protections, we urge that any covered-bond 

legislation preserve the FDIC’s flexibility in handling covered 

bonds in receiverships. Today, the FDIC has three options. First, 

it can continue to perform under the covered bonds and then sell 

the program intact to another bank. Second, the FDIC can turn 

over the collateral to the investors. Finally, the FDIC can terminate the program, pay the full value of the bonds plus interest, and 

reclaim the cover pool. This flexibility is critical to protect the Deposit Insurance Fund. It allows the FDIC to effectuate the least 

costly resolution for a failed bank by recovering the best value for 

its assets, as we did when Washington Mutual failed and we sold 

the program to JPMorgan Chase. 

Unfortunately, in our view, H.R. 5823 gives the FDIC only two 

options, transfer a covered-bond program in a certain period of 

time or turn over the collateral to the investors. In effect, it transfers the risk of loss to the Deposit Insurance Fund if, as is usually 

the case, the cover pool is worth far more than the total due on the 

bonds. 

H.R. 5823 gives investors rights that no other creditors get under 

U.S. law, whether in bankruptcy or in FDIC receiverships. Under 

the House bill, investors get to keep all the cover pool, even if the 

full par value of their bonds plus interest is far less, which is usually the case. All the Deposit Insurance Fund would get is a, quote, 

‘‘residual certificate’’ for any remaining value left after 10 or 20 

years. Unfortunately, the certificate is likely worth nothing. 

Longstanding U.S. law properly says a secured creditor, like the 

covered-bond investors, has a claim to keep the collateral only up 

to the amount due on the debt. H.R. 5823 turns this on its head 

and makes the Deposit Insurance Fund bear the lost value of the 

collateral that exceeds the total due on the bonds. In effect, the 

proposed bill would give the covered-bond investors a superpriority 

over the Deposit Insurance Fund. 

I want to be clear. Contrary to what some argue, the FDIC is not 

trying to pay only the market value of the bonds, which, as we saw 

during the fall of 2008, can be dramatically discounted. The FDIC 

will support legislation that guarantees the investors the bond’s 

par value plus accrued interest if we cannot sell the program and 

must terminate it. This gives the investor full value while preserving the FDIC’s existing power to recapture the excess collateral 

value on behalf of the fund and the depositors. So long as investors 

are paid the full principal amount of the covered bonds and interest to the date of payment, there is no policy reason to protect 

them beyond that, especially through an indirect subsidy from the 

Deposit Insurance Fund. 

In effect, the super-priority could create a new class of investments that appear to be risk-free and can lead to a mispricing of 

the risk of covered bonds. As we have seen, mispricing of risk can 

have disastrous consequences. 

As I said before, the FDIC supports a vibrant covered-bond market in the U.S. and will continue to work with Congress, other regulators, and the industry to create one. Thank you again for the 

opportunity to testify. 

Chairman DODD [presiding]. Thank you very, very much. I appreciate it very much. 
12 

Mr. Stengel, welcome. 

STATEMENT OF SCOTT A. STENGEL, PARTNER, ORRICK, 

HERRINGTON AND SUTCLIFFE LLP, ON BEHALF OF THE U.S. 

COVERED BOND COUNCIL, SECURITIES INDUSTRY, AND FINANCIAL MARKETS ASSOCIATION 

Mr. STENGEL. Chairman Dodd, Ranking Member Shelby, and 

Members of the Committee, I am grateful for your invitation to testify today on the crucial role that U.S. covered bonds can play in 

stabilizing our financial system and contributing to our economic 

recovery. 

I am a partner with Orrick, Herrington and Sutcliffe and a member of the Steering Committee for the U.S. Covered Bond Council. 

The Council is comprised of investors, issuers, dealers, and other 

participants in the covered-bond market and we strive to develop 

policies and practices that harmonize the views of these different 

constituencies and that promote a vibrant market for U.S. covered 

bonds. 

The precarious state of our Nation’s economy has become all too 

apparent. Almost 17 percent of Americans are still unemployed or 

underemployed. More than half of small business owners are experiencing cash-flow issues. Nearly one out of four homeowners is underwater on a mortgage, and a record percentage of commercial 

mortgage loans is delinquent. 

In the Council’s view, sustained economic growth begins with a 

stable financial system. While the Dodd-Frank Act has supplied 

some important structural elements, there is still a need for longterm and cost-effective funding that is sourced from diverse parts 

of the private sector capital markets and that can be translated 

into meaningful credit for households, small businesses, and 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 debt 

that is issued by a bank or other regulated 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 the cover pool after the 

issuer’s default or insolvency, and only 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 long-term, 

stable liquidity and that are significant to national economies. 

U.S. covered bonds can stabilize our financial system and encourage economic growth in several ways. First, with maturities that 

extend out to 10 years or more, covered bonds can infuse longerterm 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. 
13 

Third, covered bonds can add funding from a separate investor 

base that would not otherwise make this liquidity available 

through the unsecured debt or securitization markets. 

Fourth, covered bonds can deliver funding from the private sector 

even in distressed market conditions without any explicit or implicit Government guarantee or other taxpayer support. 

Fifth, because issuers continue to own the assets in their cover 

pools and have 100 percent skin in the game, incentives relating 

to loan underwriting, performance, and modifications are strongly 

aligned. 

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 and this 

precedent, now found in almost 30 other countries, has 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, perhaps 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 forced 

acceleration of covered bonds and a fire sale of the cover pool after 

the issuer’s default or insolvency. These pillars, which afford the 

legal certainty required for investors to dedicate funds to this market, cannot be replicated by regulatory action like the FDIC’s Covered Bond Policy Statement. 

Without action by Congress, European and other non-U.S. 

issuers will be left to fill the void. Thus far in 2010, they have targeted over today $19 billion in U.S. dollar covered bonds to investors of the United States. The result is an increasingly uneven 

playing field for U.S. institutions of all sizes and less available 

credit for families, small businesses, and the public sector. 

The Council, therefore, fully supports covered-bond legislation of 

the kind offered during the House–Senate Conference on the DoddFrank Act, and I want to thank Senator Corker and Congressman 

Garrett for their leadership and Chairman Dodd for holding this 

hearing. I would be pleased to answer any questions that Members 

of the Committee may have. 

Chairman DODD. Thank you very, very much. 

Professor, Snowden, thank you. 

STATEMENT OF KENNETH A. SNOWDEN, ASSOCIATE PROFESSOR OF ECONOMICS, UNIVERSITY OF NORTH CAROLINA 

AT GREENSBORO 

Mr. SNOWDEN. Chairman Dodd and Members of the Committee, 

I appreciate the opportunity to testify today before the Committee 

concerning potential uses and regulation of covered bonds in the 

U.S. mortgage market. I am an economic historian who for the past 

two decades has studied the development of the U.S. mortgage 

market. The purpose of my testimony is to share with you some of 

the research I and others have done concerning the history of the 
14 

market and the role that covered mortgage bonds have played 

within it. 

Really, one of the motivations we hear for using covered bonds 

is what I will talk about mostly today, which is that they are very 

popular and have a record of success in Europe. In fact, the European record of covered mortgage bond success stretches back over 

200 years. 

My own research is completely U.S.-centric, but I became aware 

of the history of covered bond use in Europe two decades ago when 

I came across commentaries by late 19th century writers in the 

United States that complained bitterly about the absence of covered bonds in this country. These comments provided evidence that 

market participants in the U.S. were well aware of covered mortgage bonds as early as 1870, and this led me to question why the 

mechanism hadn’t been implemented here. 

Further exploration revealed, in fact, that they had been introduced several times between 1870 and 1935. So at that point, the 

important question became, why did covered bonds not become a 

permanent fixture in the U.S. mortgage market after being introduced? My testimony briefly surveys the record to provide the Committee with this historical perspective as you consider legislation to 

encourage the introduction of covered mortgage bonds one more 

time. 

I divide the historical record into two parts. The first lies between 1870 and 1900, when covered mortgage bonds were introduced in the U.S. without the regulatory framework that was used 

at that time in Europe. The covered mortgage bond had its greatest 

success during this period in the Western farm mortgage market 

with companies that normally brokered whole mortgage loans to investors, but they began to issue bonds secured by mortgages instead of selling the loans outright. 

I have examined one of these companies in depth and found that 

the loans it placed behind its covered bonds were, in fact, riskier 

than the ones that it brokered. That result appears to contradict 

the generalization that underwriting standards are strict inside a 

covered mortgage bond structure. But in this case, the issuer could 

shift risk between brokerage and covered bonds because of ineffective regulation. 

A more obvious lesson can be drawn by the way these companies 

failed during the general farm mortgage crisis of the 1890s. Serious 

malfeasance occurred throughout the covered mortgage bond sector 

during the crisis because there was no regulation in place to control the behavior of the mortgage companies after their financial 

capital had dissipated. These failures affected the reputation of covered mortgage bonds in the United States for decades. 

The Federal Government takes center stage in the history of covered mortgage bonds between 1900 and 1935. Your predecessors in 

the 63rd and 64th Congresses benefited from an extensive investigation of covered-bond systems in Europe before they created the 

Federal Farm Loan Bank System in 1916. The system was comprised of both public and private institutions and both relied on 

covered mortgage bonds as their financing. 

The privately financed Joint Stock Land Bank component of this 

system was structured and regulated just like institutions in Ger-
15 

many, and this led private farm mortgage companies in the United 

States to oppose and avoid the system because of restrictions on 

their activities that were placed by these German practices. 

Twenty years later, the 73rd Congress authorized the creation of 

a privately financed, federally regulated covered residential mortgage bond program to provide a liquid market for the new FHA insured mortgage loans. No private institution was ever chartered 

under this authority, and the discussion about introducing covered 

mortgage bonds to the U.S. went silent for decades. 

In the final section of my testimony, I provide an overview of the 

development of the institutional residential mortgage market over 

the past century to provide perspective on how the introduction of 

covered mortgage bonds at this time fits into its long-run pattern 

of development. 

I will close my remarks, however, by summarizing two lessons 

that I draw from the historical record. First, past failures of covered mortgage bonds in the U.S. are explained by a combination of 

bad timing, poor implementation, and ineffective regulation. We 

need to do a better job of incorporating covered bonds into the U.S. 

mortgage market rather than to abandon the effort. 

Second, a common failure in past attempts was to transplant elements of a European covered mortgage bond system without tailoring them to fit U.S. institutions. We need to identify features of 

the U.S. mortgage market that could be incompatible with European covered mortgage bond practice while, rather than after, regulation is being formulated. 

I thank you for your time and would be happy to answer questions. 

Chairman DODD. Thank you very much, Professor. 

Mr. Campo, good to have you with us this morning. 

STATEMENT OF RIC CAMPO, CHAIRMAN AND CHIEF EXECUTIVE OFFICER, CAMDEN PROPERTY TRUST, ON BEHALF OF 

NATIONAL MULTI HOUSING COUNCIL AND THE NATIONAL 

APARTMENT ASSOCIATION 

Mr. CAMPO. Thank you, Chairman Dodd and distinguished Members of the Committee. I am Ric Campo, Chairman and CEO of 

Camden Property Trust, a publicly traded apartment firm. I am 

the Immediate Past Chairman of the National Multi Housing 

Council and I am testifying today on behalf of NMHC and our joint 

legislative partner, the National Apartment Association. 

We applaud the Senate Banking Committee for exploring alternative sources of capital to support housing. We believe covered 

bonds could indeed provide some degree of additional liquidity to 

the U.S. multifamily finance. We caution, however, that it is quite 

unlikely that covered bonds could provide the capacity, flexibility, 

or price superiority necessary to adequately replace any of the U.S. 

traditional sources of multifamily mortgage credit. I am hoping to 

provide you with the apartment sector’s perspective based on our 

general credit needs and to share some insights into what role covered bonds could play in meeting those needs. 

One-third of American households rent. About 16.7 million 

households live in rental apartments. Our industry depends on a 

reliable source and sufficient capital to meet the Nation’s rental 
16 

housing demand. Currently, private mortgage lenders have left the 

market, forcing us to rely heavily on credit insured or guaranteed 

by the Federal Government, namely FHA, Fannie Mae, and 

Freddie Mac. Eighty percent of the apartment loans that were 

issued in the first 6 months of 2010 have some form of Government 

credit behind them. Therefore, our concerns are over the broader 

issue of housing finance reform and the unintended consequences 

that could reduce credit now provided by the GSEs. 

Since the conservatorship, the latest data shows that Freddie 

Mac’s multifamily unit has generated a billion dollars of profits 

that have been used to offset the losses on their single-family book. 

Fannie Mae’s numbers are similar. This is a strong indicator that 

the model for the multifamily finance market works pretty well. 

We support a careful look at covered bonds as a supplemental 

source of credit. The European experience indicates that covered 

bonds provide numerous benefits to issuers and investors. Investors 

earn attractive risk-adjusted yields on low-risk diversified securities. Financial institutions that issue the bonds benefit from the 

lower cost of funds and reduced risk-based capital requirements 

along with meaningful collateral substitution capabilities. 

For numerous reasons, though, it is quite unlikely that covered 

bonds could provide the capacity, flexibility, and pricing superiority 

necessary to adequately replace the U.S. existing sources of multifamily credit. First, it is unclear whether covered bonds would actually increase the amount of credit banks would make available 

to apartment firms because the covered-bond structure limits the 

issuers’ lending volumes by requiring them to hold loans on their 

balance sheet and retain capital reserves in case of losses. It is also 

possible that banks could simply replace some of the home loan activities with covered bonds, which would not increase lending capacity. Even then, however, larger banks are anticipated to be 

more—major covered-bond issuers may choose not to issue covered 

bonds for multifamily mortgages because they already originate 

such mortgages for the GSE and CMBS market and avoid any balance sheet liability. Additionally, since so many asset classes qualify for covered bonds, it is unclear whether the banks would use 

them to increase multifamily lending. 

It is also important to understand that the European experience 

with covered bonds for multifamily properties may not be 

transferrable to the U.S. In Europe, the rental markets operate on 

a condominium model comprised of small investors buying individual units and renting them out. For instance, in the U.K., 73 

percent of the rental stock is owned by mom-and-pop operators and 

there is no institution investors. 

Likewise, questions remain about whether a purely private 

American covered-bond market could be a critical backstop capital 

during the periods of financial instability. Europe’s covered-bond 

market came to a standstill during the global financial crisis, going 

dormant for several months after Lehman Brothers collapsed. 

Some European jurisdictions have still seen no issuance. In contrast, in the U.S., Fannie Mae and Freddie Mac continued to provide liquidity to the multifamily sector at a profit. 

For all these reasons, we can only conclude that the covered-bond 

market might augment but not adequately replace any of the com-
17 

ponents of the U.S. multifamily finance. Apartments are a critical 

component of our Nation’s housing market and the apartment industry depends on the reliable, reasonably priced, and readily 

available supply of credit to meet the Nation’s growing demand for 

rental housing. We look forward to the return of credit liquidity 

from all sources, including covered bonds, and welcome your efforts 

to increase the credit liquidity in the future. 

Thank you, and I look forward to your questions. 

Chairman DODD. Thank you very, very much. We appreciate 

your testimony, as well, and all of you this morning, and I will ask 

the Clerk to kind of keep an eye on the timing here so we don’t 

go over too long. There are only three or four of us here. Senator 

Merkley has joined us, as well. I will begin with a few questions, 

and then I will turn to Senator Corker and we will go back and 

forth here this morning. But I thank all of you again for your participation this morning. 

Let me begin, if I can, Mr. Krimminger and Ms. Williams, your 

testimony suggested covered-bond programs as now proposed could 

create the impression of implied guarantees by Federal bank regulators. One, do you agree this could be the case, and I think you 

implicitly have suggested that, and if so, then how can this be prevented? 

Ms. WILLIAMS. Mr. Chairman, the point that we noted in our testimony was that the selection of a single covered-bond regulator, 

and depending upon what entity that single covered-bond regulator 

would be, an existing agency or even if one new one were created, 

might incrementally enhance an impression that there was a Government backing of the financial performance of the bond itself as 

compared with the impression that one would take if the Federal 

financial regulators were the covered-bond regulators for the respective institutions that they supervise. So that would sort of put 

the covered-bond regulator role more in the framework of oversight 

supervision of adherence to standards that the financial regulators 

adopt and then implement and apply as opposed to having a single 

agency viewed as the covered-bond regulator. 

Mr. KRIMMINGER. I would certainly agree with Ms. Williams that 

I think there are three key factors from our view that could give 

that kind of implied, if you will, view of Government support. One 

is we certainly support the idea that there could be or should be 

standards being set, particularly by the Federal banking regulators 

or the Federal Financial Institutions Examination Council, which 

combines all the regulators. But to have direct oversight specifically for the purpose of protecting the investors’ interests versus 

the safety and soundness of the financial institutions certainly creates another level, if you will, of Federal involvement in the program. 

Chairman DODD. Would that be unique? Would that create a 

unique category, then? 

Mr. KRIMMINGER. It would create, from our view, a unique category in the United States certainly, and it is very common in Europe. You have, for example, in the European Pfandbriefe example, 

the BaFin, which is the primary regulator in Germany for banks, 

does have the responsibility by law to provide specific oversight for 

covered bonds for the benefit of investors. I think that creates a 
18 

conflict and creates certainly an implication of there being some 

support. 

The third part of that is in the resolution of covered-bond defaults, or defaults by issuers. Under the proposed regulation or the 

proposed legislation, the regulator would then be responsible for 

perhaps removing a trustee that would be used over the separate 

estate. So you have an estate leaping out, if you will, of the failed 

institution, the failed bank, depriving the banker receivership of 

collateral that benefits the Deposit Insurance Fund and other 

creditors. But, also the trustee could be removed by the regulator 

based upon the interest of the investors. That provides a level of 

oversight of the insolvency process for the private investors’ benefit 

that would be somewhat unique under U.S. law. 

I think one last point I would make is that there are very great 

differences between the U.S. system and the European system. In 

many cases in Europe, part of the support for covered bonds has 

been the fact that banks that issue covered bonds are simply not 

closed, and certainly that is not consistent with the intent of the 

Federal Deposit Insurance Act and certainly the intent of the 

Dodd-Frank Act, that is certainly not an avenue we wish to go 

down. 

Chairman DODD. No, that was one area there was pretty significant agreement, I think. 

[Laughter.] 

Chairman DODD. Let me give Mr. Stengel a chance to respond 

to that, but let me ask you a question, if I can, Mr. Stengel, and 

then give you the opportunity to respond to what has been raised 

here. The FDIC in its testimony here this morning, and I am 

quoting them here, said any covered-bond legislation must preserve 

the flexibility that current law provides to the FDIC in resolving 

failed banks, including the options of continuing to perform under 

the covered-bond program pending a sale to another bank, turnover 

of collateral to the investors, and repudiation. It was on page seven 

of the testimony. 

The Covered Bond Council testified that having all of these alternatives raises uncertainty for investors, and I think it is a legitimate point. But should the FDIC have this flexibility or should investors of covered bonds have greater certainty and the choice 

here? And again, obviously, given the history of the FDIC and how 

important that has been for avoiding the kind of problems that created the FDIC in the first place here, what about what would happen in the event of a failure of a bank that issued covered bonds, 

where you might have that certainty if you would take the Council’s point of view, but lack the flexibility that the FDIC would 

need. How do you answer that? 

Mr. STENGEL. Well, I think in a couple of ways. First, it is certainly not unprecedented. I mean, looking at just some rough data, 

the top—looking at the top 50 banks alone, they have over $1 trillion of assets pledged either under securities lending or repos, and 

that represents over approximately 10 percent of their assets. Now, 

these lenders have much more enhanced rights than anything in 

the proposal from the U.S. Covered Bond Council. 

So I think the notion that there is a dichotomy between secured 

creditors and unsecured creditors and there is uniformity among 
19 

secured creditors is not entirely accurate, that there are, in fact, 

quite a few secured creditors with quite a lot of flexibility, and particularly those with these qualified financial contracts, repos, and 

securities loans, not to mention the Federal Home Loan Banks. So 

the notion that today the FDIC has unlimited flexibility, I think is 

just not entirely accurate. 

In response to the notion about the regulator, I think certainly 

the Council understands the perspectives of the regulators and the 

concern about having a single covered-bond regulator. Our primary 

concern is a fragmentation of the market. So, for instance, if you 

were to have each individual regulator able to write separate rules 

of the road for covered bonds, that would create a fragmented market that we don’t think would be quite helpful. 

I think we could be supportive and would support, for instance, 

the Department of the Treasury writing the rules of the road and 

then having those implemented by the individual prudential regulators. That is something that seems to be a compromise that 

makes a lot of sense. 

Chairman DODD. Do either of you other two want to comment on 

this exchange, Mr. Snowden or Mr. Campo? No? 

Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman, and I thank all of 

you for your testimony. 

It seems to me the essence of the rub on covered bonds and all 

of these other things that we have talked about can be worked out 

pretty easily, but the essence is going to be the rub between the 

FDIC and everybody else. I mean, they have the ability to do whatever they wish when they resolve an institution today, and obviously a covered bond potentially eats into that flexibility. So it 

seems that to create a regimen that is going to work, that is the 

issue that has got to be—that is the rub. That is the essence of this 

entire deal. 

I will ask a couple of questions of you, Mike, but when we have 

risk-weighted sort of assessments now of institutions and if institutions are involved in covered bonds, couldn’t you—doesn’t that actually enable the DIF to be stronger when you make those assessments? I mean, isn’t that something that, on one hand, is a plus 

as it relates to the DIF itself? 

Mr. KRIMMINGER. Well, certainly, Senator. The fact that now the 

assessment process is essentially assets minus net equity does 

allow us, does allow, for example, covered bonds, since they are on 

the balance sheet, to be part of the assessment base, whereas they 

weren’t. I think the problem, however, is that the assessments 

would need to be extraordinarily high on assets if they were to 

cover against the loss of our ability to recapture the 

overcollateralization. 

And if I might just give one illustration, when Washington Mutual failed in the fall of 2008, they had one of the two covered-bond 

programs that were outstanding. At the time that they failed, the 

overcollateralization requirement by the rating agencies in the industry, if you will, to try to maintain a AAA rating, which they 

weren’t able to maintain, was 149-plus percent. So that is a huge 

amount of overcollateralization. 
20 

I think all the flexibility we are seeking would simply be that we 

would pay—and this is different from our original statement of policy, and I want to make sure that people understand that—we 

would be, under legislation be willing to certainly make sure that 

covered-bond investors were covered to the full par value of their 

bonds plus accrued interest through the date of payment so that 

there would be—that would be the full amount of debt they could 

ever claim. And I think that provides the benefit that a coveredbond investor would be entitled to. It would give a pool of cash that 

could be then either reinvested by a trustee or through a guaranteed investment contract or something to pay the cash over the 

long term, which is what the investors are looking for. 

And if I might comment on the unprecedented nature of what 

would be done for covered-bond investors, I think an important 

thing here is that Mr. Stengel mentions the qualified financial contracts. As I noted in one of the footnotes in my testimony, there is 

some additional protection provided for qualified financial contracts, but even for those contracts, you are limited to the amount 

of your collateral protection by the amount of the actual debt due 

at the time the bank fails, and that is all we are seeking here, as 

well. Covered bonds simply are not QFCs. 

Senator CORKER. So, Mr. Stengel, does the solution that Mr. 

Krimminger has offered, is that something that would create a viable covered-bond market? 

Mr. STENGEL. We could certainly build a covered-bond program 

if covered bonds were treated like qualified financial contracts. So 

if the concept is we would like to use existing precedent that qualified financial contracts or something that are known in the United 

States, and the FDIC feels like the remedies there are more consistent with something that they are familiar with and would agree 

to, I think that that could very easily be done. 

I think the counterparties under qualified financial contracts like 

repos and securities loans have a number of enhanced rights which 

we did not initially recommend because of our intent to try to accommodate concerns that we expected from the FDIC. They have 

a higher claim for damages, in fact, that includes the costs of cover, 

which covers the reinvestment risk which covered-bond investors 

are very concerned about. So that would be covered under the QFC 

structure. They have a right to take more rapid remedies. So within 1 day, if the entire covered-bond program, and, in fact, all covered-bond programs of an issuer were not moved to another bank, 

in 1 day, the investors could come in and take their collateral. They 

have immunity from nearly all avoidance actions. And there are 

limits on the FDIC’s ability to repudiate the contracts and transfer 

them. Again, they all have to go or none of them go. 

So I think if we were to use a QFC structure, the Covered Bond 

Council could be very supportive of that kind of approach, and if 

that is what is being proposed here, I think that we probably have 

a lot of middle ground to cover. 

Senator CORKER. Since it is, in essence, a debate between the 

two of you, and I notice he disagrees, go ahead. 

Mr. KRIMMINGER. That, as the Senator knows, that is not what 

we were proposing. I was just making the point that even under 

the QFCs, your value is limited to the amount of your debt. Yes, 
21 

there is a cost recovered, but you don’t get to keep your collateral 

for the balance of your contract. 

Senator CORKER. When you were moving, say, an institution fails 

and you move the covered bond off to another institution, can’t the 

FDIC sell that overcollateralization and reap some benefit from 

that? So it is not like—it is not quite like you said. I mean, you 

have a benefit there, too, do you not? 

Mr. KRIMMINGER. Well, that is one of the three options that we 

talked about. Certainly, one of the options and the preferred option—we have made this very clear in our statement of policy, as 

well—is to transfer the covered-bond program over to another 

bank, which is what we did with the WaMu covered-bond program. 

There, it is part of the assets and we are getting the benefit of the 

franchise value of that program as a liquidity tool back to the Deposit Insurance Fund. 

The reason we need the repudiation power is that in those cases 

where we cannot transfer it, there is no interest in that particular 

program and it is heavily overcollateralized. We think that the Deposit Insurance Fund and the creditors should get the 

overcollateralization, not the investors. The investors should get 

paid in full, but not overpaid. 

Senator CORKER. Mr. Chairman, my time is up. I know we have 

had debates in our conference rooms between the FDIC and others 

and we look forward to having the two of you in soon, so thank you. 

[Laughter.] 

Mr. KRIMMINGER. Thank you, Senator. 

Chairman DODD. Thank you very much. 

Senator Reed. 

Senator REED. Thank you, Mr. Chairman. 

I want to follow up the thoughtful questioning of the Chairman 

and Senator Corker and just clarify in my mind a couple of points. 

One, if there was a covered-bond program, that would require, 

since these assets are on the balance sheets, higher capital? Would 

that be a general point? 

Ms. WILLIAMS. The basic point is that there would be a capital 

requirement that would apply—— 

Senator REED. Right. 

Ms. WILLIAMS. ——because it is on balance sheet. 

Senator REED. Right. 

Ms. WILLIAMS. Yes. 

Senator REED. And in contrast to selling the mortgages in the 

secondary market where that would—— 

Ms. WILLIAMS. In contrast—— 

Senator REED. ——a bona fide real sale—— 

Ms. WILLIAMS. Yes, in contrast to a sale of the mortgages that 

would be treated under the accounting standards as a sale. 

Senator REED. So one of the things if we pursue a covered-bond 

program would be there would be a conscious decision the institution would have to make between doing covered bonds and likely 

having higher capital. That is—— 

Ms. WILLIAMS. That is definitely a factor that affects the 

attractiveness for any given issuer. 

Senator REED. And then with respect to the FDIC, is the implication in your testimony that there would be a higher assessment be-
22 

cause of the—if the rules were changed, in effect, that you would 

fully protect the covered bondholder in a failed institution, that 

would require a higher assessment? 

Mr. KRIMMINGER. I think it no doubt would. We are currently obviously looking at our assessment structure and the risk-based assessments generally because of the change to the assessment base. 

But certainly if the flexibility were taken away, we would need to 

seriously look at much higher assessments for those who issue covered bonds. 

Senator REED. So if the covered-bond program was authorized in 

the broadest framework, as the proponents suggest, two likely consequences for financial institutions would be maintaining higher 

capital, which in effect probably limits their ability to provide more 

liquidity in the marketplace, and higher assessments. So it is not 

a completely win–win for the economy, is that fair? 

Ms. WILLIAMS. I think it is absolutely fair to say that there are 

advantages and disadvantages of covered bonds relative to other 

funding options. 

Senator REED. And let me just again, to the point I sense you 

are making, is that in a failed institution, the FDIC is obligated to 

pay not just the par value plus accrued interest, but all of the interest and par value of the bond, that in some respects could be described as a subsidy by the Government to those bondholders that 

is not extended to other parties. Is that—— 

Mr. KRIMMINGER. Our view certainly, Senator, is that that would 

be—it would be certainly creating a subsidy for the covered bonds 

by the Deposit Insurance Fund, because otherwise that 

overcollateralization would come to the Deposit Insurance Fund 

now. 

Senator REED. Right. Right. And so in some respects, and Mr. 

Stengel, and I want everyone else to comment, too, there is the 

issue of uncertainty, but there is the issue of is there a disguised 

subsidy here also because of preferential rules in the failed institution. Is that one reason now that these aren’t as attractive or as 

used as they could be? 

Mr. STENGEL. I would not characterize the covered-bond programs that at least the Council has proposed as involving any Government subsidy of any kind. It is probably important to remember 

that it is the banks, after all, that fund the Deposit Insurance 

Fund. In fact, the top four banks account for approximately 40 percent of the Deposit Insurance Fund, so if there are stakeholders 

here, certainly I think the disadvantages, and the banks are aware 

that it involves higher capital and it also involves perhaps higher 

deposit insurance assessments. The FDIC before the Dodd-Frank 

Act had come out with a particular secured liability assessment to 

penalize banks for engaging in secured lending from an insurance 

assessment standpoint. 

So I think that there is a recognition that there are costs and 

benefits. I think the message that we want to convey is that if we 

are talking about covered bonds that can be accelerated, we are not 

talking about covered bonds and we can put our pencils down and 

there will be no market. And so there certainly is a different treatment for covered bonds than normal secured debt. It is not as aggressive as the QFCs. It is certainly not as aggressive as the Fed-
23 

eral Home Loan Banks. So it was something that we thought 

struck a reasonable middle ground in order to get the market and 

introduce it into the United States. But without those, there will 

be no market. 

Senator REED. Well, let me just shift briefly, because one of the 

comparisons we have is with the Europeans who use these, and 

Professor, you have pointed out that in 1916, our predecessors—I 

don’t think anyone is here from that Congress, but who knows—— 

[Laughter.] 

Senator REED. The Europeans, though, particularly, and I will 

express my ignorance, use very short-term nonrecourse mortgages 

for residential mortgages. Is there a difference between the types 

of mortgages that they are doing this routinely with that makes a 

difference? Maybe you might comment, Professor. 

Mr. SNOWDEN. I would be happy to. Again, I am not an expert 

on contemporary European practice. Actually, in the farm mortgage 

market, one of the great advantages of covered bonds there were 

very long-term amortized loans, mortgage loans, at a time in the 

United States where farmers had to rely on 3- to 5-year debt, rollover, and this is why farmers wanted a covered-bond program. This 

is why you guys passed it—I mean, not you, your predecessors. Excuse me. 

[Laughter.] 

Senator REED. Yes. We have established they are not here. 

[Laughter.] 

Mr. SNOWDEN. Right. But if I could point out that one of the 

characteristics of these early covered-bond programs in Europe 

were they were monoline. This was their job. This was all they did. 

And I think as you think about these issues of insured institutions 

taking on this product line, one way of thinking about the subsidy, 

to me, is what would this business look like if it stood alone, and 

especially, I think, it makes you look at the dynamic pool aspect. 

People complain about securitization. One thing about 

securitization that is good is once you stick the loans in there, no 

matter how they perform, they stay there. In a dynamic pool, you 

are going to have—if there are any problems in that pool, those 

loans have to be pulled out. Now, this is what my guy did in Kansas in the 1880s. He was able to put them behind his covered 

bonds because there was no regulation of covered bonds and he 

bilked people this way. 

I think the concern—we are not in that situation today, obviously, but if there is any difference between underwriting standards in the covered-bond program and whoever else the deposit 

fund is supporting, there is going to be shifting of risk between 

those programs. 

The other thing is, when you talk about subsidy, if these were 

stand-alone businesses, these covered bonds, who would cure the 

bad loans? And that would have to be a cost of business. 

I will just bring up this last point, and a difference with Europe 

is at least in my time period, foreclosure was very rapid in Europe. 

These mortgage banks could take over foreclosed land in 15 days 

in some cases, which means not only could they cure defaults very 

rapidly, they were expected to. In the United States today, we have 

a problem where foreclosure is a long process, apart from the 
24 

securitization problem. I mean, I understand that. But just the fact 

of doing it. So you are going to have default pools sitting there. 

Where will they sit? Who will fund those default pools, because 

they have to be pulled out from behind the secured bonds. 

Senator REED. Thank you. My colleagues have been very gracious. Just one other point, and I will make it and if you have to 

correct me, please correct me. I have been told basically, too, that 

in most mortgage arrangements in Europe, there is personal liability, as well, so that you can’t just sort of walk away, they take the 

house and you are fine. They come after you. And that makes a difference in terms of what these types of pools will look like. 

Thank you, Mr. Chairman. You are very kind. 

Chairman DODD. Thank you very much, Senator. 

Senator Merkley. 

Senator MERKLEY. Thank you very much. There are many aspects of this strategy that are extremely appealing. One certainly 

is that rather than having a pool of securities to which the rights 

are sold to the cash-flow and then those bonds are remixed into a 

second waterfall and a third waterfall and so forth, but it makes 

it impossible, Professor, to know what they are buying, this is a 

much more direct transaction, potentially, and this is what I want 

to ask. 

Would the structure be limited to a bank having a pool of loans, 

mortgages, and as you mentioned potentially other products, loan 

products, against which they are providing the collateral for essentially the loan to the bank, for the bond, or would banks be buying 

other bonds that they then use as collateral, and then would the 

bonds against those pools, would they be able to buy those so we 

end up with the same multilayered complexity that makes it impossible to understand the true nature of the collateral that we 

have in the mortgage market now? 

Mr. STENGEL. At least under the Council’s proposal, it would be 

a single eligible asset class, which would be loans, backing a single 

issuance of covered bonds, so something much more straightforward. There would be the opportunity to invest proceeds in 

Treasuries and other what we call substitute assets, which are 

really cash equivalents. But the notion of the CDO-squared or 

cubed is not something that we are looking for. 

Senator MERKLEY. I am very glad to hear that. Another challenge we had was with rating agencies not having access to all the 

details of the specific loans themselves. Is it envisioned under this 

proposal that a rating agency would be involved to help establish 

to investors the quality of the underlying collateral, and would they 

have access to all the loan-level detail? 

Mr. STENGEL. It is expected that covered bonds would receive a 

rating, assuming we still have that process going on in the wake 

of the Dodd-Frank Act. And so certainly as part of that process, 

rating agencies would have access to whatever they felt was required in order to provide the rating. 

On that point, I think it is worth noting, none of these programs 

have a trip wire on the rating. So the notion that they have to keep 

putting in good assets to maintain a rating which is a covenant in 

the documents is not required. The rating agencies will provide 

their rating and certainly, as the regulators have done in the past 
25 

using their existing cease-and-desist authority, and certainly all 

the new powers under the Dodd-Frank Act, have more than enough 

power to say, you are not going to put any more assets into the 

cover pool just to maintain a rating. So the rating agencies will be 

involved, and I think there are a lot of protections to make sure 

that that process does not go off the tracks. 

Senator MERKLEY. If we turn the clock back just a little bit, the 

pools that were utilized in the CDOs and CDO-squared, there was 

also a right to substitute failing bonds, and there was a—an account manager had a responsibility to do that. For some reason, 

that really didn’t unfold in a manner that sustained the value of 

those pools and it all collapsed and I never really quite caught 

what went wrong in that substitution process. 

Mr. STENGEL. In the case of CDOs, it really was—to some degree, 

they worked in the sense that they transferred the risk of the underlying assets to the investors. I think the issue was there were 

no good assets to bring in and substitute because the CDOs weren’t 

set up to actually have an originator like a bank that makes loans 

and can put new assets into a pool, much like you think of any 

commercial lending with a borrowing base and that there is a revolving inventory of assets coming in and out. So CDOs weren’t set 

up that way. So while there was a possibility of going out and 

bringing in new assets, ultimately, you were limited to the proceeds 

of what you had available to begin with and those just turned out 

to be very risky and for a lot of loss. 

Senator MERKLEY. So let me turn to another piece of this. We 

have had a lot of discussion in this Committee about the situation 

where firms that originate securities should be limited, or people 

had various opinions, I had the opinion they should be limited in 

their ability to buy insurance that exceeds the value of the bonds 

they are issuing, in other words, gamble on the failure of the very 

products they are selling to the public. That was addressed in the 

Merkley-Levin Amendment. 

Do you anticipate here that banks would be able to hedge their 

risk by purchasing insurance against the failure of the product, 

and if they were allowed to do that, would that be limited to the 

value of the product so that they are not actually gambling on the 

failure of what they are selling? 

Mr. STENGEL. I think just a couple of points. You know, the 

Council, because of its unique composition, being equal investors, 

dealers, and issuers, we spent months having a very, very robust 

debate among ourselves, and we few lawyers who were allowed to 

tag along tried to proxy for regulators and the consumer, about 

how to create a benchmark covered-bond market. You know, there 

may be folks—there are a lot of smart folks out there and they may 

be able to come up with structured covered bonds and covered 

bonds that do all kinds of different things. But we wanted to propose legislation to the Members of Congress that would create a 

benchmark very safe and conservative market. So the kinds of 

things that certainly the Dodd-Frank Act was very focused on is 

not something at all that we are contemplating in the context of 

a covered-bond market. 

Now, banks, I am sure, will hedge the assets on their balance 

sheet, their interest rate risk, their currency risk, according to pru-
26 

dent risk management standards as dictated and informed by regulatory standards. But nothing of the kind that I think you are talking about is contemplated, at all. 

Ms. WILLIAMS. Senator, if I could just add to that and reinforce 

the last point that Mr. Stengel made, the assets remain on the institution’s balance sheet and so we will continue to have the concerns that we would have as a supervisor with respect to effective 

sound asset liability risk management. 

Senator MERKLEY. I believe the—oh, please, go ahead. 

Mr. KRIMMINGER. I am sorry to interrupt. I just wanted to make 

one comment on one point Mr. Stengel made just to make sure that 

it is clear. While there is not a trigger in the documents requiring 

it based upon rating agency action to replace delinquencies, there 

are contractual provisions that require replacement of delinquencies over a certain date so that this is a constantly refreshing 

pool. So there is constantly the requirement to put new loans in. 

So there is a benefit to the investors of having a quality pool 

throughout the time supporting a security for the general obligation of the bank, and our point really is that once the institution 

closes, no one is going to be adding to that pool. You are going to 

have a diminishing asset pool that is going to be of diminishing 

value. 

We just believe that the investors should not get the benefit of 

a constantly refreshing pool but then be able to take all the collateral after a failure as you would with a securitization that is off 

balance sheet. They should get one or the other, but not both. 

Senator MERKLEY. OK. Let me turn to a piece of the FDIC action 

in this regard, which is in 2008, a rule issued that limited covered 

bonds to, I think, 4 percent of the capitalization. Can you comment 

on that, because there is a concern that that type of limit would 

prevent development of a robust covered-bond market. 

Mr. KRIMMINGER. That was a statement of policy that was issued 

by our board in July of 2008, and we had a 4-percent limit there 

in part based upon prior precedent of countries that had begun to 

introduce covered bonds, both in the United Kingdom and in Canada. In their early introduction of covered bonds, they had a 4-percent limit, as well. We were simply modeling on that with the expectation, which we stated up front in our board meeting as well 

as in the document, that we could limit as the market developed. 

We had talked with major issuers and they were of the view that 

4 percent would be—was far in excess of their immediate plans to 

expand the programs they had as far as new issues, as well. So it 

was not going to be a constraint at the beginning of any type of 

covered-bond program. So we felt that that would be something 

that could be modified going forward. 

Senator MERKLEY. I want to thank you all. I am way over my 

time. I thank the indulgence of the Chair, and I appreciate this discussion as we think about Fannie and Freddie and how we make 

home mortgages work in America. It is very helpful. 

Chairman DODD. Thank you, Senator. 

Let me ask a question and turn to Senator Corker for any questions he has. One, I would like to get Mr. Campo into this conversation a bit on the rental housing aspects of all of this, and he 

makes a very good point. One of the very legitimate complaints 
27 

over the years is that we have placed so much stock on home ownership, which has value in my view, and so very little increasing 

the stock of rental housing in the country that I think we contributed in no small measure to the problems we have been wrestling 

with over the last several years. 

But I wonder if, Mr. Stengel, you might comment on Mr. 

Campo’s testimony, his concern in the multifamily housing context, 

the problems posed by covered bonds. 

Mr. STENGEL. I think Mr. Campo’s point is very well taken in the 

sense that covered bonds will not replace securitization. Just looking at some quick figures, in 2006, the volume of securitization was 

$2.4 trillion—$2.4 trillion of issuance. Thus far in 2010, there is 

$0.4 trillion in issuance. And because securitization involves transferring these assets onto the balance sheets of investors, you are 

talking about $2 trillion—and this is just private label ABS and 

RMBS, so it doesn’t include the agencies. So you are talking about 

$2 trillion of balance sheet that has been wiped away until the 

securitization market is resuscitated. So I think Mr. Campo’s point 

there is very well taken, that covered bonds are no substitute. They 

are a complement, but no substitute for securitization. 

I do think, at least based on the views expressed by the Council, 

that commercial mortgage, including multifamily covered bonds are 

something that are being actively looked at by potential issuers 

once the market gets up and running. Whether those are first out 

of the gate, I don’t know, but I don’t think they will be relegated 

to the sidelines at all. I think they will be center in the target of 

possible issuers. 

Chairman DODD. I would encourage you to look at that and offer 

those ideas, because I think, and again, I am speaking for myself, 

but I think one of the things I feel strongly—I am looking at my 

own State of Connecticut where you have got to have an income of 

$20 an hour on average to afford a two-bedroom apartment, a rental unit. We have such a paucity of stock that obviously the supply 

and demand issues have driven up the cost tremendously, driving 

it out of the range of an awful lot of people who need that rental 

housing market to provide decent shelter for themselves. So to the 

extent we can increase the opportunity if the covered-bond market 

is going to be developed here that would allow for it to be used in 

the multihousing area would be important, it seems to me. 

Mr. STENGEL. We completely agree, Senator. 

Chairman DODD. And last, I wonder if you just might quickly, 

and maybe if you want, obviously, what the most important consideration the Committee should keep in mind in the issue of regulating covered bonds going forward. Why don’t we begin with you, 

Ms. Williams. Tell me one or two things you think we ought to 

really keep in mind as we look at this. 

Ms. WILLIAMS. I think that the conversation this morning has 

really highlighted the central issue. There is a tradeoff here with 

issues that are important to the FDIC. The set of issues that they 

have identified center on the differences between covered bonds 

and what we have now. 

Chairman DODD. Yes. 

Ms. WILLIAMS. And to the extent that you want to move to something new, you are implicitly raising issues about having something 
28 

different from the traditional way that the FDIC has viewed these 

situations. There is very much a balance for policy makers, a very 

interesting set of issues here to resolve. 

What I hear the Covered Bond Council saying is that some of the 

features that are most critical to the success of having a robust covered-bond market in the United States are the very features that 

the FDIC has the concerns about changing. 

Chairman DODD. Yes. 

Mr. KRIMMINGER. I would just note that I think the key concerns 

are making sure that we don’t create a super class of investments 

that can create mispriced risk and we should not transfer that risk 

on to the Deposit Insurance Fund in the case of a failure. 

I would note also in response to one of the comments made earlier that although it has been stated, and I know this is the argument of the Council, that a covered-bond market cannot develop if 

the FDIC has the power to repudiate, I think there were certainly 

two very large programs that were developed before the financial 

crisis where that power still remained with the FDIC, and we are 

willing certainly to clarify these powers further. But I think it 

might be a bit of a misstatement to say that the market cannot develop. The financial crisis has sort of interrupted the markets here 

and in Europe. 

Chairman DODD. Mr. Stengel. 

Mr. STENGEL. Mike is a friend, and we have known each other 

a long time. And I grew up in my early years as a bankruptcy lawyer, so I, more than most, am sympathetic to the FDIC’s concerns 

and appreciate them. The netherworld of receivership and bankruptcy is neither glamorous nor easy, and I think the FDIC does 

excellent, excellent work and excellent public service. 

But the perspective is a narrow one. There is a reason we don’t 

have our funeral directors and life insurance companies dictating 

every aspect of our lives. There would be no airplanes. There would 

be no deep sea research. And there certainly wouldn’t be anybody—— 

[Laughter.] 

Mr. STENGEL. ——there would be nobody walking outside of 

those white lines of the crosswalks. 

Chairman DODD. Dodd-Frank has funeral plans all through 

here—— 

[Laughter.] 

Mr. STENGEL. There is no life in that world and there certainly 

is no economic recovery. We do need to be very prudent and have 

cautious risk management, but we need to be able to breathe. 

Those two issuers that Mike referenced are on the Council and 

we have heard in no uncertain terms that there were programs developed, very unique structures because we have much more debtor-friendly insolvency laws in the United States than exist in Europe, so we are already starting from an investor standpoint with 

strikes against us. There was a very elegant and careful structure 

created, but it is one of a bygone era, one of a very frothy market 

which is not with us anymore and we don’t foresee coming again. 

So I am very confident in the instructions that I have been given 

from our Council to say that without those twin pillars, the public 
29 

supervision and the separate resolution process, we should shift the 

focus to other avenues. 

Chairman DODD. Mr. Snowden, any comments, or Mr. Campo? 

Mr. CAMPO. Yes. I think it really gets down to balance, because 

what we are talking about here is the balance between sort of what 

product is used to finance housing overall. Between now and 2015, 

it is predicted by the Harvard Joint Center that two-thirds of the 

households will be renters. That is six million people. And what is 

happening right now in the marketplace is that the multifamily 

business is doing very well with the existing model, as evidenced 

by Freddie Mac making $1 billion in profits net of charge-offs that 

have been used to fund the losses they have experienced on single 

family. 

So we as an industry know that we have to finance. We know 

that the balance between our financing models needs to change 

over time and it is all about sort of a balanced housing policy in 

conjunction with a balanced finance policy and I think covered 

bonds are clearly an area that make some sense, but we just have 

to be thoughtful about it where we are not crowding out other 

parts of the financial market. 

Chairman DODD. I agree with that. 

Senator Corker. 

Senator CORKER. Well, thank you, and I want to thank, even 

though Mr. Snowden and Mr. Campo, I have no questions, I want 

to thank you for the historical perspective, which is also always 

very useful, and certainly some of the rubs that you can create in 

the multifamily market by taking away resources, I appreciate you 

saying that and agree with the Chairman that certainly having 

more affordable rental stock might help in certainly times like 

right now. 

But I want to move back to the first three and say that I know 

we are not going to resolve the issue of the rub today and I look 

forward to having, seriously, both of you all in our conference room 

and trying to figure out a way to resolve that rub. 

But I do want to go back to something Senator Reed mentioned 

because we will be talking about just home finance, mortgage 

issues, I think, in a very focused way over the next year or so. The 

issue of personal recourse loans, I have to be candid, I was a fairly 

sophisticated borrower and was shocked when I got to the Senate 

and realized that people had no recourse mostly in residential 

loans. And I know that as we tried to address that during the debate on Dodd-Frank, we realized there were some State Constitutions around this country that kept there from being any recourse 

against home mortgages. I don’t know how many there are. There 

are a handful. But what happened, I guess, over time is the mortgage industry said, look, it is just easier not to have recourse if 

some States you cannot do that. 

What impact do you think that would have, though, if somehow 

or another we were able to create a situation where there was personal recourse on home mortgages? What would that do to the durability, if you will, of the mortgage market and what effect do you 

think that would have? 

Ms. WILLIAMS. The imponderable there is to what extent that the 

existence of personal recourse would significantly affect default 
30 

rates, and I don’t know personally how to answer that question 

right now. 

Mr. KRIMMINGER. I would just note that I think I agree with Ms. 

Williams. I think it is hard to predict exactly what the effects 

would have. I mean, obviously, there are many States in which 

there is recourse. There tends to be a very involved process, of 

course, of going through a judicial foreclosure process in order to 

retain that recourse right, so many lenders simply avoid the judicial foreclosure route and go through a more streamlined route and 

don’t have the recourse. 

It certainly might, if there is an impact upon defaults, reduce the 

cost of mortgages to some degree, but it is really hard to predict 

because you would need to have some real comparisons to make 

any judgments about the potential risk impact on the mortgage 

lending process, either from the investors’ or from an issuer’s perspective. It is a little unclear at this point. 

Senator CORKER. Mr. Stengel. 

Mr. STENGEL. I think that is an incredibly difficult issue and I 

think it is one that not only needs to be explored in the economic 

context of default, but how individuals are living their lives and 

able to maintain a certain standard of living. So I think that is an 

extraordinarily complex part of the debate and might well be that 

be one of the options and that might make a lot of economic sense 

in whatever comes out of housing finance reform. But I am certainly neither edified nor intelligent enough to speak on it today. 

Senator CORKER. Our resident historian? 

Mr. SNOWDEN. Yes, neither edified nor—— 

[Laughter.] 

Mr. SNOWDEN. In any case, that was very well done. We do have 

a little experience of what happens. The problem with judicial foreclosures, they have to be fair. This is one of the examples, mortgage market institutions generally work very well for idiosyncratic 

risk. It is when the system gets dumped and you have lots of foreclosures. 

And so what has happened is in the 1930s, we had 23 States 

pass foreclosure moratoria. We just stopped the process because no 

longer can the recourse—without a fair market, you cannot determine what the amount of recourse ought to be. Well, the argument 

is anyway, and it is persuasive enough that we see that. 

So I would be—I think it would work very well on idiosyncratic 

risk. I don’t think it would fix what we are going through right 

now. I think it would be very difficult to maintain recourse in this 

environment and has been. 

Senator CORKER. As a practical matter, it would be tough. 

Should we—on the covered-bond market, should we—one of the 

writers gave us some input before we came today and mentioned 

that one of the problems with the House bill is there is no homogeneous fashion to these covered bonds. I mean, you are talking 

about cats and dogs. Should we look at that as one of the criteria 

on covered bonds, to create a slightly more homogeneous nature for 

the loans that would be in these covered-bond sales? 

Ms. WILLIAMS. I think that the—your starting point is determining what your threshold eligible asset categories would be, and 

then you certainly could specify as a direction that there should be 
31 

some principle or desirability of the nature of the loans being homogeneous. I think that from the perspective of the issuer trying 

to put together a pool and determine what the appropriate 

collateralization, overcollateralization level would be and just the 

predictability of the risk, the issuers are going to be attracted to 

having loans that are of a homogeneous type in the covered-bond 

pools as opposed to having lots of sort of cats and dogs. 

Mr. KRIMMINGER. If I might note, as well, we worked very closely 

with the Treasury Department in mid-2008, early 2008 on the development of what was viewed at that time as the gold standard 

for covered bonds. It was issued as a Treasury Department document in August of 2008. Obviously, we know what happened in 

September, so nothing really happened as a result of it. 

And one of the principles behind that gold standard was that if 

you create a very high standard for the types of collateral that 

would be in the cover pool and you create a homogeneous pool, particularly with some substitution rights, then it would give investors 

more confidence starting out in the market. Then the market could 

be expanded beyond that as the market gets more solidified. 

And despite being described a bit as the dead hand of insolvency, 

I think the FDIC is in the market on a very frequent basis and 

what we are seeing really in the marketplace is I think there is 

certainly interest in different types of investment vehicles, but 

what we are really talking about when you get down to the brutal 

facts of it is money. You know, different options that we are talking 

about are really affecting how much money the issuers are going 

to make, much more than how interested investors will be in the 

particular product, because there are ways of dealing with that acceleration risk. I think there are ways of trying to accommodate all 

of these issues, and hopefully we can work those out. 

Mr. STENGEL. I certainly didn’t mean to suggest dead hand, not 

at all. 

There is some irony, of course, in the gold standard because it 

is highlighting the fact that it should have a lot of high-quality assets, so I think it highlights Ms. Williams’ comment about there is 

some balance here. We want risk retention, but we don’t want a 

lot of high-quality loans all going into cover pools while bad loans 

stay behind. So there is some balance on that particular issue. 

We have viewed at least the approach to covered bonds as being 

layered, the legislative framework providing the foundation. As Ms. 

Williams suggested, more specific regulator descriptions about eligibility in the cover pool, if homogeneity is important, if a certain 

style of loan, a certain either kind of product or certain quality, and 

then on top of that, individual transactions may differ. So the legislative framework would be the foundation on top of that regulation 

setting a minimum standard with more specificity, and then within 

those boundaries, individual issuers could go out and do transactions, and I think the view of the Council, including the institutional investors on our Council, is that there will be a lot of homogeneity to begin with, and the market will dictate a lot of that. 

Senator CORKER. Mr. Chairman, I know that you are a shorttimer and there is probably some celebratory lunch that you need 

to go to, so I will stop now—— 

[Laughter.] 
32 

Senator CORKER. ——and I look forward to carrying on this conversation with these folks later on. But thanks for having a most 

interesting hearing at a time when nothing much else interesting 

is happening. Thank you. 

Chairman DODD. And that lunch is with my niece, who has come 

to town. 

[Laughter.] 

Chairman DODD. So it has come down to your family at the end 

of your career. No one else will have lunch with you. 

[Laughter.] 

Chairman DODD. It has been a good hearing, very informative. 

And again, to both of our lead witnesses here, we thank you for 

your service. Just listening to the two of you, how valuable it is to 

have people with your background and knowledge, and I appreciate 

Mr. Stengel talking about the relationship you and Michael have 

had over the years just in dealing with these issues. That is a comforting note, that you actually talk with each other with some frequency about these matters, as well. So that is an encouraging 

sign. 

At a time when we realize the environment we are in, but I 

think it is important in an environment like this to remind in a 

public setting that we are so blessed in this country to have talented people who give their lives to public service, and the two of 

you have and I want to express my gratitude to you. 

The Committee will stand adjourned. 

[Whereupon, at 11:41 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 
33 

PREPARED STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Today, the Banking Committee will hear testimony on covered bonds, a potentially significant alternative means for raising capital for housing finance. Covered 

bonds have been issued widely in Europe for many years, but not in the United 

States. The purpose of today’s hearing is to learn more about covered bonds, exploring whether they could contribute to sustained economic growth and whether it is 

in the public interest to encourage their broader use in the United States. 

The hearing grew out of discussions on covered bonds that came up during the 

latter part of the Senate–House conference for the Dodd-Frank Act. I am pleased 

to have worked with Ranking Member Shelby and Senator Corker in organizing the 

hearing. As the Banking Committee has not previously held hearings on covered 

bonds and the subject has raised issues among Federal regulators, we determined 

to explore the matter more carefully before acting. 

When speaking of a covered bond in the U.S. context, we generally mean a debt 

security issued by a bank and backed by cash flows from mortgages or public sector 

loans. The bond is backed both by the bank’s promise to repay and by the assets 

pledged as collateral. 

Covered bonds can provide an additional option to the two dominant funding 

mechanisms in the U.S. marketplace, which are securitization and the traditional 

portfolio lender model, where a bank holds mortgages on its balance sheet and funds 

them with deposits. Proponents of covered bonds point to their greater transparency, because these assets remain on a bank’s balance sheet so investors can 

analyze their value more easily than in the case of some other asset-backed securities. Proponents also note that issuers of covered bonds have a long term interest 

in the underlying loans because they keep them on the balance sheet, which increases investor confidence. 

While American banks are not prohibited from issuing covered bonds to raise capital, few currently do so. Some potential investors are concerned about the treatment of covered bonds if the issuer goes into conservatorship or receivership. They 

believe that legislation and agency rulemaking are needed to provide clarity about 

how covered bonds would be regulated. Any such measures would define the rights 

and responsibilities of investors, issuers, and regulators. They feel that this would 

stimulate the growth of a larger domestic covered-bond market. 

It is important that Congress look for alternative measures that could stimulate 

the economy. The Committee is holding today’s hearing to learn more about this alternative and whether it will contribute to safe, stable, and sustained economic 

growth. 

We are pleased to have before us experts who will provide testimony about the 

history of covered bonds, their uses and potential benefits, as well as their interaction with existing mortgage financing mechanisms. The panel also includes Federal regulators who can share their perspective on the regulation of banks that 

would issue covered bonds, including the impact on the Deposit Insurance Fund. 

On the first panel, I am pleased to welcome Congressman Scott Garrett, who has 

a strong interest in this area and introduced legislation on covered bonds. On the 

second panel, we will hear from Julie Williams, Chief Counsel and First Senior Deputy Comptroller, Office of the Comptroller of the Currency; Michael Krimminger, 

Deputy to the Chairman, Federal Deposit Insurance Corporation; Scott Stengel, on 

behalf of the U.S. Covered Bond Council; Professor Kenneth Snowden, University 

of North Carolina at Greensboro; and Mr. Ric Campo, on behalf of National Multi 

Hhousing Council and the National Apartment Association. 

PREPARED STATEMENT OF SENATOR TIM JOHNSON 

Thank you, Mr. Chairman. While covered bonds have been used in Europe, they 

are not widely used here. I look forward to hearing from our witnesses regarding 

the potential for a covered-bond market here in the United States. 

In addition to various covered-bond proposals being considered by the Congress, 

it is important that we explore the many different ways mortgage markets are 

structured and their ability to maintain stability through the recent economic downturn. As our economy stabilizes, the Dodd-Frank Wall Street Reform bill is implemented and we look towards a new structure for the housing finance system, we 

will need to have extensive discussions about the benefits and pitfalls of any potential changes. 

We face a fragile housing market and our decisions should not exacerbate that 

situation. It is our responsibility to ensure that the regulatory structure will support 

a functioning housing market and maintain long-term, fixed-rate mortgage financing at reasonable interest rates. I look forward to learning from our witnesses—spe-
34 

cifically how covered bonds might achieve this goal, what parts of the banking sector 

have the capacity to utilize cover bonds and how other covered-bond markets have 

responded to the economic downturn. 

PREPARED STATEMENT OF REPRESENTATIVE SCOTT GARRETT 

Thank you, Chairman Dodd and Ranking Member Shelby, for holding this hearing 

today and inviting me to testify before you. I also want to thank Senator Corker 

for all of his hard work and advocacy on creating a U.S. covered-bond market. 

As our Nation continues to recover from the recent financial crisis and certain 

credit markets remain locked, Congress must examine new and innovative ways to 

encourage the return of private investment to our capital markets. We must also 

consider creative ways to enable the private sector to provide additional consumer, 

commercial, public sector, and other types of credit. Establishing a U.S. coveredbond market would further these shared policy goals. 

One reason I am particularly fascinated with covered bonds is the fact that they 

can be a purely private means of finance without Government guarantees or subsidies. Many proposals to help alleviate the current strains in our credit markets 

focus on Government loans or guarantees. However, I believe covered-bond legislation offers a way for the Government to provide additional certainty to private enterprise and generate increased liquidity through the innovation of a new marketplace without putting the taxpayers on the hook. 

There are many potential benefits for a wide variety of interested parties that can 

be derived from a U.S. covered-bond market: 

• Consumers will experience lower loan rates because of the additional liquidity 

in the various asset classes. 

• Consumers will also be able to more easily have their loans modified because 

the loans will still be on the balance sheet of the originating institution. 

• Investors will have a new transparent and secure vehicle to invest in. This will 

allow for additional diversification within their portfolios. 

• And finally, the broader financial markets will benefit by having an additional, 

low cost, diverse funding tool for financial institutions. 

Covered bonds will ensure more stable and longer term liquidity in the credit 

markets, which reduces refinancing risks as well as exposure to sudden changes in 

interest rates and investor confidence. And they will allow U.S. financial institutions 

to compete more effectively against their global peers. 

In the House, we have worked in a very constructive bipartisan fashion to push 

the ball forward on comprehensive covered-bond legislation. Chairman Kanjorski, 

Ranking Member Bachus, and I have introduced three different versions of coveredbonds legislation. The most recent is H.R. 5823, the U.S. Covered Bond Act of 2010. 

A week before the August recess, we successfully marked up the legislation and 

reported it out of Committee by a unanimous vote. It is my hope that we can pass 

this legislation out of the House over the next several weeks. 

Some have asked why we need covered-bond legislation. Simply, to get the market 

off the ground and provide investors with the needed confidence to invest in the 

product, the resolution procedure of a bond when an issuer fails needs to be spelled 

out specifically in statute. Otherwise, without the certainty of a legally binding process, there is not significant enough appetite from the investor community to make 

covered bonds cost-effective for issuers to offer. Also, a regulatory regime needs to 

be put in place to ensure proper oversight of the marketplace. 

Throughout this process, there have been some people who have said, ‘‘Let’s wait 

and do this next year with housing finance reform.’’ But the proposal we are discussing today is broader than just housing finance. Covered bonds offer a complementary source of funding that can spur much-needed lending to consumers, 

small businesses, and State and local governments. 

The reason why I have been so active in pushing covered bonds this year is because I believe they could help NOW. We hear almost daily about the liquidity concerns throughout various asset classes. The House Financial Services Committee 

held a recent hearing about the lack of liquidity in the Commercial Real Estate market. The Senate just passed a bill already approved by the House with the intent 

of providing more liquidity to small businesses. 

Also, we have all spoken to local and State officials about the problems municipalities face with increased funding costs for their projects. The President has continuously stressed the need to help these segments of the economy and this legisla-
35 

tion is one we can pass immediately. More importantly, this is something we can 

pass immediately at NO cost to the taxpayer. 

Another reason to move quickly on establishing a covered-bond market in the U.S. 

is because billions of U.S. investment dollars are moving overseas and north of the 

border. So far, in 2010, there have been a dozen covered-bond deals issued by foreign banks to U.S. investors totaling close to $18 billion. This is U.S. private capital 

that could be invested here and help with our consumer needs. 

Private industry realizes that we are currently missing out on an opportunity as 

well. I have formal letters of support for the U.S. Covered Bond Act from: the National Association of Realtors, the Mortgage Bankers Association, the American 

Bankers Association, the National Multifamily Housing Council, the National Apartment Association, the CRE Finance Council, the Real Estate Roundtable, SIFMA, 

the American Securitization Forum, the Financial Services Roundtable, and others. 

Now, I don’t pretend to believe that covered bonds are some sort of magic bullet 

that will help solve all of our funding needs. However, what I do know is that during a time of economic uncertainty, lack of liquidity and rising budget deficits, we 

must consider innovative approaches to help attract private investment back into 

our capital markets. I believe this legislation can help us in that regard. 

I thank the Chairman and Ranking Member again for holding this hearing and 

inviting me to testify. I look forward to any questions you may have. 

PREPARED STATEMENT OF JULIE L. WILLIAMS 

FIRST SENIOR DEPUTY COMPTROLLER AND CHIEF COUNSEL, OFFICE OF THE

COMPTROLLER OF THE CURRENCY

SEPTEMBER 15, 2010 

Introduction 

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, my 

name is Julie Williams and I am the Chief Counsel and First Senior Deputy Comptroller at the Office of the Comptroller of the Currency (OCC). I appreciate the opportunity to testify on behalf of the OCC today about covered bonds, their potential 

uses and key issues that they present for policy makers. 

The OCC recognizes that covered bonds can play a role in an institution’s overall 

funding strategy, offer a new source of funds for lending activities, and provide an 

alternative source of liquidity for financial institutions. Over the past few years, the 

OCC has supported efforts to remove obstacles to the development of this market. 

My testimony today first briefly reviews the characteristics of covered bonds and 

their pros and cons relative to other funding options. The second portion of my testimony focuses on a set of key issues that would define the essential framework for 

a statutory covered-bond program. 

Part I. General Information on Covered Bonds 

Covered bonds are debt obligations issued by a financial institution. The bonds 

are backed both by the institution’s promise to pay and by a dynamic pool of assets 

pledged as collateral that comprise what is referred to as the ‘‘cover pool.’’ The underlying assets are typically high quality assets, subject to various eligibility criteria 

and must be replaced by the institution should they fail to meet specified criteria. 

Investors look first to the institution to make payments on the bonds, but investors 

also have a claim against the cover pool that has priority over unsecured creditors 

of the institution. This is commonly referred to as the ‘‘dual recourse’’ feature of covered bonds. There is no single definition of a covered bond, however. Covered bonds 

have been issued using different transaction structures and sold with varying features in many European countries for centuries. 

Covered bonds may provide financial institutions, including depository institutions, an alternative to securitization and other funding options. For the banking 

system, covered bonds provide a funding source that is longer-term and more stable, 

and potentially less expensive than currently available alternatives, and may also 

require less collateral or accommodate broader types of collateral than current options. Because the bank retains the credit risk on the collateral for a covered bond, 

it has a strong incentive to maintain prudent underwriting standards for those loan 

assets. The structure of risk associated with covered bonds also may attract types 

of investors that would not otherwise invest in general bank debt. 

Covered bonds are well-established in Europe as a means for facilitating mortgage 

financing. Many European jurisdictions have a public supervisor specifically dedicated to set uniform standards and regulate covered bonds. A statutory structure 
36 

1 Covered bonds have no credit risk tranching as is the case with securitizations. 

for covered bonds in the U.S. would potentially remove one obstacle to growth of 

a U.S. covered-bond market. 

A. Comparison With Securitization 

Covered bonds differ from typical securitizations in ways that offer benefits and 

disadvantages. Investors may have more confidence in covered bonds because they 

are less complex and more transparent. 1 As noted above, covered bonds provide investors dual recourse against the issuer and the cover pool, which is segregated and 

managed exclusively for the benefit of the covered bondholders. In contrast, 

securitizations in the past typically have been off balance sheet transactions and 

provide investors fewer sources of repayment. 

The collateral underlying covered bonds is dynamic—underperforming or prepaid 

assets must be substituted with performing assets. Assets underlying securitizations 

are typically static, with the notable exception of credit cards. In the case of default, 

covered bonds are structured to avoid prepayment prior to maturity, whereas 

securitization investors are subject to prepayment risk in the event of a default on 

an asset held as collateral or prepayment of such assets. 

Covered-bond issuers typically have a longer-term interest in the performance of 

the assets underlying the cover pool than issuers in typical securitizations because 

of the bonds’ structure and dual recourse features. In addition, the cover pool typically remains on the financial institution’s balance sheet, whereas the assets backing a securitization usually do not. This may give investors more confidence in covered bonds because it creates an incentive for the institution issuing the covered 

bond to adhere to strong underwriting standards. This feature also may enhance the 

transparency of covered bonds because covered bonds are not structured into complex tranches. 

Covered bonds also permit issuers to lengthen the maturity profile of their liabilities by issuing bonds with long-dated maturities to support long-dated assets. This 

may enhance the ability of banks to avoid maturity mismatches in their assets and 

liabilities. But, compared to securitizations, an increased reliance on covered bonds 

also could increase maturity mismatch risks because of the difficulty in forecasting 

with certainty the actual maturity of many loan products. In contrast, for 

securitizations, banks can sell their longer term assets and avoid maturity mismatch risks associated with longer-dated mortgages and other similar assets. 

Because covered bonds remain on an institution’s balance sheet, the institution 

must hold more capital than in a typical securitization. Thus, capital requirements 

could constrain the growth of the covered-bond market. New accounting rules, upcoming changes in capital rules that may require higher levels of capital for assets 

held on a bank’s balance sheet, and the ‘‘skin-in-the-game’’ securitization provisions 

in the recent Dodd-Frank Wall Street Reform and Consumer Protection Act, which 

require forms of risk retention for securitizers of loans, are among the factors that 

may have an impact going forward on the relative advantages and disadvantages 

of covered bonds and securitization for financial institutions. 

B. Comparison With Other Funding Options 

Covered bonds also offer a potentially less expensive and more liquid funding 

source compared to senior, unsecured debt. 

In contrast to Federal Home Loan Bank (FHLB) advances, for example, covered 

bonds offer issuers access to a potentially wider investor pool. Financial institutions 

may issue covered bonds without becoming a member of a FHLB. Covered bonds 

could offer more attractive pricing, transparency, and lower collateral levels than 

some FHLB requirements. The amount, type, and quality of collateral pledged to 

covered-bond issuances also may provide institutions with additional options to obtain funding. The extent to which there are advantages will depend upon details of 

how the U.S. covered-bond program is implemented as well as other regulatory developments mentioned above. 

Part II. Key Issues for the Framework of a Covered-Bond Program 

The U.S. does not have a specific statutory covered-bond framework, although various legislative and regulatory efforts have emerged over the past few years, particularly in response to recent years’ mortgage market turmoil. These proposals 

have included a variety of mechanisms for designing a U.S. covered-bond regime. 

The appeal of establishing a statutory covered-bond framework is to enable a sound 

and viable alternative funding option for financial institutions, which could enhance 

liquidity options and foster healthy competition in the funding markets. This needs 
37 

to be done without compromising the safety and soundness of institutions participating in covered-bond programs. 

That said, development of such a framework for a U.S. covered-bond program presents complex issues for consideration by policy makers. The remainder of my testimony focuses on a set of key issues and explores considerations for how those issues 

could be addressed. 

A. What Entities Are Eligible Issuers? 

A threshold issue in designing a statutory covered-bond program is determining 

the type of entity eligible to issue covered bonds under the statutory program. Limiting eligible issuers to entities subject to supervision by Federal financial regulators 

has the advantage of dedicated financial supervisors that can monitor and control 

the growth of covered bonds, react to emerging market issues, and generally act to 

promote safe and sound covered-bond programs by their respective institutions. Expanding eligible issuers beyond such a group of federally supervised institutions, 

while expanding the number of issuers and volume of issuances, has the disadvantage of issuers not being subject to the same level of oversight. 

As provided for in recent legislative proposals, an ‘‘eligible issuer’’ could mean any 

insured depository institution or any subsidiary; any bank or savings and loan holding company and any subsidiary; any nonbank financial company that is approved 

by the primary Federal financial regulator for the nonbank financial company; and 

any issuer that is sponsored by one or more eligible issuers for the sole purpose of 

issuing covered bonds on a pooled basis. Regarding the last category, a definition 

that recognizes the issuance of pooled covered bonds from appropriately regulated 

firms likely would provide greater access for regional and community banks to this 

market. 

B. What Agency or Agencies Should Regulate Covered-Bond Issuers? 

Another key issue in designing a statutory covered-bond program is determining 

the agency or agencies appropriate to regulate the covered-bond issuers and programs. One agency, multiple regulatory agencies, or the Department of the Treasury, are options that have been suggested at various times. Our suggestion is for 

the Federal financial regulators to be the covered-bond regulators for their respective institutions, and to implement a single, uniform set of standards that are applicable to all covered-bond issuers. 

While having one designated U.S. covered-bond regulator has an advantage of inherent uniformity with respect to all covered-bond issuers and programs, it has the 

disadvantage of not utilizing existing supervisory knowledge and expertise of current Federal financial regulators. Designation of a single covered-bond regulator, 

particularly depending on the agency chosen (or created), also might incrementally 

enhance a market misimpression of Government backing of the financial performance of the covered bonds themselves. 

Designating an eligible issuer’s Federal financial regulator takes advantage of 

that regulator’s existing knowledge of an institution’s operations. It would also be 

consistent with the current regulatory approach which provides financial regulatory 

agencies with responsibility for supervising covered-bond programs by institutions 

under their jurisdiction. 

Recent legislative proposals have taken this approach to structuring a U.S. covered-bond framework, proposing that the covered-bond regulator be an eligible 

issuer’s Federal financial regulator. Thus, in the case of national banks and (going 

forward for Federal thrifts), the covered-bond regulator would be the OCC. For 

State-chartered, nonmember banks and State-chartered thrifts, it would be the 

FDIC; for State-chartered member banks, the Federal Reserve Board, and for any 

other issuers, it would be the Securities and Exchange Commission (SEC). 

Under this framework, as discussed further in Section D below, the designated 

covered-bond regulators would jointly issue a uniform set of regulations establishing 

a covered-bond regulatory regime. The statutory framework could provide the covered-bond regulators with authority to approve covered-bond programs of their respective institutions, require the regulators to maintain a public registry of approved programs, and authorize an appropriate funding mechanism for the regulators’ oversight of the programs. 

In determining the parameters of the programs, the regulators could jointly establish reasonable and objective standards for the covered-bond programs, including eligibility standards for eligible assets, and other criteria as determined necessary. 

These considerations are discussed in more detail in Section D below. 

C. What Types of Assets Are Eligible for Covered Bonds? 

Another important component of a statutory covered-bond program is the types 

of assets eligible to collateralize the covered bonds. Typically, in Europe, covered 
38 

bonds are associated with high quality assets comprised of residential or commercial 

mortgage loans and public-sector debt. While some have advocated a broad statutory 

spectrum of U.S. asset types, including credit card, student, small business, and 

auto loans, more recent proposals have tended to narrow the eligible asset classes. 

One approach to the question of asset eligibility would be to start with a relatively 

conservative scope. Thus, for example, policy makers could decide to have the statutory framework initially authorize certain asset classes that typically have more homogeneous product terms and credit risk profiles (e.g., residential mortgages). Authorization also could be provided for the covered-bond regulators to expand the eligible classes going forward on an incremental basis as more experience is gained 

with covered-bond programs and after careful review of relevant considerations. 

Asset classes with similar characteristics, e.g., credit cards, would be logical first 

candidates for expansion. 

D. What Standards Are Applicable to Issuances of Covered Bonds? 

The question of standards applicable to covered bonds and covered-bond issuers 

has two facets: How are those standards set and what should the standards address? 

For policy makers, determining the standards to be prescribed in the statutory 

framework versus those to be left to regulatory rulemaking involves a balance of factors. Providing detailed standards by statute offers the legal certainty of having the 

standards set by law, but has the disadvantage of less flexibility for needed changes 

as covered bonds evolve and regulators ascertain strengths and weaknesses in covered-bond programs and with issuers. Also, different standards may be appropriate 

for different asset classes. For those reasons, policy makers may wish to direct covered-bond regulators to adopt standards to address particular key areas. 

As noted in Section B above, while we suggest that Federal financial regulators 

are best situated to serve as the covered-bond regulators for the institutions subject 

to their jurisdiction, we strongly believe that those regulators should implement a 

common set of rules. Thus, the regulators could be charged with designing the detailed rules that govern covered-bond programs, including any key areas that legislation specifically requires them to address. In order to avoid the risk of interagency 

gridlock, however, we also suggest that some mechanism be specified to ensure that 

rules are issued on a timely basis. One option that was considered in a recent legislative proposal was to provide by statute that the Treasury Department would issue 

the required rules if the covered-bond regulators failed to jointly adopt rules within 

a prescribed time. 

Various types of standards could be embodied in a covered-bond regulatory framework. For example, all covered bonds, by asset class, should have minimum eligibility criteria setting asset quality standards to promote the inclusion of high quality assets in the cover pool. Most European jurisdictions prescribe asset quality criteria for the assets subject to the statutory covered-bond program. Those standards 

in the U.S. could be set by statute or by the covered-bond regulators through rulemaking. Given the likely detail involved, regulatory standards seem preferable. 

It is also important to recognize that there are implications if a depository institution begins to use covered bonds extensively as a funding vehicle, as the institution 

may have an incentive to pledge stronger credit quality assets for collateral, thus 

giving investors the priority claim on the institution’s best assets and leaving the 

institution, its shareholders, and ultimately, in the case of insolvency, the FDIC, 

with weaker quality assets. From this standpoint, regulatory or supervisory standards may be needed to address risk management issues similar to other funding vehicles, including an issuer bank’s overall liquidity risk management framework and 

maintaining covered-bond programs in a manner consistent with safe and sound 

banking practices. 

Covered-bond regulators also should have the authority to impose a cap on the 

percentage of particular asset types that issuing institutions could use for the covered-bond program. An issuer’s total covered-bond obligations as a percentage of the 

issuer’s total liabilities also could be limited. Unrestricted growth in covered bonds 

could excessively increase the proportion of secured liabilities to unsecured liabilities at an institution, and thus present issues in the event the issuer becomes insolvent. As noted above, if the issuer is a depository institution, this creates concerns, 

notably with respect to potential losses to the Deposit Insurance Fund. 

Another important standard is a designated minimum amount of 

overcollateralization. Typically the collateral for covered bonds has a market value 

in excess of the face amount of the covered bonds that it backs, i.e., 

overcollateralization. Having sufficient overcollateralization helps to preserve the 

value of the covered bondholders’ claims in the event of issuer distress, and the ex-
39 

tent of overcollateralization should also affect the rate the covered-bond issuer must 

pay to investors. 

Covered-bond legislation could authorize the covered-bond regulators to establish 

minimum overcollateralization requirements for covered bonds backed by different 

eligible asset classes. As a related standard, legislation also could set forth a framework requiring each cover pool to satisfy an asset coverage test that assesses whether the minimum overcollateralization requirements are met, and obligates the issuer 

and an independent ‘‘Asset Monitor’’ to confirm on a periodic basis whether the 

asset coverage test is satisfied. 

Legislation also could authorize covered-bond regulators to establish certain types 

of standards viewed as the most necessary and prudent to start with, and then authorize regulators to adopt additional standards deemed appropriate for particular 

asset classes. This approach would permit covered-bond regulators to revise standards as more experience is gained with covered-bond programs and regulators obtain a fuller understanding of the relevant considerations. 

E. What Are the Consequences of a Default of a Covered-Bond Issuance or Failure 

of a Covered-Bond Issuer? 

A critical component in designing a U.S. statutory covered-bond program is determining the consequences of a default of a covered-bond issuance or the failure of 

a covered-bond issuer. A key advantage typically associated with covered bonds in 

Europe is their continuing nature despite a default on the issuance or the insolvency 

of the issuing institution. Under European special law-based frameworks, usually 

there is a specific legal framework superseding the general insolvency law of the 

country. The general premise is that if an issuing institution of covered bonds becomes insolvent (or goes into bankruptcy), the cover pool is segregated and held for 

the benefit of the covered bondholders. The covered bonds do not automatically accelerate when the credit institution goes insolvent, and the rights of the bondholders 

are protected. 

Without a U.S. legal framework addressing the operation and management of the 

cover pool in the event of a default or insolvency, U.S. covered bonds will continue 

to lack predictability and clarity compared to other jurisdictions. 

From a general standpoint, there are two distinct situations to be addressed: (1) 

a default on the covered-bond issuance before the issuer enters conservatorship, receivership, liquidation, or bankruptcy; and (2) the insolvency of the issuer institution. When considering the default of a covered-bond issuance, ‘‘default’’ should be 

clearly defined for this purpose, and also should clearly address what will happen 

to the cover pool and the rights of the covered bondholders if a default occurs. 

One legislative approach is to define the term ‘‘uncured default’’ to mean a default 

on the covered bond that has not been cured within the time required by the transaction documents related to the covered bond. In that situation, a separate estate 

will automatically be created by operation of law and will exist and be administered 

separately from the issuing institution. The separate estate is comprised of the applicable cover pool and assumes liability for the covered bonds and any related obligations secured by that cover pool. Consideration also might be given to authorizing 

the covered-bond regulators to establish minimum time periods for an ‘‘uncured default’’ in order to avoid ‘‘hair trigger’’ defaults. 

Another area for consideration is statutory provisions addressing the preservation 

of deficiency claims against the issuer; the creation of a residual interest that represents the right to any surplus from the cover pool; and the obligation of the issuer 

to transfer applicable books, records, files, and other documents to the covered-bond 

regulator or another designee. Consideration also should be given to provisions that 

provide that the covered-bond regulator may elect for an issuer to continue servicing 

the cover pool for some reasonable and operationally practical period of time. 

The second situation to be addressed is the potential for insolvency of the coveredbond issuing institution, and if the issuer is an insured depository institution, the 

FDIC’s statutory role as conservator or receiver. Again here it is important to clarify 

and address what would happen to the cover pool and the rights of the bondholders. 

Similar to the default situation approach, a statutory framework could create a 

separate estate for the covered-bond program similar to those in certain European 

jurisdictions. A recent legislative proposal creates a structure with the following 

general components when the FDIC is appointed as conservator or receiver for an 

insolvent issuer: 

• Creation of a separate estate and provision to the FDIC of an exclusive right 

for 180 days to transfer the issuer’s covered-bond program to another eligible 

issuer. 
40 

2 Covered bonds issued by banks do not appear to fall within the definition of an asset-backed 

security under the Federal securities law. However, legislation clarifying that covered bonds are 

not asset-backed securities could provide certainty conducive to the development of covered-bond 

markets. 

• A requirement that the FDIC as conservator or receiver, during the 180-day period, perform all monetary and nonmonetary obligations of the issuer until the 

FDIC completes the transfer of the covered-bond program, the FDIC elects to 

repudiate its continuing obligations to perform, or the FDIC fails to cure a default (other than the issuer’s conservatorship or receivership). 

If the FDIC as conservator or receiver, does not timely effect a transfer of the covered-bond program to another eligible issuer, repudiates its continuing obligations 

to perform, or fails to cure a default, then the statutory framework could provide 

for the automatic creation of a separate estate and attendant responsibilities, along 

the lines previously described. 

A comprehensive approach for covered bonds that reflects a consistent and predictable process across the Federal financial regulators would serve to provide certainty and predictability to investors and the marketplace in cases of default. This 

type of framework would require the covered-bond regulator to act as or appoint a 

trustee of the separate estate and to appoint and oversee a servicer or administrator 

for the cover pool held by the estate. Given the nature of the events triggering this 

aspect of the covered band framework, litigation by unhappy private parties could 

attempt to draw in the covered-bond regulator. We therefore urge consideration of 

limitations on actions against, and recognition of sovereign immunity for, the covered-bond regulator acting in its statutorily designated capacities. 

A further specific issue for policy makers is the appropriate treatment of any excess amounts from the cover pool once the covered bondholders have been paid in 

full. For example, a recent approach proposed that a residual interest would be created in the estate that represented the right to any surplus from the cover pool after 

the covered bonds and all other liabilities of the estate had been paid in full. The 

issue here is whether the FDIC, or the covered bondholders, receives the excess collateral. 

F. What Securities Disclosure Requirements Should Apply to Covered Bonds? 

The securities disclosure requirements applicable to covered bonds is the final 

issue I will highlight in this written statement. Requiring meaningful disclosures 

and making detailed information available about assets in a cover pool is essential 

to provide consistency and transparency across covered-bond issuances. Required 

disclosures, along with appropriate reporting, by different issuers should be standardized to permit comparison of current information by investors. This transparency 

and consistency are fundamental to the structure and discipline of covered-bond programs. 

To assure these goals, covered-bond legislation could direct the covered-bond regulators to adopt uniform disclosure and reporting standards for banks and other 

issuers. Those standards should cover a number of important areas. For example, 

covered-bond issuers could be required to provide investors detailed information 

about the cover pool at the time of issuance and on a periodic (e.g., monthly) basis 

thereafter. The issuer could be required to provide updated cover pool information, 

for instance, if more than 10 percent of the cover pool is substituted within a month, 

or more than 20 percent within a quarter. Issuers also could be required to provide 

investors the results of monthly Asset Coverage Tests, which typically should validate collateral quality and the proper level of overcollateralization. Similarly, the results of any reviews by an Asset Monitor could be made available to investors, as 

well as any other relevant material information. 

The SEC’s disclosure requirements for asset-backed securities (ABS) under Regulation AB provide a useful starting point for developing disclosure and reporting requirements for covered-bond programs. However, because covered bonds do not 

present the same structural complexities generally possible with ABS, it is probably 

more appropriate to select from, rather than duplicate, the disclosure requirements 

of Regulation AB in the case of covered bonds. 2 Thus, it would be important for policy makers to clarify that covered bonds are not ‘‘asset-backed securities’’ for such 

purposes, and to the extent necessary should address the application of the Federal 

securities laws to any U.S. covered-bond program. 

Conclusion 

We are encouraged by the continuing interest in establishing a statutory structure 

for covered bonds in the U.S. Such a step, prudently structured and implemented, 

holds promise as an additional, complementary funding source for financial institu-
41 

tions, and a catalyst for sound competition among the financial product funding alternatives available in the U.S. A complex combination of factors will determine the 

extent to which these goals are achieved. 

I appreciate the opportunity to appear before the Committee today, and I would 

be happy to answer any questions. Thank you. 

PREPARED STATEMENT OF MICHAEL H. KRIMMINGER 

DEPUTY TO THE CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION

SEPTEMBER 15, 2010 

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, on behalf of the Federal Deposit Insurance Corporation (FDIC), thank you for the opportunity to testify on the regulatory and legislative issues posed by covered bonds. The 

FDIC has long worked with the financial industry to establish a sound foundation 

for a vibrant covered-bond market that will provide U.S. banks with an additional 

source of liquidity. These efforts include working with the first U.S. banks to issue 

covered bonds in 2006 and the FDIC’s adoption of a Statement of Policy in mid-2008 

to clarify key issues related to deposit insurance and bank resolutions. With this 

background, we hope our views on the covered-bond market may be helpful for the 

Committee. 

The FDIC supports balanced legislation to create a sound foundation for covered 

bonds that also promotes market discipline and protects the Deposit Insurance Fund 

(DIF). In order to meet these goals, we believe that there are three key principles 

that should be followed. First, the rights and responsibilities of investors, issuers, 

and regulators should be clearly defined. Second, the investment risks to coveredbond investors should not be transferred to the public sector or to the DIF. Third, 

the legislative framework should be consistent with long-standing U.S. law and policy, and not unduly impair the interests of depositors and other creditors. 

While the FDIC’s existing Statement of Policy provides a sound foundation, a 

properly designed legislative and regulatory framework could further facilitate development of a vibrant covered-bond market. In doing so, however, it is important 

to not create a new class of investments that appears ‘‘risk-free’’ by providing investors with protections unavailable for any other investment. We have already seen 

the consequences when risks are mispriced in the market. Most importantly, the 

risks should not be transferred, implicitly or explicitly, to the Government or the 

DIF. While covered bonds can be a valuable tool to provide liquidity, they do carry 

risks that should be considered in fashioning any final legislation. 

Our testimony will discuss the FDIC’s July 28, 2008, ‘‘Policy Statement on Covered Bonds’’, provide background on covered bonds and their potential role in the 

financial marketplace, and address the proposed legislation recently adopted by the 

House Financial Services Committee, H.R. 5823, the ‘‘United States Covered Bond 

Act of 2010.’’ 

The FDIC’s Existing Policy on Covered Bonds 

Before the crisis, the FDIC worked closely with Washington Mutual Bank and 

Bank of America when they launched the first U.S. covered-bond programs in 2006. 

As a result of our efforts, the banks were able to issue covered bonds at a competitive price. The 2008 Statement of Policy later adopted by the FDIC’s Board of Directors addressed questions from the marketplace about how covered bonds would be 

treated in the receivership of an issuing bank. The market’s reaction to this Statement was very positive and most commentators stated that it provided a solid foundation for the covered-bond market. Shortly after the adoption of the Statement of 

Policy, the Department of the Treasury issued a companion document entitled ‘‘Best 

Practices for Residential Covered Bonds’’ to establish greater clarity and homogeneity for the market so that investors would have confidence in future issuances. 

The FDIC worked with the Treasury Department in developing the Best Practices 

to create a coordinated framework for the responsible and measured roll-out and 

further development of covered bonds in the U.S. Unfortunately, the financial crisis 

disrupted all forms of structured finance. Even during the crisis, however, the FDIC 

was able to sell Washington Mutual’s covered-bond program intact to JPMorgan 

Chase Bank in a failed bank resolution—demonstrating the effectiveness of the 

process outlined in our Statement of Policy. 

Given the FDIC’s existing Statement of Policy, the Treasury Department’s companion Best Practices, and the prior successful covered-bond programs developed in 

cooperation with the FDIC, it is unclear that legislation is necessary to relaunch the 

market. At a minimum, the FDIC suggests that its Statement of Policy should be 
42 

considered as a framework for any legislation in order to provide a sound, balanced 

foundation for the market. 

Covered Bonds in Context 

Covered bonds are general obligation bonds of the issuer, normally an insured 

bank or thrift, with payment secured by a pledge of a pool of loans. During normal 

operations, like any general obligation corporate bond, investors are paid from the 

issuing bank’s general cash flows, while the cover pool of loans serves simply as collateral for the bank’s duty to pay the investors. As a result, both functionally and 

legally, the cover pool is not the source for repayment as in a securitization, but 

is simply collateral to secure payment if the issuing bank cannot make payment 

from its general cash flows. 

Another distinction between covered bonds and most securitizations further demonstrates that the cover pools function as collateral and not as sources of payment 

when covered bonds are not in default. In a covered bond, any loans and other assets in the cover pool that become delinquent must be replaced with performing assets. As a result, the collateral for the covered bond is constantly refreshed—and 

imposes an ongoing obligation on the issuing bank to produce new loans or other 

qualifying collateral to replace delinquencies. Finally, the issuer must always maintain more collateral in the cover pool than the outstanding notional or ‘‘face’’ balance 

of the outstanding bonds. If the issuing bank fails to pay on the covered bond, then 

the investors have recourse to the cover pool as secured creditors. This is precisely 

how normal collateral arrangements work in other secured transactions. 

Under the long-standing U.S. law applied to all types of secured transactions, secured creditors have a claim to the collateral—here the loans or other assets pledged 

to secure payment on the covered bond—only to the full amount of their claim for 

payment at the time of any default. They do not have a claim to any part of the 

value of the collateral that exceeds their current claim for payment. Any collateral 

or proceeds in excess of that claim for payment are returned to the debtor or, if it 

has been placed into bankruptcy or receivership, are used to pay the claims of unsecured creditors. If, on the other hand, the secured creditor’s claims are greater than 

the value of the collateral, the creditor will have a secured claim up to the value 

of the collateral and an unsecured, general claim for the remaining balance along 

with other unsecured creditors. 

The same rules apply in FDIC receiverships. Secured creditors are fully protected 

under Section 11(e)(12) of the Federal Deposit Insurance Act (FDI Act) for the 

amount of their claim up to the value of the collateral. As a result, covered bonds 

provide two avenues for recovery—from the issuing bank and from the cover pool 

of collateral. What they do not have, under U.S. law, is a right to keep collateral 

in excess of their right to payment. 

Legislation To Address Covered Bonds 

As mentioned at the outset, the FDIC supports balanced covered-bond legislation. 

We believe this legislation should embody three key principles. First, it should clarify the rights and responsibilities of investors, issuers, and regulators. Second, it 

should ensure that investment risks are not be transferred to the public sector or 

to the DIF. Third, it should remain consistent with long-standing U.S. law and policy for secured creditors. Unfortunately, H.R. 5823 would muddy the relationship between investors and regulators, transfer some of the investment risks to the public 

sector and the DIF, and provide covered-bond investors with rights that no other 

creditors have in a bank receivership. As a result, this legislation could lead to increased losses in failed banks that have issued covered bonds. 

Clarifying Rights and Responsibilities—To clarify the respective roles of investors, 

issuers, and regulators, we suggest that any legislation establish a regulatory 

framework for the appropriate Federal regulators to jointly establish standards for 

covered-bond issuances by regulated institutions. One existing forum for setting 

such joint standards is the Federal Financial Institutions Examination Council, 

which includes the Federal regulators and a representative from the Conference of 

State Bank Supervisors. H.R. 5823 provides an alternative approach—by making 

the Federal prudential regulators the covered-bond regulators—which could also be 

workable. 

The resulting standards, like the FDIC’s Statement of Policy, should address the 

key elements in covered-bond transactions and the safety and soundness issues that 

can be implicated by a bank’s use of covered bonds. The standards should address 

the types of collateral, underwriting standards, required over-collateralization, frequency and content of reports on collateral and satisfaction of required 

overcollateralization, disclosure standards for performance of underlying loans or assets, and the rights of the investors in the event of default. As discussed in greater 
43 

detail later, a particularly important element in clarification of investors’ rights is 

the treatment of the covered bonds if the issuer defaults on its payments under the 

bonds. This is both critical to the investor and to the relative balance of risks retained by the investor or transferred to other parties. 

The standards setters for covered bonds should have discretion in expanding the 

use of covered bonds and categories of cover pool assets as sustainable markets develop and the liquidity of the instruments increases. The gradual expansion of cover 

pool categories is essential to ensure the quality of covered bonds and of the assets 

in the cover pools. 

Unfortunately, H.R. 5823 appears to go beyond setting standards to provide for 

detailed oversight of the covered-bond program for the benefit of the investors. This 

shift of the focus of Federal regulation towards protection of the investment interest 

of specific investors raises significant questions about the proper role of Federal regulation for individual investment programs. It must be made clear that the Federal 

regulators are not guarantors of performance by the issuing banks and are not responsible for ensuring that the banks do not breach any of the standards. The Federal Government should not determine the roles, responsibilities, or quality of performance of the issuers or be perceived as protecting the investment interests of specific investors. These are issues best resolved by private contracts based on transparent disclosures about the operations of covered-bond programs. It is important 

that the federal government is not viewed in any way as a guarantor of performance 

under the covered bonds. Performance should be a matter of private contract. 

In addition, H.R. 5823 would also make the Federal prudential regulators the appointing and supervising authority of trustees that would operate the separate estates of the covered bonds. This level of Government entanglement in what are private contractual matters could lead to an implied guarantee of covered bonds. An 

implied guarantee of covered bonds would put covered bonds on a near par with the 

Government sponsored enterprises—a status that should not be granted without 

strong policy reasons because of the risk that status represents for taxpayers. 

Legislation Should Not Increase the Potential Loss to the DIF—Intimately related 

to the foregoing principle is the key issue for the FDIC—new covered-bond legislation should not limit the FDIC’s ability to recover the losses the DIF incurs in resolving a failed bank. To protect the DIF, any covered-bond legislation must preserve the flexibility that current law provides to the FDIC in resolving failed 

banks—including the options of continuing to perform under the covered-bond program pending a sale of the program to another bank, turn-over of the collateral to 

the investors, and repudiation—a statutory termination of the contracts—of the covered bond obligation. 

Because there is sometimes confusion concerning the FDIC’s power to repudiate, 

it requires some explanation. Repudiation is the ability of the FDIC to terminate 

(or breach) a contract and then pay statutorily defined damages to the other parties. 

In the case of covered bonds, repudiation allows the FDIC, as receiver for the failed 

issuer, to cut-off future claims and end the obligation to replenish the cover pool 

with new assets. Under the FDI Act, the FDIC will then pay damages to compensate the covered-bond investors. 

covered-bond investors, as noted above, are secured creditors of the bank. The 

amount of their claim is defined by the balance or par value of outstanding bonds 

plus interest. The FDIC would support covered-bond legislation that clarifies the 

amount of repudiation damages to be the par value of outstanding bonds plus interest accrued through the date of payment. This provides a remedy that fully reimburses the covered-bond investors. In return, as in any other repudiation, the FDIC 

as receiver would be entitled to reclaim the collateral in the cover pool after payment of those damages. The FDIC could then sell this collateral and use the proceeds to pay part of the claims of the DIF (which has a claim after meeting its insurance obligation for insured deposits), uninsured depositors, and other creditors 

of the failed bank. 

If the FDIC does not repudiate a covered bond, it should have the authority to 

continue to perform under the covered bond until it can sell the program to another 

bank. This would not expose the investors to any loss, by definition, since the FDIC 

would meet all requirements of the covered-bond program, including replenishment 

of the cover pool and meeting the overcollateralization requirement. As long as the 

FDIC is performing under a covered-bond agreement, covered-bond legislation 

should not limit the time in which the FDIC has to decide how best to proceed. 

Any legislation that fails to preserve these important receivership authorities 

makes the FDIC the de facto guarantor of covered bonds and the de facto insurer 

of covered-bond investors. Unfortunately, H.R. 5823 would expose the DIF to additional losses by restricting the FDIC’s ability to maximize recoveries on failed bank 
44 

operations and assets. This is contrary to a long-standing Congressional goal of preserving the DIF to help maintain confidence in the U.S. banking system. 

Over the past several decades, Congress has revised the laws governing the resolution of failed banks on several occasions. However, two of those revisions are crucial to today’s discussion. First, Congress required the FDIC to use the ‘‘least costly’’ 

transaction for resolving insured depository institutions. Second, Congress created 

depositor preference, which gives depositors a priority among unsecured creditors. 

Both reforms were designed to reduce losses to the DIF. 

Unfortunately, H.R. 5823 would restrict the FDIC’s current receivership authorities used to maximize the value of the failed bank’s covered bonds. The bill leaves 

the FDIC with only two options: continue to perform until the covered-bond program 

is transferred to another institution within a certain timeframe; or hand over the 

collateral to a separate trustee for the covered-bond estate, in return for a residual 

certificate of questionable value. The FDIC would not have the authority—which it 

can use for any other asset class—to repudiate covered bonds, pay repudiation damages and take control of the collateral. This restriction would impair the FDIC’s 

ability to accomplish the ‘‘least costly’’ resolution and could increase losses to the 

DIF by providing covered-bond investors with a superpriority that exceeds that provided to other secured creditors. These increased losses to the DIF would be borne 

by all of the more than 8,000 FDIC-insured institutions, whether or not they issued 

covered bonds. 

Limiting the time in which the FDIC could market a covered-bond program to 

other banks will constrain the FDIC’s ability to achieve maximum value for a program through such a transfer. Similarly, preventing the FDIC from using its normal 

repudiation power will prevent the FDIC from recapturing the overcollateralization 

in the covered-bond program. The ‘‘residual certificate’’ proposed in H.R. 5823 is 

likely to be virtually valueless. More importantly, the legislation would provide the 

investors with control over the collateral until the term of the program ends, even 

though the FDIC (and any party obligated on a secured debt) normally has the ability to recover overcollateralization by paying the amount of the claims and recovering the collateral free of all liens. Providing the FDIC a residual certificate instead 

of the ability to liquidate the collateral itself would reduce the value to the receivership estate and would not result in the least costly resolution. 

So long as investors are paid the full principal amount of the covered bonds and 

interest to the date of payment, there is no policy reason to protect investment returns of covered-bond investors through an indirect subsidy from the DIF. However, 

some market participants have argued that continuing to allow the receiver to exercise its statutory repudiation authority would reduce investors’ interest in U.S. covered bonds due to the reinvestment risks. This argument misses the mark both from 

the perspectives of equitable risk allocations and real financial risk. 

As discussed earlier, if there is reinvestment risk, it should be borne by private 

investors, not the public sector, other creditors, or the DIF. Covered-bond investors 

should receive full payment for the face value of their bonds plus interest. However, 

they should not be guaranteed control of the cover pool where it vastly exceeds the 

actual amount of their claims. In addition, there is no real financial risk if the FDIC 

repudiates the covered-bond transaction, pays the full value of the outstanding 

bonds, plus interest, and takes control of the cover pool. If that happens, it simply 

means that the investors’ trustee has a pot of money to reinvest into a guaranteed 

investment contract—like an annuity—to continue to pay investors the steady 

stream of bond payments which they are seeking. 

The financial returns for the investors will not be different, in any meaningful 

way, from the return they could expect if they had been able to seize control of the 

cover pool as H.R. 5823 allows. The reason is that, once seized, the cover pool becomes a static pool with no new loans entering, but with delinquent and paid-off 

loans exiting. Like a static securitization pool, it will be a diminishing pool of collateral as these loans exit. In addition, like other pass-through investment vehicles, 

the amount of cash generated in any period can be highly variable because of delinquent or missed payments, prepayments, and payoffs. A mismatch will occur between the bond payment obligations and the remaining cash flows of the cover pool. 

This mismatch would result in early prepayment of the covered bonds to maintain 

parity. To the extent investors put in place contingent liquidity and/or credit support mechanisms to reduce the asset/liability mismatch, they also reduce the internal rate of return on the covered bonds or increase the cost of issuance to the financial institution. There would also be administrative or management fees associated 

with the management of the pool. Finally, investors of a static pool pass-through 

would be subject to default risk, which would be eliminated by the payment in full 

of the covered bonds. The net economic consequences of the early redemption of the 

covered bonds would be roughly equivalent to the cost of managing the assets to 
45 

1The only exception to the stay in 11(e)(13)(C) is for qualified financial contracts (QFCs). This 

exemption is based on the fact that performance of the derivatives markets requires prompt 

transfer or closeout of derivatives positions, thereby reducing potentially negative systemic effects of counterparty failures. Covered bonds do not meet the definitions as QFCs. Nonetheless, 

H.R. 5823 gives covered-bond investors a right to retain all collateral that not even secured parties with QFCs receive. 

the covered-bond’s maturity. However, by giving the FDIC the option to redeem the 

covered bonds, this cost would not be subsidized by the DIF. 

The protections to the insurance fund, depositors and the flexibility afforded the 

FDIC as receiver of a failed depository institution has become a standard that other 

countries want to emulate. The flexibility that Congress afforded the FDIC permits 

us to respond to market conditions at the time of insolvency and to achieve bank 

resolutions that protect insured depositors at the least cost to the DIF. This is an 

important public policy that we believe has served the Nation well and should be 

maintained. 

Legislation Should Not Create a ‘‘Super-Priority’’ for Covered-Bond Investors— 

Under U.S. law, secured creditors are entitled to payment of their claims before unsecured creditors up to the lesser of the full amount of their claim or the value of 

the collateral. We should avoid upsetting this settled principle of law—which is enshrined both in State commercial law under the Uniform Commercial Code and in 

Federal and State insolvency law in the Bankruptcy Code and the FDI Act, among 

other statutes. 

Covered bonds do offer some advantages over securitization towards improved underwriting. The potential for improved alignment of the bank’s incentives toward 

better quality underwriting is a consequence of the loans remaining on the bank’s 

balance sheet, the duty to replace any delinquent loans in the cover pool, and holding capital for the loans in the pool. However, these advantages come at a cost. The 

obligation to replace delinquent loans means that there is a continuing demand for 

new originations, which can act as a liquidity drain if delinquencies increase. This 

also means that, as poorer loans are taken out of the cover pool, the remaining balance sheet will consist of more and more delinquent loans. In a receivership, this 

can lead to greater losses to the DIF—particularly if the FDIC’s options to sell the 

covered-bond transaction are restricted. 

Clearly, strong origination standards will continue to be required. The potential 

stress on issuing banks is illustrated by Washington Mutual Bank, which had to increase the cover pool to almost 150 percent overcollateralization in a failed effort 

to maintain high ratings for the transaction. This further exacerbated Washington 

Mutual’s asset and liquidity problems. 

This example also illustrates another important consideration in covered-bond legislation—investors should not be completely shielded from investment risk and their 

risk should not be transferred to the public sector or to the DIF. If, as under H.R. 

5823, the investors can seize the entire cover pool for the duration of the covered 

bonds irrespective of the degree of overcollateralization, it will provide a strong incentive for investors to maximize the overcollateralization. Naturally, this will increase pressure on the issuing bank during periods of stress. The ability of investors 

to seize the entire cover pool will also further reduce the loan assets available for 

sale by the FDIC in any receivership. If creditors of covered bonds are shielded from 

all risks, there is a strong possibility that covered bonds could lead to a mispricing 

of risk and distortions in the market, imperiling banks in the future. On the other 

hand, if the long-standing treatment of secured creditors is maintained—which 

would allow the FDIC to pay the outstanding principal and interest on the bonds 

and recover the overcollateralization—there will be very limited incentive for the 

creditors to demand increasing levels of collateral as a bank becomes troubled. 

The super-priority given covered-bond investors by H.R. 5823 also runs against 

the policy direction established by Congress in recent legislation. In 2005, Congress 

enacted Section 11(e)(13)(C) of the FDI Act, which prohibits secured creditors from 

exercising any rights against any property of a failed insured depository institution 

(IDI) without the receiver’s consent for the first 90 days of a bank receivership. 1

This provision prevents secured creditors from taking and selling bank assets at fire 

sale prices to the detriment of the receiver and the DIF. More recently, section 215 

of the Dodd-Frank Wall Street Reform and Consumer Protection Act mandates a 

study to evaluate whether a potential haircut on secured creditors could improve 

market discipline and reduce cost to the taxpayers. This study was prompted by the 

recognized roles that the run on secured credit and the insatiable demand for more 

collateral had in the financial crisis of 2008. In contrast, the unprecedented protec-
46 

1The U.S. Covered Bond Council is sponsored by The Securities Industry and Financial Markets Association (SIFMA). SIFMA brings together the shared interests of hundreds of securities 

firms, banks, and asset managers. SIFMA’s mission is to develop policies and practices which 

strengthen financial markets and which encourage capital availability, job creation, and economic growth while building trust and confidence in the financial industry. SIFMA, with offices 

in New York and Washington, DC, is the U.S. regional member of the Global Financial Markets 

Association. For more information, please visit www.sifma.org. 

tion for one form of secured creditors—covered-bond investors—in H.R. 5823 runs 

counter to the policies underlying these provisions. 

A further concern created by H.R. 5823 is that it could encourage covered-bond 

transactions that include ‘‘triggers’’ for early termination or default before a bank 

is closed by the regulators. Under H.R. 5823, a separate estate, which removes the 

entire cover pool from the bank’s control, is created upon any event of default. Once 

created, the separate estate and all collateral in the cover pool would be outside the 

control of the FDIC, as receiver for the bank. The residual value of the pool, and 

all of the loans, would be outside the receivership and be lost for all other creditors 

of the failed bank. This additional special protection creates a strong incentive for 

covered-bond transactions to include a trigger that acts before the bank is placed 

into receivership. Since such a trigger would deprive the bank of the cash flows from 

the cover pool and signal to the market its imminent demise, the bank would almost 

inevitably suffer a liquidity failure. As a result, these early triggers represent another source of increased loss to the DIF. 

The FDIC has recommended that the receiver should have the authority to cure 

any defaults under the covered-bond transaction within 30 days of the appointment 

of the FDIC as conservator or receiver of an issuer. This would reduce the incentive 

for covered-bond investors to declare a default and take control of the cover pool in 

anticipation of an FDIC receivership. Providing the FDIC 30 days to cure a default 

would allow the FDIC to recapture the value of the overcollateralization in the program for receivership creditors, including uninsured depositors and the DIF. The 

FDIC would then have the same options to resolve the covered-bond transaction and 

maximize the value of this asset in the receivership. 

Conclusion 

The FDIC supports a vibrant covered-bond market that would increase liquidity 

to financial institutions and enable sustainable and robust asset origination. However, any legislation should avoid promoting development of a covered-bond market 

by reducing market discipline and protection for the Deposit Insurance Fund (DIF). 

We believe the principles, described above, will ensure that covered bonds serve as 

a sustainable investment for bondholders and the financial system. We will continue 

to work with the Congress, other regulators and market participants on ways to create a sustainable covered-bond market in the U.S. 

Thank you for inviting me to appear at this hearing. I will be happy to answer 

any questions. 

PREPARED STATEMENT OF SCOTT A. STENGEL 

PARTNER, ORRICK, HERRINGTON AND SUTCLIFFE LLP, ON BEHALF OF THE U.S. COVERED BOND COUNCIL, SECURITIES INDUSTRY, AND FINANCIAL MARKETS ASSOCIATION

SEPTEMBER 15, 2010 

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, I am 

grateful for your invitation to testify today on the crucial role that U.S. covered 

bonds can play in stabilizing our financial system and contributing to our economic 

recovery. 

I am a partner in the Washington, DC, office of Orrick, Herrington & Sutcliffe 

LLP and a member of the Steering Committee for the U.S. Covered Bond Council 

(the Council). The Council is a collaborative forum 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. 1

The precarious state of our Nation’s economy has become all too apparent. Weakness persists in the labor market, with almost 17 percent of Americans still unemployed or underemployed. More than half of small-business owners are experiencing 

cash flow issues and are expecting economic conditions to remain unfavorable for 

at least the next 6 months. Home prices in the United States have fallen 34 percent 

since their peak in 2006, and nearly one out of every four homeowners is under-
47 

water on a mortgage. The delinquency rate on loans backing commercial mortgagebacked securities has increased to a record 8.92 percent, even though more loans 

have been modified in 2010 than in the prior 2 years combined. In this volatile environment, credit remains relatively tight for both families and small businesses, public-sector resources are increasingly strained, and consumers are understandably 

cautious. 

In the Council’s view, sustained economic growth begins with a stable financial 

system. While the Dodd-Frank Act has supplied some important structural elements, there remains a considerable need for long-term and cost-effective funding 

that is sourced from diverse parts of the private-sector capital markets and that can 

be translated into meaningful credit for households, small businesses, and the public sector. 

We believe that U.S. covered bonds are an untapped but proven resource that 

could be invaluable in meeting this need. We also believe that, with the success of 

a fragile economic recovery hanging in the balance, the time for U.S. covered bonds 

is now. 

Much has been written about U.S. covered bonds in the last year, and because 

not all of the commentary has been entirely accurate, I want to take just a moment 

to describe this financial tool. At its core, a covered bond is simply a form of highgrade senior debt that is issued by a regulated financial institution and that is secured—or ‘‘covered’’—by a dynamic cover pool of financial assets which is continually replenished. What distinguishes covered bonds from other secured debt is a 

legislatively or sometimes contractually prescribed process for managing (rather 

than immediately liquidating) the cover pool upon the issuer’s default or insolvency 

and continuing scheduled (rather than accelerated) payments on the covered bonds. 

Over the course of this product’s 240-year history, cover pools have included residential mortgage loans, commercial mortgage loans, agricultural loans, ship loans, and 

public-sector loans, and in the Council’s view, loans for small businesses, students, 

automobile owners and lessors, and consumers using credit or charge cards also are 

appropriate. 

Covered bonds are an effective vehicle for infusing long-term liquidity into the financial system. With maturities that typically range from 2 to 10 years and that 

can extend out to 15 years or more, they provide a natural complement to the shortand medium-term funding that is available through the Federal Home Loan Banks 

and the securitization and repo markets. This kind of stable liquidity, moreover, allows banks to turn around and provide long-term credit to consumers, small businesses, and governments without being vulnerable to sudden changes in interest 

rates or investor confidence. In addition, by using covered bonds to more closely 

match the maturities of their assets and liabilities, financial institutions are able 

to reduce refinancing risks that can have a destabilizing influence on the banking 

system more broadly. 

Covered bonds also represent a cost-efficient form of on-balance-sheet financing 

for financial institutions that, in turn, can reduce the cost of credit for families, 

small businesses, and the public sector. The importance of this cost efficiency cannot 

be overstated. Recent accounting changes and increased regulatory capital requirements, as well as continued challenges in the securitization market, have made 

lending far more expensive. Spreads on long-term unsecured debt, moreover, are 

substantially wider than the short-term rates that have been pushed down to historically low levels by recent Government initiatives, and these long-term rates 

could move even higher as the Federal Government exits those initiatives and competes for funding to finance its own budget deficits. 

Another benefit of covered bonds is their separate and distinct investor base. 

These investors are providing liquidity that would not otherwise be made available 

through the unsecured-debt or securitization markets, and as a result, covered 

bonds enable financial institutions to add another source of funding rather than 

merely cannibalize their existing sources. Such diversification, not only in the kind 

but in the supply of liquidity, is crucial to reducing systemic risk and securing the 

financial system. With a growing shortage of fixed-income securities of the kind that 

appeal to rates investors, moreover, covered bonds are attracting as much interest 

as ever. 

Equally important, covered bonds deliver funding from the private-sector capital 

markets without any reliance on U.S. taxpayers for support. The ongoing debate 

about GSE reform is a stark reminder of how dependent some parts of the financial 

system remain on Government intervention. That kind of intervention not only exposes the taxpayers to risk but also creates dislocations in the market that inhibit 

the private-sector economy from generating a self-sustaining recovery. Covered 

bonds, which have demonstrated resilience even in distressed market conditions, 
48 

can serve as an important bridge from an economy that is limping along on Government support to one that is able to stand and thrive on its own. 

Two other features of covered bonds bear mention. First, in contrast to 

securitization, a financial institution issuing covered bonds continues to own the assets in the cover pool that are pledged as security. This creates 100 percent ‘‘skin 

in the game,’’ and as a result, incentives relating to underwriting, asset performance, and loan modifications are strongly aligned. Second, the success of covered 

bonds is attributable in no small measure to their high degree of transparency and 

uniformity. As one of the most straightforward of financial products, covered bonds 

are a model of safe and sound banking practices. 

With covered bonds supplying long-term and cost-efficient liquidity from a separate private-sector investor base, the Council believes that credit will more effectively flow to households, small businesses, and State and local governments. Because covered bonds are ultimately constrained by the balance sheets of issuers, 

however, they cannot be called a silver bullet, and action still needs to be taken to 

resuscitate securitization and other parts of the financial markets. But, like some 

of the measures in the Dodd-Frank Act, covered bonds represent a critical first 

step—and one that, in this constrained credit environment, is urgently needed now. 

To function successfully, however, a U.S. covered-bond market must be deep and 

highly liquid. Covered bonds are viewed as a conservative and defensive investment, 

and just as with any other high-grade instrument, investors expect active bids, offers, and trades. Sporadic issuances, one-off transactions, cumbersome trading, and 

shallow supply and demand are incompatible with covered bonds. 

This need for a deep and liquid covered-bond market was recognized by the Treasury Department (Treasury) and the Federal Deposit Insurance Corporation (FDIC) 

in 2008 when they collaborated to issue, respectively, Best Practices for Residential 

Covered Bonds and a Final Covered Bond Policy Statement. Regulators and market 

participants alike hoped that, in the absence of a legislative framework, these regulatory initiatives might serve as an adequate substitute and foster the growth of 

U.S. covered bonds. 

But, during the last 2 years, it has become apparent that regulatory guidance 

alone will not suffice. 

Covered bonds were originated and developed in Europe under legislative frameworks that require public supervision designed to protect covered bondholders, and 

this precedent has set market expectations. Today, almost 30 countries across the 

continent of Europe have adopted national legislation to govern covered bonds. 

These include Germany, France, the United Kingdom, the Netherlands, Spain, Italy, 

Russia, Denmark, Ireland, Portugal, the Czech Republic, the Slovak Republic, Austria, Hungary, Slovenia, Switzerland, Luxembourg, Sweden, Finland, Norway, Poland, Latvia, Lithuania, Ukraine, Romania, Bulgaria, Greece, Armenia, and Turkey. 

Even in Canada, where financial institutions have been able to actively tap the covered-bond market because of more creditor-friendly insolvency laws and the unique 

nature of their cover pools, a legislative framework is being developed. 

Dedicated covered-bond legislation and public supervision, from the perspective of 

market participants, creates a degree of legal certainty that regulatory initiatives 

just cannot replicate. This kind of certainty is critical because the nature of covered 

bonds as a high-grade defensive investment with limited prepayment risk has no 

room for ambiguity on the rights and remedies available at law, especially in the 

event of the issuing institution’s insolvency. Investors will not dedicate funds to this 

market unless the legal regime is unequivocal and the risks can be identified and 

underwritten. 

To provide an example, if a U.S. depository institution were to issue covered 

bonds and later enter receivership under existing law, the FDIC has expressed the 

view that three options are available at its discretion: (1) the FDIC could continue 

to perform on the covered bonds according to their original terms, (2) the FDIC 

could repudiate the covered bonds or allow a default to occur, make a determination 

about the fair market value of the cover pool securing them, pay covered bondholders an amount equal to the lesser of that fair market value and the outstanding 

principal amount of the covered bonds with interest accrued only to the date of its 

appointment as receiver, and retain the cover pool, or (3) the FDIC could repudiate 

the covered bonds or allow a default to occur, leave covered bondholders to exercise 

self-help remedies against the cover pool, and recover from them any proceeds in 

excess of the outstanding principal amount of the covered bonds with interest accrued only to the date of its appointment as receiver. Any of these three options 

would be exercised against the backdrop of a temporary automatic stay that would 

last for 90 days after the FDIC’s appointment as receiver or, at best under the Final 

Covered Bond Policy Statement, 10 business days after an uncured monetary default (though not an uncured nonmonetary default). 
49 

2See, e.g., Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation, Statement on 

Establishing a Framework for Systemic Risk Regulation before the U.S. Senate Committee on 

Banking, Housing, and Urban Affairs (July 23, 2009); Sheila C. Bair, Chairman, Federal Deposit 

Insurance Corporation, Statement on Regulatory Perspectives on Financial Regulatory Reform 

Proposals before the U.S. House Committee on Financial Services (July 24, 2009); Sheila C. 

Bair, Chairman, Federal Deposit Insurance Corporation, Remarks to the International Institute 

of Finance (October 4, 2009); Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation, 

Statement on Systemic Regulation, Prudential Measures, Resolution Authority, and 

Securitization before the U.S. House Committee on Financial Services (October 29, 2009). 3See, Section 215 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010). 4This would be consistent with the FDIC’s existing policy on the treatment of secured obligations. See, Federal Deposit Insurance Corporation, Statement of Policy Regarding Treatment of 

Security Interests After Appointment of the Federal Deposit Insurance Corporation as Conservator or Receiver (March 23, 1993). 

In these circumstances, investors face a number of uncertainties: Which of the 

three options will the FDIC exercise? When will the FDIC make its choice? How will 

the FDIC calculate the fair market value of the cover pool, and how long will that 

process take? Will self-help remedies alone suffice, or will the FDIC instead need 

to be involved in releasing the cover pool? Will the FDIC challenge the method of 

liquidation used by the trustee for the covered bondholders? What will happen if the 

FDIC elects to perform for some period of time and then later repudiate, especially 

if the cover pool has deteriorated in the meantime? Legal uncertainties like these 

simply do not exist under the legislative frameworks found in Europe. 

Equally troubling to investors and other market participants is the fact that this 

optionality resides with the FDIC, which has a rather clear conflict of interest because of its fiduciary duty to depositors and the deposit-insurance fund. The conflict 

was recently highlighted by the FDIC’s repeated calls for legislation that would 

force secured creditors like covered bondholders to take a haircut even if their 

claims are fully collateralized—a development which, to our knowledge, would be 

unprecedented in the history of credit. 2

Although this proposal was not adopted as part of the Dodd-Frank Act, the 

FDIC’s advocacy was sufficiently vigorous to prompt a wide-ranging study on the 

subject. 3

Layered on top of these concerns is the obvious incompatibility of a forced acceleration by the FDIC with the core nature of a covered bond. A sine qua non of covered bonds is the use of collections and other proceeds from the cover pool to continue making scheduled payments after the issuer’s default or insolvency. If forced 

acceleration were possible, the instrument would no longer be a covered bond but 

instead would be just plain-vanilla secured debt. In addition, if the FDIC were to 

take the position that secured claims of investors are limited to the fair market 

value of the cover pool at a moment in time rather than to its cash flow value over 

time, forced acceleration would expose them to losses arising from short-term market volatility and liquidity risks that are not part of the economic bargain in the 

covered-bond market. 

For these reasons, the Council has concluded that a well-functioning market for 

U.S. covered bonds cannot develop without a legislative framework that stays true 

to the distinctive features of traditional covered bonds. Anything less would preclude 

issuing institutions—and ultimately consumers, small businesses, and the public 

sector—from realizing the cost efficiencies that make covered bonds worthwhile. 

We are confident, moreover, that such a framework could be constructed in a way 

to fully protect the interests of an issuer’s other creditors (including, in the case of 

a bank, the deposit-insurance fund) as well as any conservator, receiver, or bankruptcy trustee. Taking a bank receivership as an example once again, we would support a period of up to 180 days for the FDIC to transfer an affected covered-bond 

program to another eligible issuer so long as all monetary and nonmonetary obligations were performed during that time. 4 If such a transfer turned out to be impossible or inadvisable and the covered-bond program were moved to a separate estate 

for administration, we believe that the receivership’s equity in that estate should 

take the form of a residual interest that the FDIC could sell or otherwise monetize 

immediately for the benefit of other creditors and the deposit-insurance fund. We 

also could support the holder of that equity interest being afforded consent rights 

over the selection of any servicer or administrator for the estate. 

The absence of a legislative framework for U.S. covered bonds is already coming 

at a cost. European and other non-U.S. issuers have been taking advantage of favorable laws in their home countries and filling the vacuum. Thus far in 2010, over 

$18 billion in U.S.-dollar-covered bonds have been targeted to investors in the 

United States. With governments in Europe providing the requisite legal certainty 

for covered bonds issued by their domestic institutions, we fear that the playing 
50 

field could grow increasingly uneven in the fierce competition among banks for less 

expensive and more stable sources of funding. 

The cost of such an outcome, of course, will be born in the end by families, small 

businesses, and governments throughout the United States, especially those that 

are dependent on banks for their liquidity needs. When possible, the higher funding 

costs will be passed along to them; when not, credit will be denied altogether. Neither result can be described as at all desirable. 

The Council, therefore, fully supports the kind of comprehensive covered-bond legislation that was proposed by Congressman Garrett and the other House conferees 

during the House–Senate conference on the Dodd-Frank Act. 

In particular, the Council endorses the following elements of a legislative framework for U.S. covered bonds: 

• Public Supervision by a Covered-Bond Regulator—The public supervision of covered-bond programs by a Federal regulator, whose mission is the protection of 

covered bondholders, is central to any legislative framework. In the European 

Union, this feature is enshrined in Article 22(4) of the Directive on Undertakings for Collective Investment in Transferable Securities (the UCITS Directive). Compliance with Article 22(4) is what gives covered bonds their unique 

status in Europe, including privileged risk weighting under the EU’s Capital 

Requirements Directive and preferential treatment by the European Central 

Bank in Eurosystem credit operations. 

We therefore support a framework that includes the following: The Comptroller of the Currency or another U.S. Government agency—excluding the 

FDIC because of its conflict of interest—would be appointed as the CoveredBond Regulator, which would have as its mission the protection of covered 

bondholders. The Covered-Bond Regulator, in consultation with other applicable 

primary Federal regulators, would ensure compliance with legislative requirements and would establish additional regulatory requirements that are tailored 

to the different kinds of covered-bond programs. Covered bonds would fall under 

the legislative framework only if issued under a covered-bond program that has 

been approved by the Covered-Bond Regulator in consultation with the issuer’s 

primary Federal regulator. The Covered-Bond Regulator would maintain a public registry of approved covered-bond programs. 

• Eligible Issuers—Issuances by regulated financial institutions is another fundamental element of covered bonds that is also recognized in the UCITS Directive. 

In order to afford competitive market access to regional and community banks, 

however, pooled issuances by entities that have been sponsored by one or more 

regulated institutions should be permitted as well. 

We therefore support a framework that includes the following: Eligible issuers 

of covered bonds would be comprised of (1) FDIC-insured depository institutions 

and their subsidiaries, (2) bank holding companies, savings and loan holding 

companies, and their subsidiaries, (3) nonbank financial companies that are approved by the Covered-Bond Regulator and other applicable primary Federal 

regulators, and (4) issuing entities that are sponsored by one or more eligible 

issuers for the sole purpose of issuing covered bonds on a pooled basis. 

• Covered Bonds—To ensure that covered bonds retain their essential attributes 

as the market evolves, we support a framework that includes the following: A 

covered bond would be defined as a nondeposit senior recourse debt obligation 

of an eligible issuer that (1) has an original term to maturity of not less than 

1 year, (2) is secured by a perfected security interest in a cover pool which is 

owned directly or indirectly by the issuer, and (3) is issued under a coveredbond program that has been approved by the Covered-Bond Regulator. 

• Cover Pool—One other indispensable feature of covered bonds is a cover pool 

that contains performing assets and that is replenished and kept sufficient at 

all times to fully secure the claims of covered bondholders. This too receives 

specific mention in the UCITS Directive. 

We therefore support a framework that includes the following: The cover pool 

would be defined as a dynamic pool of assets that is comprised of (1) one or 

more eligible assets from a single eligible asset class, (2) substitute assets (such 

as cash and cash equivalents) without limitation, and (3) ancillary assets (such 

as swaps, credit enhancement, and liquidity arrangements) without limitation. 

No cover pool would include eligible assets from more than one eligible asset 

class. A loan would not qualify as an eligible asset while delinquent for more 

than 60 consecutive days, and a security would not qualify as an eligible asset 

while not of the requisite credit quality. 
51 

• Eligible Asset Classes—The real benefit of covered bonds is long-term and costeffective funding from the private sector that can be converted into meaningful 

credit for families, small businesses, and State and local governments throughout the United States. 

We therefore support a framework that includes the following eligible asset 

classes: (1) residential mortgage asset class, (2) home equity asset class, (3) 

commercial mortgage (including multifamily) asset class, (4) public sector asset 

class, (5) auto asset class, (6) student loan asset class, (7) credit or charge card 

asset class, (8) small business asset class, and (9) other asset classes designated 

by the Covered-Bond Regulator in consultation with other applicable primary 

Federal regulators. 

• Overcollateralization, Asset-Coverage Test, and Independent Asset Monitor—Full 

transparency, independent monitoring, and regular reporting must be among 

the hallmarks of U.S. covered bonds. 

We therefore support a framework that includes the following: The CoveredBond Regulator would establish minimum overcollateralization requirements for 

covered bonds backed by each of the eligible asset classes based on credit, collection, and interest-rate risks but not liquidity risks. Each cover pool would be 

required at all times to satisfy an asset-coverage test, which would measure 

whether the eligible assets and the substitute assets in the cover pool satisfy 

the minimum overcollateralization requirements. Each issuer would be required 

to perform the asset-coverage test monthly on each of its cover pools and to report the results to covered bondholders and applicable regulators. Each issuer 

also would be obligated to appoint the indenture trustee for its covered bonds 

or another unaffiliated entity as an independent asset monitor, which would periodically verify the results of the asset-coverage test and provide reports to covered bondholders and applicable regulators. 

• Separate Resolution Process for Covered-Bond Programs—Hand in hand with 

public supervision is legal certainty on the resolution of a cover pool if the 

issuer were to default or become insolvent. A dedicated process must exist that 

provides a clear roadmap for investors, that avoids the waste inherent in a 

forced liquidation of collateral, and that allows the cover pool to be managed 

and its value maximized. 

Central to this resolution process is the creation of a separate estate—like the 

ones created under the Bankruptcy Code—for any covered-bond program whose 

issuer has defaulted or become insolvent. To ensure that timing mismatches 

among the assets and liabilities of the estate do not unnecessarily erode the 

cover pool’s value or cause a premature default, both private-sector counterparties and the Federal Reserve Banks should be authorized to make advances to 

the estate on a superpriority basis for liquidity purposes only. Importantly, however, advances by a Federal Reserve Bank should be prohibited if U.S. taxpayers could be exposed to any credit risk whatsoever. 

Special rules also are appropriate should the FDIC be appointed as conservator or receiver for an issuer before any default occurs on its covered bonds. 

All interested parties would benefit if the FDIC were able to transfer the entire 

covered-bond program to another eligible issuer, much like Washington 

Mutual’s program was conveyed to JPMorgan Chase. As a result, the FDIC 

should be afforded a reasonable period of time (not to exceed 180 days) to effect 

such a transfer before a separate estate is created. 

In addition, neither an issuer that has defaulted nor its creditors in the case 

of insolvency should forfeit the value of surplus collateral in the cover pool. To 

enable this value to be realized promptly by the issuer or its creditors (including 

the FDIC and the deposit-insurance fund) without disrupting the separate resolution process, a residual interest should be created in the form of an exempted 

security that can be sold or otherwise monetized immediately. Such an approach should satisfy all constituencies—covered bondholders will be able to 

rely on the separate, orderly resolution process for their cover pool, and the 

issuer and its creditors (including the FDIC and the deposit-insurance fund) 

will not have to wait for that process to conclude before turning any surplus 

into cash. 

We therefore support a framework that includes the following: If covered 

bonds default before the issuer enters conservatorship, receivership, liquidation, 

or bankruptcy, a separate estate would be created that is comprised of the applicable cover pool and that assumes liability for the covered bonds and related 

obligations. Deficiency claims against the issuer would be preserved, and the 

issuer would receive a residual interest that represents the right to any surplus 

from the cover pool. The issuer would be obligated to release applicable books, 
52 

records, and files and, at the election of the Covered-Bond Regulator, to continue servicing the cover pool for 120 days. 

If the FDIC were appointed as conservator or receiver for an issuer before a 

default on its covered bonds results in the creation of an estate, the FDIC would 

have an exclusive right for up to 180 days to transfer the covered-bond program 

to another eligible issuer. The FDIC as conservator or receiver would be required during this time to perform all monetary and nonmonetary obligations 

of the issuer under the covered-bond program. 

If another conservator, receiver, liquidator, or bankruptcy trustee were appointed for an issuer before a default on its covered bonds results in the creation of an estate or if the FDIC as conservator or receiver did not transfer a 

covered-bond program to another eligible issuer within the allowed time, a separate estate would be created that is comprised of the applicable cover pool and 

that assumes liability for the covered bonds and related obligations. The conservator, receiver, liquidating agent, or bankruptcy court would be required to estimate and allow any contingent deficiency claim against the issuer. The conservator, receiver, liquidating agent, or bankruptcy trustee would receive a residual interest that represents the right to any surplus from the cover pool. The 

conservator, receiver, liquidating agent, or bankruptcy trustee would be obligated to release applicable books, records, and files and, at the election of the 

Covered-Bond Regulator, to continue servicing the cover pool for 120 days. 

The Covered-Bond Regulator would act as or appoint the trustee of the estate 

and would be required to appoint and supervise a servicer or administrator for 

the cover pool. The servicer or administrator would be obligated to collect, realize on, and otherwise manage the cover pool and to invest and use the proceeds 

and funds received to make required payments on the covered bonds and satisfy 

other liabilities of the estate. The estate would be authorized to borrow or otherwise procure funds, including from the Federal Reserve Banks. Other than to 

compel the release of funds that are available and required to be distributed, 

no court would be able to restrain or affect the resolution of the estate except 

at the request of the Covered-Bond Regulator. 

• Securities Law Provisions—With covered-bond programs subject to rigorous 

public supervision, investors will be well-protected. As a result, an expansion 

of existing securities-law exemptions may be appropriate. Regardless, because 

legal certainty for covered bonds is paramount, we support a framework that 

includes at least the following: Existing exemptions for securities issued or 

guaranteed by a bank would apply equally to covered bonds issued or guaranteed by a bank. Each estate would be exempt from all securities laws but would 

succeed to any requirement of the issuer to file applicable periodic reports. Each 

residual interest would be exempt from all securities laws. 

• Miscellaneous Provisions—We also support a framework that includes the following conforming changes to other applicable law: The Secondary Mortgage 

Market Enhancement Act of 1984 would be expanded to encompass covered 

bonds. Covered bonds that are backed by the residential mortgage asset class, 

the home equity asset class, or the commercial mortgage asset class would be 

qualified mortgages for Real Estate Mortgage Investment Conduits (REMICs) 

and, subject to regulations that may be promulgated by the Secretary of the 

Treasury, may be treated as real estate assets in the same manner as REMIC 

regular interests. The estate would not be treated as a taxable entity, and no 

transfer of assets or liabilities to an estate would be treated as a taxable event. 

The acquisition of a covered bond would be treated as the acquisition of a security, and not as a lending transaction, for tax purposes. The Secretary of the 

Treasury may promulgate regulations for covered bonds similar to the provisions of Section 346 of the Bankruptcy Code. 

In addition to these elements of a legislative framework, the Council also believes 

that U.S. covered bonds should be afforded favorable regulatory capital treatment 

like that found in Europe, including in the context of risk weighting and liquidity 

buffers. 

On behalf of the Council, I want to thank Chairman Dodd for holding this hearing 

and Senator Corker and Congressman Garrett for their leadership on U.S. covered 

bonds. 

I would be pleased to answer any questions that Members of the Committee may 

have. 
53 

PREPARED STATEMENT OF KENNETH A. SNOWDEN 

ASSOCIATE PROFESSOR OF ECONOMICS, UNIVERSITY OF NORTH CAROLINA AT

GREENSBORO

SEPTEMBER 15, 2010 

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, I appreciate the opportunity to testify before the Committee concerning the potential 

uses and regulation of covered bonds in the U.S. mortgage market. I am an economic historian who for the past two decades has studied the development of the 

U.S. mortgage market. Up until 3 years ago my specialty was relatively obscure 

even among other historians, but crisis always seems to enhance the value of looking back. The purpose of my testimony is to share with you some of the research 

I and others have done concerning the history of our mortgage market and the role 

that covered mortgage bonds have played within it. The hope is that the historical 

perspective will provide useful guidance as you consider whether and how to incorporate regulated covered bonds into the U.S. mortgage market. 

Covered bonds are being recommended for the U.S. mortgage market at this time 

because they address weaknesses that we have observed over the past 40 years in 

the two funding mechanisms that have dominated the U.S. mortgage market for the 

past century. One of these systems is what I refer to here as the traditional portfolio 

lender model in which an intermediary holds mortgage loans on its own balance 

sheet and funds them by issuing deposits. In the other funding mechanism that is 

used extensively in the U.S., called securitization, bonds are issued against a pool 

of mortgages that has been taken off the balance sheet of the intermediary that 

originated or assembled the mortgage loan pool. Covered mortgage bonds differ from 

both of these systems in that the intermediary issues debt that is secured by a pool 

of mortgage loans that it holds on its own balance sheet. Investors who purchase 

covered bonds are given senior claims on the designated mortgage cover pool, and 

also have recourse to the other assets held by the intermediary as security for the 

promised payments on their bonds. As a result of this structure, covered mortgage 

bonds can reduce the risks of funding long-term mortgages with short-term deposits 

that arise in the traditional portfolio lender model, while providing greater incentives to impose strict mortgage underwriting standards than are found in 

securitization. 

Covered mortgage bonds are also being recommended at this time because of their 

popularity and record of success in Europe. The European record of covered mortgage bond success, in fact, stretches back over 200 years. Although my own research 

is completely U.S.-centered, I became aware of the history of covered bond use in 

Europe two decades ago when I came across commentaries by late 19th century 

writers that complained bitterly about the absence of European-style covered mortgage bond programs in the U.S. These comments provided evidence that market 

participants in the U.S were well aware of covered mortgage bonds as early as 1870 

and led me to question why the mechanism had not been implemented here. Further exploration revealed that covered mortgage bond systems actually had been introduced several times between 1870 and 1935. At that point the important question 

became why did covered mortgage bonds not become a permanent fixture in U.S. 

mortgage markets. It turns out that bad timing, poor implementation, and ineffective regulation all played roles, and my testimony briefly surveys that record to provide the Committee with this historical perspective as you consider legislation to encourage the introduction of covered bonds into the U.S. mortgage market one more 

time. 

The history of covered mortgage bonds in the U.S. is messy. It spans the farm 

and nonfarm residential mortgage market, State and Federal regulatory structures 

and fundamental changes in mortgage contract design—all during a seven-decade 

period which saw three mortgage crises, including the most severe one in the 1930s. 

Before venturing more deeply into this chronology, a brief summary of its highlights 

and the lessons that I have drawn from it will be useful. 

I divide the historical record into two parts. The first lies between 1870 and 1900 

when covered mortgage bonds were introduced into the U.S. without the regulatory 

framework that was used in Europe. The covered mortgage bond had its greatest 

success during this period when western farm mortgage companies that normally 

brokered whole mortgage loans began to issue bonds secured by the mortgages instead of selling the loans outright. I have examined one of these companies in depth 

and found that the loans it placed behind its covered bonds were riskier than those 

that it brokered. That result appears to contradict the generalization that underwriting standards are strict inside a covered mortgage bond structure; but in this 

case the issuer could shift risk between two mortgage funding channels because of 
54 

1 Brewer (1976, 373–380) also examines the mortgage bond business of the Mercantile Trust 

Company of New York, a subsidiary of the Equitable Insurance Company. 

ineffective regulation. A more obvious lesson can be drawn from the way these companies failed during the general farm mortgage crisis of the 1890s. Serious malfeasance occurred throughout the covered mortgage bond sector during the crisis because there was no regulation in place to control the behavior of the mortgage companies after their financial capital dissipated. These failures affected the reputation 

of covered mortgage bond programs in the U.S. for decades. 

The Federal Government takes center stage in the history of covered mortgage 

bonds between 1900 and 1935. Your predecessors in the 63rd and 64th Congresses 

benefited from an extensive investigation of covered mortgage bond systems in Europe before creating the Federal Farm Loan Bank System in 1916. This system was 

comprised of both public and private institutions, and both relied on covered bonds 

to fund mortgages. The privately financed, joint-stock land bank component within 

the system was structured and regulated just like institutions in Germany which 

led private farm mortgage companies to oppose and avoid the system because of the 

restrictions it imposed on activities that were standard practice in the U.S. farm 

mortgage market. Twenty years later the 73rd Congress authorized the creation of 

a privately financed, federally regulated covered residential mortgage bond program 

to provide a liquid market for the new FHA-insured mortgage loans. No private institution was ever chartered under this authority, and the discussion about introducing covered mortgage bonds to the U.S. went silent for decades. 

In the final section of my testimony I provide an overview of the development of 

the institutional residential mortgage market over the past century to provide perspective on how the introduction of covered mortgage bonds at this time fits into 

its long-run pattern of development. I close this introduction, however, by summarizing three lessons I draw from the historical record: 

1. Past failures of covered mortgage bonds in the U.S. are explained by a combination of bad timing, poor implementation, and ineffective regulation. We 

need to do a better job of incorporating covered bonds into the U.S. mortgage 

market, rather than abandon the effort. 

2. A common failure in past attempts was to transplant elements of European 

covered mortgage bond systems without tailoring them to fit U.S. institutions. 

We need to identify features of the U.S. mortgage market that could be incompatible with European covered mortgage bond practice while, rather than after, 

regulation is being formulated. 

3. Finally, history gives us a clear bottom line in this case. If it had been easy 

to incorporate covered bonds into the U.S. mortgage market, we would have 

already done so. 

Unregulated Early Experiments With Covered Mortgage Bonds 

By the mid-1800s covered farm mortgage bonds were trading in Europe in broad 

and active secondary markets with yields as low as those on Government securities. 

These bonds were issued by mutually owned institutions (Landschaften) and privately owned, joint-stock mortgage banks in Germany, and by a national monopoly 

bank (the Credit Foncier) in France. The success of these programs attracted attention in the U.S. where the focus in the mortgage market during the late nineteenth 

century was on the spatial mismatch of mortgage credit between savings-rich, eastern urban areas and rapidly growing, capital-hungry areas in the Midwest and 

Great Plains (Davis, 1965). Several innovations appeared between 1870 and 1900 

to facilitate the movement of mortgage credit from east to west to arbitrage the substantial differentials in mortgage rates that had appeared. Among these were attempts to establish covered mortgage bond programs patterned after European models, but not subject to the same strict regulatory oversight. 

Henry Villard, who was German-born and traveled in Europe as a journalist, is 

given credit for initially advocating for the importation of the European mortgage 

system into the U.S. in the late 1860s (Herrick and Ingalls, 1915, 1–2). Villard’s attempts to establish a mortgage bank failed, but in 1871 Pierpont Morgan and other 

respected American and European investment bankers organized a trust under New 

York law to implement a European-style covered mortgage bond business. The New 

York board of the U.S. Mortgage Company was charged with the task of assembling 

pools of high-yielding western mortgages, while the European board took charge of 

marketing and selling the covered bonds in their home markets (See, Brewer, 

1976). 1 The focus on continental markets led the firm to adopt the norms and even 

some of the language of European systems: outstanding bonds could not exceed 20 

times paid-in capital and had to be fully secured by mortgages on improved farm 
55 

2 Brewer (1976, 363) provides a fuller description of the bylaws. Brewer (373–380) also examines the mortgage bond business during the 1870s of the Mercantile Trust Company of New 

York, a subsidiary of the Equitable Insurance Company. Mercantile acted as custodian and 

guarantor of bonds issued against mortgages that it had taken off of its own books. These, and 

similar structures discussed below that were issued in the 1920s are classified here as 

securitizations, not as covered bonds. 3The companies sold brokered loans with recourse, but the promise to buy back loans was 

not a formal, legal obligations as the companies could and did suspend recourse when in distress. 4Mortgage companies assigned loans to investors and then mailed applications and documents for investor approval. Loans that investors rejected had to be reassigned to another investor. 5 Regulation came too late to be effective as western mortgage companies operating in Connecticut, New York and Massachusetts were not required to report even basic financial data to 

investors until 1889—years after the debenture movement began to expand rapidly. Even at this 

point the information was self-reported and the companies were not subject to on-sight examinations.(New York, Annual Report (1891), pp. 15–27.) The trustees who administered debenture 

programs for the mortgage companies were also did not monitor their western lending operations. 6The discussion here is summarizes evidence reported in Snowden (2010b). 

and urban properties with low loan-to-value ratios. 2 The company was incorporated 

as a trust which meant that its covered mortgage business was virtually unregulated relative to European standards. U.S. Mortgage issued securities successfully 

for 2 years, but its growth was soon cut short by the Panic and recession of 1873. 

The company never defaulted on its bonds, but gradually wound down its covered 

mortgage bond business because marketing western mortgage loans turned out to 

be too risky and time-consuming to command the attention and risk the reputation 

of its high-profile organizers (Brewer 1976, 380). 

Western farm mortgage companies, unlike U.S. Mortgage, were intimately involved in the western farm mortgage market and much more successful, at least at 

first, in establishing covered-bond programs. Hundreds of these mortgage companies 

were organized in the Midwest and Great Plains during the 1860s and 1870s to 

broker and service individual whole farm mortgage loans for eastern and European 

investors. In the early 1880s several of these companies began to place whole mortgages that they had originated into eastern trust accounts and to issue covered 

bonds, then called debentures, against this collateral. The innovation enjoyed immediate popularity, and by 1890 two-thirds of the western mortgage companies that 

were licensed to operate in New York and Massachusetts were selling their own covered mortgage bonds. By that time the new securities were funding about one-tenth 

of outstanding western farm mortgage debt. 

Investors were attracted to covered bonds because they offered less idiosyncratic 

lending risk and lower transaction costs than the brokered whole farm loans that 

the companies had been selling up to that time. In order to issue the bonds, however, the mortgage company had to issue its own debt obligations that exposed it 

to risk that brokerage did not impose. 3 Starting a debenture program also entailed 

the costs of incorporating the company and formulating a trust arrangement, most 

often with an eastern trust company. The trustee was required to evaluate mortgage 

loans designated for the trust account against criteria the company itself specified— 

they usually required mortgages written for no more than 40 or 50 percent of the 

value of the encumbered property. Debentures were issued and sold only after the 

trustee had certified the collateral. The trustee was also obligated to take control 

of the assigned mortgage loans on the behalf of the bondholders if the company defaulted on its obligations to them. 

An interesting feature of the farm mortgage bond movement is that it provided 

investors with less information about mortgage loan quality than the brokered loan 

business it was intended to supplant. 4 In this environment investors who bought 

covered bonds could have relied on three mechanisms to assure that the bonds were 

well-secured: the trust arrangement through which debentures were issued, supervision by State regulatory authorities, and the mortgage company’s own incentive 

to uphold underwriting standards in order to protect its own financial and 

reputational capital. Regulation and trust arrangements provided no effective 

hands-on supervision, however, so investors relied most heavily on the mortgage 

company’s own ‘‘skin in the game.’’ 5 This helps to explain why the debenture movement did not appear until the 1880s after some of the mortgage companies had become large enough and sufficiently well-capitalized in their brokerage businesses to 

credibly issue their own securities. 6 It also explains why not all western mortgage 

companies issued debentures; I have recently found that debentures were most like-
56 

7Some of the western mortgage companies placed into trust mortgages written to their employees on property the company had acquired after buying back defaulted brokered loans. 8For accounts of similar abuses by other mortgage companies see New York (Annual Report 

(1891), pp. 16–19). Snowden (1995, pp. 279–281) summarizes regulators’ findings and criticisms 

of both operating and failed farm mortgage debenture companies. 

ly to be adopted, and to be used more intensively, by older, larger companies with 

strong balance sheets and successful records of performance as mortgage brokers. 

A second interesting feature of these covered bonds is that all of the companies 

that issued debentures continued to broker loans. Mortgage companies that operated these mixed brokerage-debenture businesses, therefore, had to allocate mortgage loans between the two funding channels. I recently examined how that allocation was made in 1887 in one large and highly respected Kansas mortgage company. 

The evidence shows that the loans placed behind the covered bonds were smaller 

in size, shorter in term and riskier than those that the company brokered. By packaging these types of loans behind covered bonds the mortgage companies improved 

the efficiency of the interregional mortgage market by creating a funding mechanism for loans that were difficult and costly to broker. This result provides an interesting counterexample to the generalization that the issuer’s ‘‘skin in the game’’ in 

a covered-bond structure necessarily leads to stricter underwriting standards. It also 

indicates that combining a covered mortgage bond program with another mortgage 

funding channel can create incentives to shift risks among the two. 7

A third interesting feature of the farm debenture movement is its spectacular failure in the 1890s. The backdrop was a general farm mortgage crisis that generated 

substantial losses for farmers, investors and intermediaries in the western mortgage 

market. It was not surprising, therefore, that virtually all of the mortgage companies that had issued covered bonds, as well as most of the brokerage-only operations, failed. Many investors were shocked, however, when audits of the failed 

mortgage companies by eastern regulators found evidence of widespread and egregious violations of the company’s own trust agreements within their covered mortgage bond programs. 8 The problem, of course, was that the incentives of the mortgage companies changed dramatically once the financial capital that supported their 

debenture programs had been exhausted in the broader mortgage crisis. Investors 

learned the hard way in the 1890s that the ‘‘skin-in-the-game’’ that promotes diligence within a covered-bond structure is not the mortgage loans on the issuer’s balance sheet, but the value of its capital. 

Federal Sponsorship of Covered-Bond Programs 

The Federal Farm Loan Bank System 

The spectacular failure of the covered-bond programs of the western mortgage 

companies was remembered for decades as a cautionary tale. It also left a void in 

the market for farm mortgages that was filled by a new generation of mortgage companies that relied exclusively on the old system of loan brokerage. The typical farm 

mortgage contract at the time was a balloon loan with a term of 3 to 5 years that 

the borrower had to renew one or more times before extinguishing the debt. Between 1908 and 1912 a ‘‘Rural Credits Movement’’ called for Federal intervention 

into the mortgage market so that farmers in the U.S. could benefit from the same 

type of long-term, low-cost amortized mortgage loans that had been written for decades within European covered-bond systems (Herrick and Ingalls, 1915a). The 

movement grew strong enough to pressure President Taft and the Congress to create a commission to investigate European mortgage banking systems and to make 

recommendations for a publicly sponsored covered farm mortgage bond system. The 

commission reported back to a joint hearing before the Banking Subcommittees of 

the Senate and the House in 1914, and that testimony provides an exhaustive discussion of covered mortgage bond practices as it existed at that time in Europe 

(United States, 1914). 

A heated debate arose about which one of several European models would be most 

appropriate in this country—a quasi-public monopoly bank like the Credit Foncier, 

a cooperative land credit system along the lines of the German Landschaften, or a 

regulated system of private joint-stock mortgage banks. The compromise that took 

shape in the Federal Farm Loan Act of 1916 was a mixed model that included a 

publicly sponsored cooperative mortgage lending system alongside a federally chartered system of private joint-stock mortgage banks. Both systems were to issue covered mortgage bonds under the supervision of the Federal Farm Loan Bank Board. 

The public, cooperative system was two-tiered. The foundation of the system was 

locally based, voluntary cooperatives that were authorized to make loans to members of the association that met underwriting standards established by the Federal 

Farm Loan Board. These included a maximum loan-to-value ratio of 50 percent, a 
57 

9The opposition to the Federal Farm Bill actually led to the formation of the Farm Mortgage 

Bankers Association—the precursor to the modern Mortgage Bankers Association (Robins, 

1916). 10O’Hara (1983) argues that the FHLB tax exemption diverted credit into agriculture and 

made it more difficult for tenant farmers to purchase land, one of the system’s intended goals, 

by capitalizing the subsidy in higher farm land prices. 

term of 30 years, and full amortization with privilege to prepay. After the loans 

were made they were sent to one of twelve district Federal Land Banks for approval 

after which Federal Land Bank Bonds could be issued in equal amounts. The bonds 

were the joint liability of the Land Banks and the Farm Loan Associations in a 

structure similar to the German Landschaften. 

We are more interested here in the privately financed Federal Joint-Stock Land 

Banks authorized under the legislation because they shared several features with 

covered mortgage bond models being considered today. The joint-stock bank charter 

was designed to attract private lending agencies so that they could issue regulated 

covered mortgage bonds rather than broker or hold farm mortgage loans. To enter 

the system the owners had to satisfy the minimum capital requirement of $250,000 

and operate under strict regulation borrowed from the German private mortgage 

bank model (Horton, et al., 1941). Each bank could issue bonds in a volume no 

greater than 15 times their capital if they were fully secured by long-term, amortized mortgage loans that met the same underwriting standards that were set for 

the cooperative farm loan associations. Examiners of the district Farm Loan Bank 

served as the pool monitors in these structures and examined and registered each 

loan that was approved as collateral. Each joint-stock bank was fully liable to its 

bondholders, and enjoyed no implicit or explicit Government guarantee. Private rating agencies graded the bonds of each joint-stock bank separately. 

The joint-stock bank system was designed to draw in existing private farm lenders, especially farm mortgage companies. But the mortgage companies, instead, 

ended up opposing the Federal system before and even after it had been passed. 9

The companies were not opposed to covered mortgage bonds, but they argued that 

joining the system would force them to abandon important elements of their existing 

business because of specific requirements of the charter. These included a restriction 

to lend only in the State in which the bank was located and one more contiguous 

to it, the prohibition on selling loans with recourse, which would have eliminated 

their brokerage businesses, and a requirement to write only long-term amortized 

loans so that they could not deal in the standard short-term, balloon loan (Schwartz, 

1938, 21–22). The final bill contained none of the modifications suggested by the 

mortgage companies. In response they then raised objection to another feature of 

the bill—the bonds of both the Federal District Land Banks and the privately owned 

joint-stock banks were fully exempt from Federal taxes. The companies pursued the 

issue after the bill had passed, and their challenge regarding the constitutionality 

of the tax exemption led to legal proceedings that lasted until 1921 and that retarded the early growth of the system. 10

Eighty-eight of the privately owned Federal Joint-Stock Land Banks were ultimately chartered under these provisions, most of them before 1925. From then on 

the banks began to experience difficulties because of general distress in American 

agriculture, and the system was particularly shaken when three of the joint-stock 

banks entered receivership in 1927. Once the Depression took hold the Treasury 

provided relief so that the District Farm Land Banks could manage and supervise 

the joint-stock banks that were forced to liquidate. Emergency farm mortgage relief 

legislation that was passed in 1933 placed the remaining joint-stock banks in liquidation and prohibited the establishment of any additional institutions. The sixdecade experiment in the U.S. with privately financed, European-style covered farm 

mortgage bonds had ended. 

A Covered Mortgage Bond System for the Residential Market? 

With the establishment of the Federal Farm Loan Act proposals soon appeared 

for the creation of a central residential mortgage bank. The discussion began in 

1919, but took more than a decade to resolve. In 1929 the Brookings Institute produced an assessment of ‘‘First Mortgages in Urban Real Estate Finance’’ (Gray and 

Terborgh, 1929). The report focused on the stubborn disparity in mortgage rates 

across regions despite the interregional activities of life insurance companies, real 

estate bond houses and the mortgage guarantee companies during the 1920s. The 

recommendation, therefore, was to establish a public, European-style central mortgage bank—similar to the Federal Farm Loan Bank system—that could place pools 

of nonfarm residential mortgages made by local originators behind covered mortgage 

bonds. 
58 

11The FHA insurance program took up much more of the hearing than any testimony on the 

National Mortgage Association. 12The New York Times, May 28, 1938, reported that applications for new NMAs increased 

after FNMA’s successful bond offering, but that with the FHA decision ‘‘private interests planning to take advantage of this potential market . . . appear doomed to disappointment or at 

least considerable delay.’’ p. 25. Jones and Grebler (1961, p. 115) refer to the NMA proposal as 

a ‘‘frustrating episode.’’ 

By 1931, when President Hoover convened a conference on home building and 

ownership in the midst of the growing mortgage crisis, it had become clear that a 

liquidity facility for residential mortgage lenders would soon be created under one 

of three proposals (Jones and Grebler 1961, 113–114). The National Association of 

Real Estate Builders supported a Federal system of mortgage banks and joint-stock 

banks similar to the one recommended by the Brookings Institute. The Hoover administration favored a Federal facility that could discount mortgages for a wide variety of approved mortgage lenders. The U.S. Building and Loan League favored the 

most restrictive plan, a home loan discount bank for only its members. Its proposal 

was adopted when the Federal Home Loan Bank System was established in 1932 

to serve what would become the modern S&L industry. 

The possibility of a federally sponsored covered-bond mortgage system was revisited when provisions to create the Federal Housing Administration and its mortgage 

loan insurance program were proposed in the National Housing Act of 1934. Although FHA loans were insured by the Federal Government, there was considerable 

doubt whether private lenders would be willing to invest and hold any long-term, 

amortized mortgage loan. To encourage participation in the FHA program, Title III 

of the National Housing Act authorized the FHA to charter privately owned facilities that could provide liquidity for FHA mortgages by issuing covered mortgage 

bonds that used the loans as collateral. This provision of the bill generated attracted 

strong objections from the United States Building & Loan League and life insurance 

companies (United States, 1934a and 1934b). 11 Both groups had reason to be concerned about the potential entrance of a new mortgage lending facility, but their testimony focused as well on the unhappy events associated with the farm mortgage 

debenture debacle of the 1890s and the ongoing liquidation of the joint-stock farm 

land bank system. Others witnesses doubted that private capital would be forthcoming given that the housing sector was at the lowest point of the crisis. 

Despite the opposition, Title III of the National Housing Act authorized the creation of a system of privately owned, federally chartered National Mortgage Associations to buy and sell FHA loans from mortgage originators. These associations were 

to be locally based institutions that would buy, hold and sell FHA loans (See, Jones 

and Grebler 1961, 115–119). The legislation did not limit the number or regional 

distribution of the associations, but required a minimum paid-in capital of $5 million. The bonds issued by an association had to be secured by FHA-insured loans, 

cash or Federal Government securities, and the total volume of its bonds could not 

exceed 10 times paid-in capital. By 1937 not one National Mortgage Association had 

been organized despite modifications to the original legislation designed to attract 

private investors (Jones, 1961, 116). 

In order to demonstrate the viability of the proposed system the Federal Housing 

Administrator authorized the Reconstruction Finance Corporation to sponsor the 

National Mortgage Association of Washington in February 1938. It was soon renamed the Federal National Mortgage Association and its first issue of $25 million 

of debentures was heavily oversubscribed. Despite the success of this experiment, 

the FHA announced in May that it would no longer process applications for private 

National Mortgage Association charters so that not one privately owned institution 

was chartered under Title II of the National Housing Act. 12 The FNMA went on, 

however, to create a secondary market for FHA loans and, somewhat later, VA 

guaranteed loans. What had been abandoned, however, were plans to create a federally chartered, private system of institutions that could issue covered residential 

mortgage bonds. 

Covered Bonds and the Long-Run Development of the Market 

Although most of our experience with covered bonds took place in the farm mortgage market, we end by focusing on the Nation’s nonfarm residential mortgage because it is there that the introduction of covered mortgage bonds in the U.S. today 

are most likely to affect the long-run development of the mortgage market. Figure 

1 provides a view of changes in the structure of that market over the past century. 

The turmoil of the past decade pales in comparison to events in the residential 

mortgage market during the 1920s and 1930s. The volume of nonfarm residential 

mortgage debt tripled during the home building boom of the 1920s and financed an 

increase in the rate of nonfarm homeownership from 41 to 46 percent. The note-
59 

13See, Goetzmann and Newman (2010) and Snowden (2010a) for discussions of both instruments. 14 HOLC is currently drawing substantial attention in the academic literature. See, Fishback 

et al. (2010), Rose (2010), and Courtemanche and Snowden (2010). 

worthy structural change in the mortgage market during the decade was the rapid 

growth of two forms of privately issued real estate securities that by 1929 funded 

nearly 10 percent of Nation’s outstanding residential mortgage debt. These innovations—single-property real estate bonds and participation certificates issued by 

mortgage guarantee companies—financed commercial as well as residential development in the Nation’s largest urban areas and were primarily directed toward the 

individual investor who played a much larger role in the residential market at that 

time. Both of these securities were early forms of off-balance-sheet securitization 

and were not covered mortgage bonds. 13

During the 1930s the U.S. experienced record levels of nonfarm foreclosures, widespread distress among mortgage lenders, a collapse and weak recovery in homebuilding, large decreases in home values and a complete reversal of the gains in 

homeownership made during the 1920s. Against this backdrop the Home Owners’ 

Loan Corporation had a sudden and large impact on the structure of the residential 

mortgage market (refer to Figure 1). Between 1933 and 1936 this Federal agency 

operated as both a ‘‘bad mortgage bank’’ (by purchasing distressed mortgages from 

private lenders) and a loan modification program (by refinancing the mortgages with 

long-term, high-leverage, amortized loans). In three short years it had refinanced 

mortgages on one out of every 10 owner-occupied homes and held nearly 10 percent 

of the Nation’s home mortgage debt. HOLC’s lending activities ended in 1936 after 

which the agency existed another 15 years to service its mortgage portfolio. 14

A second striking change in market structure during the 1930s was the disappearance of the private securitization structures that had grown so rapidly during the 

previous decade. Although the decline in the share of private real estate securities 

looks gradual in Figure 1, the actual process was not. Nearly all of the real estate 

bond houses and mortgage guarantee companies that had issued real estate securities during the 1920s failed during the early 1930s. From this point on investors 

holding these securities went through complicated and protracted proceedings in 

order to liquidate the underlying mortgage assets. Some of these resolutions took 

more than a decade during which State authorities had to act as receivers and modifications of State and Federal law were required to help resolve conflicts among the 

parties who owned the loans. The failures of these securitization structures were so 

widespread, complex, and costly that private mortgage insurance and privately 

sponsored securitization disappeared entirely from the U.S. residential mortgage 

market for decades. 

As we have seen earlier, the prospects for a covered residential mortgage bond 

system in the U.S. also diminished severely in the 1930s. But traditional portfolio 

mortgage lenders sought and received several regulatory interventions during the 

decade that strengthened their mortgage lending operations. The Building & Loan 

industry, which had been the Nation’s largest source of home mortgages before 

1930, was transformed into the modern Savings & Loan sector with the creation of 

the Federal Home Loan Bank System’s discounting facility in 1932, a new system 

of Federal S&L charters, and an insurance program for S&L share accounts. A second important development was the creation in 1934 of the FHA mortgage loan insurance program that was discussed above. Although the companion covered mortgage bond system authorized by the legislation never materialized, FHA loans became important to the lending activities of mortgage companies, commercial banks, 

mutual savings banks and life insurance companies—none of which participated in 

the FHLB system. After the Federal National Mortgage Association was established 

to serve as a dedicated secondary market facility for FHA loans in 1938, therefore, 

all of the traditional mortgage portfolio lenders were supported by new Federal 

structures. 

Traditional portfolio lenders performed well within their new Federal structures 

during the immediate post-World War II period. The S&L industry focused on local 

mortgage markets and small-scale builders; commercial banks and mortgage companies used FHA and VA loans to finance large tract builders and multifamily 

projects; and life insurance companies and mutual savings banks used insured and 

guaranteed loans to serve the interregional residential mortgage market through 

networks of closely affiliated mortgage companies. With all of this activity supported 

by the FHLB and FNMA secondary market facilities, the share of the Nation’s residential mortgage debt that was held by the portfolio lenders swelled to 80 percent 

and financed a historic surge in homebuilding and homeownership during the 1950s 

and early 1960s (See, Figure 1). 
60 

Despite the accomplishments, there were several disadvantages associated with 

relying so heavily on portfolio lenders. Strict regulatory boundaries, for example, 

limited competition and discouraged innovation. The more telling weakness, however, was the inability of portfolio lenders to profitably underwrite the risks of funding long-term, fixed-rate mortgages when nominal interest rates, driven by inflation, 

became variable around high levels in the 1970s. Institutions that relied on shortrun deposits were particularly vulnerable, but even the life insurance companies, 

which had been successful farm and residential mortgage lenders for more than a 

century, dramatically reduced their portfolio of residential mortgage loans. It took 

more than a decade, and a full-blown thrift crisis, for the depression-era S&L industry to do the same. 

Securitization reappeared in the U.S. in the 1970s to supplant the failing mortgage system that had been forged during the 1930s mortgage crisis. Securitization 

was not sponsored this time by private entities, as it had been in the 1920s, but 

by a Federal agency (Ginnie Mae) and federally sponsored GSEs (Fannie Mae and 

Freddie Mac) that had been carved out of the FHLB and FNMA secondary market 

facilities that had been created four decades earlier to support portfolio lenders. 

Agency- and GSE-sponsored securitization made modest inroads at first, but captured virtually all of the mortgage business lost by insurance companies and savings 

institutions during the 1980s. 

During this period private agencies began to repackage the cash-flows from federally sponsored mortgage securities in order to offer investors other securities that 

offered different exposures to the prepayment and interest rate risks that had proven to be so troublesome for portfolio lenders. The trajectory and composition of 

securitization then changed in the 1990s, however, as the GSEs began to hold large 

volumes of mortgages and securities within their own portfolios, and private issuers 

began to securitize mortgage pools that contained the types of loans that the GSEs, 

at least at first, would not. We continue to debate the role that the GSEs played 

in our recent crisis, and changes in their structure and mission are sure to play a 

decisive role in the future development of the residential mortgage market. 

But the topic of this hearing is the potential role that covered bonds will play in 

the future, and the chronology we have just reviewed reveals some striking similarities between the decisions Congress faces now and the ones that it confronted in 

the 1930s. Then, like now, it was responding to a mortgage crisis which had brought 

into focus severe problems with the private securitization structures that had grown 

so rapidly in the previous decade. Then, like now, it considered establishing a covered mortgage bond market to serve as a new funding channel for a housing market 

in distress. The legislation authorizing a covered mortgage bond system passed in 

the 1930s, but the system failed to materialize. What followed is the pattern of development and chain of events that has brought us here today. I hope that recounting this history provides some assistance to the Committee as it helps to shape the 

next chapter. 

References 

Brewer, H. Peers (1975). ‘‘Eastern Money and Western Mortgages in the 1870s’’, 

Business History Review, 50, 356–380. 

Courtemanche, Charles, and Kenneth Snowden (forthcoming). ‘‘Repairing a Mortgage Crisis: HOLC Lending and Its Impact on Local Housing Markets’’, National 

Bureau of Economic Research WP 16245, July 2010. 

Davis, Lance (1965). ‘‘The Investment Market, 1870–1914: The Evolution of a National Market’’, Journal of Economic History, 25 (2), 355–393. 

Fishback, Price, Shawn Kantor, Alfonso Flores-Lagunes, William Horrace, and Jaret 

Treber (forthcoming). ‘‘The Influence of the Home Owners’ Loan Corporation on 

Housing Markets During the 1930s’’, Review of Financial Studies, National Bureau of Economic Research WP 15824, March 2010. 

Frederiksen, D.M. (1894a). ‘‘Mortgage Banking’’, Journal of Political Economy 2, 

210–221. 

Frederiksen, D.M. (1894b). ‘‘Mortgage Banks in Germany’’, Quarterly Journal of Economics 9, 47–76. 

Goetzmann, William N., and Frank Newman (2010). ‘‘Securitization in the 1920s’’, 

National Bureau of Economic Research WP 15650, January 2010. 

Gray, John H., and George W. Terbough (1929). ‘‘First Mortgages in Urban Real Estate’’, The Brookings Institute Pamphlet Series, 1 (2). 

Herrick, Myron, and R. Ingalls (1915a). Rural Credits. New York: D. Appleton. 

Herrick, Myron, and R. Ingalls (1915b). ‘‘How to Finance the Farmer: Private Enterprise—Not Public Aid’’, Ohio State Committee on Rural Credits, Cincinnati. 

Horton, Donald, H. Larsen, and N. Wall (1942). ‘‘Farm Mortgage Credit Facilities 

in the United States’’, Miscellaneous Publication No. 478, USDA. 
61 

Jones, Oliver, and Leo Grebler (1961). ‘‘The Secondary Mortgage Market’’, Los Angeles: UCLA 

New York (1891–97). Annual Report of the Superintendent of Banks Relative to Foreign Mortgage, Loan, or Investment Companies. 

O’Hara, Maureen (1983). ‘‘Tax Exempt Financing’’, Journal of Money, Credit and 

Banking 15, 425–441. 

Palyi, Melchior (1934). ‘‘Principles of Mortgage Banking Regulation in Europe’’, 

Journal of Business: Studies in Business Administration V. 1-37. 

Preston, Howard (1921). ‘‘The Federal Farm Loan Case’’, Journal of Political Economy, Vol. 29, No. 6, pp. 433–454. 

Rose, Jonathan (2010). ‘‘The Incredible HOLC? Mortgage Relief During the Great 

Depression’’, Unpublished Working Paper, April. 

Schwartz, Carl Herbert (1938). Financial Study of the Joint Stock Land Banks. 

Washington, DC: Washington College Press. 

Snowden, Kenneth (1995). ‘‘Mortgage Securitization in the U.S.: 20th Century Developments in Historical Perspective’’, in M. Bordo and R. Sylla (eds.), AngloAmerican Financial Systems, New York: Irwin, 261–298. 

Snowden, Kenneth (forthcoming). ‘‘The Anatomy of a Residential Mortgage Crisis: 

A Look Back to the 1930s’’, in L. Mitchell and A.E. Wilmarth (ed.), The Panic of 

2008: Causes, Consequences and Proposals for Reform. Northampton, MA, Edward 

Elgar Publishing. National Bureau of Economic Research Working Paper #16244, 

July 2010a. 

Snowden, Kenneth (forthcoming). ‘‘Covered Farm Mortgage Bonds in the Late Nineteenth Century U.S.’’, Journal of Economic History. National Bureau of Economic 

Research WP #16242, July 2010b. 

United States (1914). Rural Credits Joint Hearings before the Subcommittees of the 

Committees on Banking and Currency of the Senate and of the House of Representatives, Charged with the Investigation of Rural Credits, Sixty-Third Congress, Second Session. Washington: GPO. 

United States (1934a). National Housing Act: Hearing Before the Subcommittee on 

Housing of the Committee on Banking and Currency, House of Representatives, 

Seventy-Third Congress, second session, on H. R. 9620. May 18, 25, 26, 28, 29, 

30, 31, June 1, 2, 4, 1934. Washington: GPO. 

United States (1934b). National Housing Act: Hearings Before the Committee on 

Banking and Currency, United States Senate, Seventy-Third Congress, second 

session, on S. 3603. May 16–24, 1934. Washington: GPO. 
62 
63 

PREPARED STATEMENT OF RIC CAMPO 

CHAIRMAN AND CHIEF EXECUTIVE OFFICER, CAMDEN PROPERTY TRUST, ON BEHALF

OF NATIONAL MULTI HOUSING COUNCIL AND THE NATIONAL APARTMENT ASSOCIATION

SEPTEMBER 15, 2010 

Chairman Dodd, Ranking Member Shelby, and distinguished Members of the 

Committee, I am Ric Campo, Chairman and CEO of Camden Property Trust, a publicly held apartment firm. 

I am the immediate past Chairman of the National Multi Housing Council 

(NMHC) and am testifying today on behalf of NMHC and its joint legislative partner, the National Apartment Association (NAA). 

Camden Property Trust is an S&P 400 Company and one of the largest publicly 

traded multifamily companies in the United States. Structured as a Real Estate Investment Trust (REIT), our company owns, develops, acquires and manages multifamily residential apartment communities. We are headquartered in Houston, TX, 

and currently operate 187 properties containing 64,074 apartment homes. Our workforce totals nearly 1,800 employees. 

NMHC and NAA represent the Nation’s leading apartment firms. Our combined 

memberships are engaged in all aspects of the industry, including ownership, development, management and finance. NMHC represents the principal officers of the industry’s largest and most prominent firms. NAA is the largest national federation 

of State and local apartment associations with 170 State and local affiliates comprised of more than 50,000 members. Together they represent just under 6 million 

apartment homes. 

We applaud the Senate Banking Committee for exploring alternative sources of 

capital to support housing. We believe that covered bonds could indeed provide some 

degree of additional liquidity to U.S. multifamily finance. We caution, however, that 

it is quite unlikely that covered bonds could provide the capacity, flexibility or pricing superiority necessary to adequately replace any of the U.S.’s traditional sources 

of multifamily mortgage credit. 

I am not here today as an expert on covered bonds. Rather, I am hoping to provide you with some background on the apartment sector, its general credit needs 

and to share some insights into what role covered bonds could play in meeting those 

needs. 

To understand the role or impact covered bonds might have on the apartment industry’s access to credit, it is necessary first to have a broad understanding of the 

apartment industry’s current capital sources—both before and during the crisis. 

One-third of American households rent, and over 14 percent of households—16.7 

million households—live in a rental apartment (buildings with five or more units). 

Our industry’s ability to meet the Nation’s rental housing needs depends on reliable 

and sufficient sources of capital. 

Multifamily Capital Markets and Industry Performance 

Since the onset of the financial meltdown, virtually all private mortgage lenders 

left the housing finance market, and the apartment industry has relied heavily on 

credit either insured or guaranteed by the Federal Government. Fully 8 out of 10 

apartment loans issued in the first six months of 2010 had some form of Government credit behind them, namely FHA, Fannie Mae, or Freddie Mac. The FHA and 

Government Sponsored Enterprises (GSEs) are expected to account for 80–90 percent of the $50–$60 billion in credit provided to the apartment sector this year. 

Historically, however, the apartment industry has enjoyed access to mortgage 

credit from a variety of capital sources. In addition to the FHA and GSEs, banks 

and thrifts, life insurance companies, pension funds and the commercial mortgagebacked securities market have all provided significant amounts of mortgage capital 

to the apartment industry. Prior to the financial crisis, these capital sources provided our sector with $100–$150 billion annually, reaching as high as $225 billion, 

to develop, refinance, purchase, renovate, and preserve apartment properties. 

These market sources have proven to be reliable and durable, with the exception 

of unique financial situations, such as the current economic crisis and the 1997– 

1998 Russian financial crisis. 

As of the first quarter of 2010, there was approximately $872 billion in outstanding multifamily mortgage debt (See, Table 1). In recent years, the industry has 

shifted from relying on whole loans from banks and life insurance companies to 

securitized loans. Currently, just under half (49 percent) of outstanding multifamily 

capital is held in the secondary market (31 percent by the GSEs, 13 percent in 

CMBS and 5 percent in Ginnie Mae.) Nevertheless, banks remain an important capital source, providing nearly one-quarter of the industry’s mortgage capital. 
64 

As policy makers consider the causes of, and solutions to, the single-family meltdown, it is important to distinguish between performance in the single-family sector 

and the multifamily sector. The multifamily industry did not overbuild in the housing boom. 

Table 2 below shows the stark contrast between the single-family housing production/bubble and resulting housing crisis and the relatively constant level of new production in the multifamily housing sector during the same period. Since the mid1990s, the multifamily industry has started approximately 350,000–375,000 new 

units annually. During the same period, the single-family market almost doubled its 

production from around 1 million to 1.75 million units. 

The discipline shown by the apartment industry has translated into stronger portfolio performance as well. Overall loan performance in the $853 billion multifamily 

sector remains relatively healthy, with delinquencies and default rates only a fraction of those seen in single-family. The 90-day delinquency rate of multifamily loans 

is estimated to be 4.3 percent or $31 billion. Compared to the single-family residential mortgage market where the mortgage debt outstanding is reported at $10.7 tril-
65 

lion as of March 30, 2010, and a 90-day delinquency rate of 9.2 percent or $984.4 

billion. 

There has been some stress recorded in bank loans and CMBS, particularly those 

originated between 2006 and 2008 when more aggressive underwriting and higher 

leverage was employed. However, that stress is largely a result of the overall economy and the worst job market in 40 years and not due to oversupply. 

Many of those problematic loans were taken out to renovate and reposition existing properties. When property values plummeted and unemployment soared, those 

projects stalled and borrowers lost most of their equity. The problem is especially 

acute in some markets such as the boroughs of New York City and other major employment centers that have large concentrations of apartment properties. 

Nevertheless, many of these distressed loans will be resolved, and most apartment 

residents will not be affected by loan delinquencies or even defaults, as such situations generally result in a smooth transition to a new operating entity with sufficient capital to maintain the property. 

Covered Bonds and the Multifamily Credit Market 

The current housing finance system has worked extremely well in providing liquidity to the apartment sector in all economic climates. That said, we welcome 

Congressional efforts to create a framework for covered bonds so they may serve as 

an additional source of capital for apartments. We do not believe, though, as some 

have suggested, that covered bonds can resolve the current financial crisis or prevent future crises that might require Government intervention. 

It is clear that covered bonds offer some advantages to issuers and investors. They 

give issuers access to lower-cost funding for mortgage and other asset-backed credit 

with more favorable risk-based capital requirements than whole loans held in their 

portfolio. For investors, they offer high credit quality, solid yield, low-risk and diversified investments. They also offer both issuer and investor the ability to substitute 

bond assets in the collateral pools if there is a problem with an individual loan or 

mortgage, thus reducing overall risk. 

My comments focus on the value of covered bonds to multifamily borrowers. 

Under the right conditions and circumstances, covered bonds could serve as an 

added credit option for our sector by augmenting banks’ mortgage credit activity. 

Therefore, we support efforts to create the legal and regulatory oversight needed to 

foster the use of covered bonds by banks. 

For numerous reasons, though, it is quite unlikely that covered bonds could provide the capacity, flexibility or pricing superiority necessary to adequately replace 

the U.S.’s existing sources of multifamily mortgage credit. 

It is unclear whether covered bonds would actually increase the amount of credit 

banks would make available to apartment firms. The covered-bond structure limits 

issuer lending volumes by requiring them to hold loans on the issuer’s balance sheet 

and retain capital reserves in case of losses. It is also possible that banks could simply replace some of their whole loans activities with covered bonds, which would not 
66 

1 European Central Bank Annual Report, p. 19. 

increase lending capacity except as it relates to how risk-based capital reserves are 

held by banks. 

Covered bonds could allow banks to compete with other credit sources such as life 

companies, thrifts, CMBS and GSEs because the loan term for covered bonds is 

longer (10-year terms) than the 5-year term banks typically provide. Even then, 

however, larger banks that are anticipated to be a major source of covered-bond 

issuance may choose not to issue covered loans for multifamily mortgages because 

many of these banks originate such mortgages for the GSEs or CMBS market and 

thereby avoid any balance sheet liability. 

It is also unclear to what extent banks would use covered bonds for multifamily 

lending since so many asset classes qualify for covered bonds. Legislation pending 

in the House of Representatives (H.R. 5823, ‘‘The United States Covered Bond Act 

of 2010’’) would allow covered bonds to be used for single-family mortgages and equity loans, commercial and multifamily real estate mortgages, auto loans and leases, 

loans for public facilities and activities, student loans, small business loans and 

credit card and revolving credit loans to consumers. We question the capacity of covered bonds to meet the demand from all of these loan categories. 

In Europe, the majority of real estate-related covered-bond debt has been for public purposes and residential home mortgages. Unless there are allocations and diversification requirements for covered-bond issuers, we expect the U.S. experience 

would be similar, with most of the additional credit created by covered bonds directed to the residential mortgage market and other consumer and loan assets and 

not toward rental housing. 

It is also important to understand that the European experience with covered 

bonds for multifamily properties is not translatable to the U.S. In Europe, the rental 

markets operate on a condominium model comprised of small investors buying individual units and renting them out. For instance, in the United Kingdom, 73 percent 

of the rental stock is owned by ‘‘mom-and-pop’’ operators, and there is no institutional investment. There is little existing data or analysis determining to what degree European covered bonds actually finance commercially developed rental housing. 

In addition to these issues, it also remains unclear whether the covered-bond 

structure can become sufficiently flexible to accommodate broad-based, public-sector 

participation in the U.S. affordable-housing finance arena. For instance, a significant proportion of apartment production in recent decades has been financed 

through Low-Income Housing Tax Credit (LIHTC) equity investments and various 

structures of tax-exempt or otherwise subsidized bonded debt. These specialized 

loans may not be able to gain access to covered-bond credit capital. 

Likewise, questions remain about whether a purely private American coveredbond market could become a critical ‘‘backstop’’ capital source during periods of financial instability. While Europe’s covered-bond market came to something of a 

standstill during the global financial crisis, in the U.S. the GSEs, Fannie Mae and 

Freddie Mac, remained a critical liquidity source in the domestic multifamily finance field. They have served this role during other capital market dislocations, including the Russian economic collapse in the late 1990s, which caused a collapse of 

the U.S. commercial mortgage conduit market, and during the 2001–2003 recession. 

Although the European covered-bond market remained liquid longer than many 

other wholesale funding markets, it was ultimately rendered dormant for several 

months during the last quarter of 2008. In the wake of Lehman Brothers’ collapse 

in September 2008, the European covered-bond market went without a public 

issuance until early 2009 and some jurisdictions have still not seen new issuance. 

The European Central Bank (ECB) reported earlier this year that the number of 

issuers has doubled since 2008 (from approximately 75 to 150 issuers). 1 But this 

was fueled in large part by ECB-sponsored bond purchase programs to facilitate liquidity. 

Despite some ÷60 billion ($76.6 billion) in ECB-sponsored purchase commitments, 

however, the return of liquidity appears to be limited. Covered bonds over the past 

few calendar quarters have traded at historically low volumes and at historically 

wide yield spreads over their relevant benchmarks. 

For all these reasons, we can only conclude that a covered-bond market might 

augment—but would not adequately replace—any of the active components of the 

U.S. multifamily finance marketplace, including ‘‘conduit’’ financing through mortgage-backed securities issued by the GSEs and private Wall Street firms, along with 

mortgages funded by life companies, banks and other balance sheet lenders. 
67 

Maintaining Credit Capacity for the Apartment Market 

The bursting of the housing bubble exposed serious flaws in our housing finance 

system. As policy makers undertake housing finance reform—including creating a 

framework for a U.S. covered-bonds market—we urge you to ensure that any actions 

taken are not done so at the expense of the much smaller and less understood, but 

vital, multifamily sector. 

Apartments are a critical component of the Nation’s housing market, and our industry depends on a reliable, reasonably priced and readily available supply of credit to meet the Nation’s growing demand for rental housing. 

The U.S. is on the cusp of fundamental changes in our housing dynamics. Changing demographics are causing a surge in rental demand that will continue long after 

the economic recovery. This includes 78 million echo boomers entering the housing 

market, baby boomers downsizing and a dramatic decrease in the number of married couples with children to less than 22 percent of households. 

Between 2008 and 2015, nearly two-thirds of new households formed will be renters. That’s 6 million new renter households. University of Utah Professor Arthur C. 

Nelson predicts that half of all new homes built between 2005 and 2030 will have 

to be rental units. The Harvard University Joint Center for Housing Studies estimates that we already have a shortage of some three million units of affordable 

rental housing. 

Our industry cannot meet the Nation’s current or future housing needs—or refinance the approximately $200 billion in mortgage debt coming due over the next 

2 years—without a fully functioning secondary mortgage market. 

For these reasons it is critically important to maintain the existing level of liquidity for the multifamily market, in good times and bad. The strong performance of 

the sector, thanks in large part to the robust capital markets supporting it, has attracted an enormous amount of private investment. These investors have supported 

the expansion of the industry and a marked improvement in its professionalism. It 

has made the production of millions of units of workforce and market-rate housing 

possible. 

For the past 50 years, the U.S. housing system has been the envy of the world 

in attracting private capital to meet our Nation’s housing needs. As lawmakers look 

for added mortgage credit sources and redesign the secondary mortgage market, we 

urge them to retain the successful elements of our present system, specifically those 

which contributed to the strength of the multifamily market, and understand the 

inherent limitations of new capital sources, such as covered bonds. 

Tomorrow’s Housing Policy: New Principles 

I would also like to take a moment to address our national housing policy more 

broadly, as I feel that it underscores the importance of explicitly considering apartments in a reformed housing finance system. 

For decades, the Federal Government has pursued a ‘‘homeownership at any cost’’ 

housing policy, ignoring the growing disconnect between the country’s housing needs 

and its housing policy. In the process, many people were enticed into houses they 

could not afford, which in turn helped fuel a housing bubble that ultimately burst 

and caused a global economic crisis. 

The Nation is now paying the price for that misguided policy and learning firsthand that there is such a thing as too much homeownership; that aggressively pushing homeownership was not only disastrous for the hardworking families lured into 

unsustainable ownership, but also for our local communities and our national economy. 

If there is a silver lining in this situation, it is the opportunity we now have to 

learn from our mistakes and rethink our housing policy. Housing our diverse Nation 

means having a vibrant rental market along with a functioning ownership market. 

It’s time we adopt a balanced housing policy that doesn’t measure success solely by 

how much homeownership there is. 

For many of America’s most pressing challenges, from suburban sprawl to affordable housing, apartments are a much better solution. Apartments help create 

stronger and healthier communities by offering enough housing for the workers that 

businesses need, by reducing the cost of providing public services like water, sewer, 

and roads and by creating vibrant live/work/play neighborhoods. 

They will help us house our booming population without giving up all our green 

space and adding to pollution and traffic congestion. And they will help us reduce 

our greenhouse gas emissions by creating more compact communities that enable 

us to spend less time in our cars. 
68 

Elements of a Balanced Housing Policy 

NMHC and NAA have joined together to advocate for a more balanced housing 

policy, one that respects the rights of individuals to choose housing that best meets 

their financial and lifestyle needs. We urge policy makers at all levels of Government to work with the apartment industry to craft a smarter housing policy that: 

• Assures that everyone has access to decent and affordable housing, regardless 

of his or her housing choice; 

• Respects the rights of individuals to choose the housing that best meets their 

financial and lifestyle needs without disadvantaging, financially or otherwise, 

those who choose apartment living; 

• Promotes healthy and livable communities by encouraging responsible land use 

and promoting the production of all types of housing; 

• Recognizes that all decent housing, including apartments, and all citizens, including renters, make positive economic, political and social contributions to 

their communities; and 

• Balances the expected benefits of regulations with their costs to minimize the 

impact on housing affordability. 

In conclusion, our industry stands ready to meet the Nation’s growing demand for 

rental housing. We would encourage lawmakers to support us in those efforts by 

helping to craft a more balanced housing policy and by ensuring that housing finance reform efforts do not have an adverse effect on the apartment sector given 

that the sector was not responsible for the meltdown and has a long track record 

of strong performance. 
69 

Attachment: NMHC Analysis: Credit Capacity of Covered Bonds, July 2010 
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM JULIE L. WILLIAMS 

Q.1. There are many differences between the U.S and European 

housing markets, which raises the question as to whether covered 

bonds would work as well in our markets as they have in Europe. 

What do you see as the primary differences between European and 

U.S. markets that this Committee must be aware of, and thoroughly examine, prior to the enactment of any policies in this area? 

A.1. In Europe, covered bonds have facilitated mortgage financing 

through the capital markets for many years. Many European jurisdictions have a special law-based framework with a public supervisor specifically dedicated to setting uniform standards and regulating covered bonds. While differences exist among jurisdictions, 

certain essential common features of covered bonds are: (1) a bond 

collateralized by a ‘‘cover pool’’ of high quality assets; (2) supervised 

management of the cover pool; (3) covered bondholders have a priority claim on the cover pool collateral and also have recourse to 

the issuing institution; and (4) legislation providing certainty on 

the treatment of the covered bonds in an insolvency situation. The 

covered-bond market in Europe is the traditional and long-standing 

means of financing mortgages. 

In contrast, U.S. institutions have had a number of alternatives 

for obtaining mortgage financing that are not available in Europe, 

such as Government-sponsored enterprises (GSEs) and the Federal 

Home Loan Banks (FHLBs). By creating the GSEs, the U.S. Government facilitated and promoted home ownership through mortgage lending. Through the GSEs, a secondary market for mortgages developed in the U.S. and, with the implicit Government 

backing, the GSEs were able to access the capital markets to fund 

their purchases of qualifying mortgage loans. By selling loans to 

the GSEs, financial institutions could obtain funding necessary to 

originate new loans. Fundamental questions are now being considered by U.S. policy makers on the future and purpose of the GSEs. 

In addition, the use of private-label securitization in the U.S. historically has played a large role in mortgage finance. 

The FHLBs also have been a significant source of funding to the 

U.S. banking system. The FHLBs are 12 banks set up under a Government charter to provide support to the housing market by advancing funds to their member banks that make mortgages. The 

FHLB system issues debt to raise capital to provide the funding to 

loan originators. Recent developments stemming from the mortgage 

market disruption, however, are creating less certainty in obtaining 

advantageous FHLB funding, and impacting the availability of 

other historically perceived advantages, such as dividend payments 

and redemption of excess stock. 

Before enacting covered-bond legislation, the Committee should 

carefully consider and examine the policy implications of covered 

bonds on other U.S. funding options. It is possible that covered 

bonds would enhance competition in the funding markets. For example, the HILBs would need to remain competitive with collateral 

coverage, haircuts, and cost of funds. The GSEs similarly would 

need to keep securitization terms competitive. Overall, competition 

is generally beneficial in promoting innovation in product structures and terms, including pricing competitiveness. 
127 

Covered bonds also present broad policy questions on issues related to housing finance that the Committee may wish to examine 

in more detail, including efforts to stabilize housing prices, increasing the availability of credit, improving underwriting standards, relying on the capital markets for housing finance and transitioning 

away from Government supported housing finance. 

Q.2. In Mr. Campo’s testimony he states that it is his belief that 

covered bonds will not lead to new lending, but rather banks would 

simply replace some of their whole loans activities with covered 

bonds. There also has been speculation, given the similarities between covered bonds and advances from the Federal Home Loan 

Banks, that a covered-bonds system simply would replace a portion 

of those advances. 

Based upon your studies and experiences, do you believe a properly designed covered-bonds system to be a tool that will allow financial institutions to shift existing activity, or do you see this as 

additional activity that will increase funding, and thus lending? 

A.2. A properly designed system of covered bonds would both shift 

the mix of funding away from other sources of funds and increase 

funding, as well as lending. However, the impact of covered bonds 

on credit provision should not be overstated, since there are many 

factors affecting the supply and demand for credit. A significant 

portion of the observed decline in bank lending has been demand 

related; business and consumers have cut back on spending. Looking at unused credit lines at banks, it appears there is a lot of 

available credit that business and consumers are not using. But it 

is also clear that bankers have generally tightened their underwriting standards—correcting practices that had become too lenient 

and responding to deteriorating economic and borrower conditions. 

In general, the introduction of a new funding instrument like 

covered bonds tends to reduce an institution’s funding costs by providing an additional vehicle for financing; it provides enhanced 

flexibility for an institution to identify the lowest cost funding alternative at any given time as market conditions evolve, and thus 

reduces the risk-adjusted cost of funds for issuing institutions. 

An important consideration is whether covered bonds help to 

‘‘complete’’ markets by providing a unique benefit. To succeed in 

the market, a financing alternative cannot be redundant, that is it 

must offer one or more features or characteristics that cannot be 

replicated by investors through other investments already available 

in capital markets. Covered bonds issued by banks (or by similar 

institutions) do present a unique combination of effective exposure 

from the perspective of bond investors, offering investors the riskreturn possibilities associated with exposure to banking activities, 

while simultaneously providing that exposure in a form secured by 

an identifiable pool of bank-originated assets. Thus, it is reasonable 

to expect that covered bonds would be in demand, and, if so, should 

tend to reduce the risk-adjusted cost of funds for issuing institutions. 

Other considerations are likely to affect this potential reduction 

in funding costs. Because the covering assets remain on an institution’s balance sheet, the institution must hold more capital than in 

a typical securitization, and the required amount of capital may be 
128 

even higher under upcoming changes in capital rules. The relative 

benefits of covered bonds and securitization may also be affected by 

accounting changes and by risk-retention provisions in the recent 

Dodd-Frank Wall Street Reform and Consumer Protection Act. 

However, if covered bonds on balance tend to reduce the cost of 

funds, they also would tend to lower the cost of, and increase the 

supply of, credit flowing from issuing institutions. This enhanced 

credit availability might be most prominent in the covering asset, 

since it would present a source of collateral for covered-bond 

issuance. However, credit expansion would not be limited to the 

covering asset alone, as all types of credit issued by an institution 

would benefit from an issuer’s overall lower cost of funding. 

The use of covered bonds would thus bring both a shift in the 

funding mix—due to the introduction of a currently unavailable 

funding alternative that at times would be the lowest cost of available funding alternatives—and an overall increase in funding (and 

many types of lending) by reducing the risk-adjusted cost of funding. 

In addition to providing a nonredundant funding alternative that 

enhances the ‘‘completeness’’ of funding markets, covered bonds 

may provide additional benefits under current capital market conditions. One of the closest existing substitutes for covered bonds is 

securitization. Currently low levels of activity in most 

securitization markets leaves a sizable niche that covered bonds 

could fill. The extent of this apparent gap in currently available 

funding and investment instruments suggests that covered bonds 

might significantly boost lending: An important counterargument 

relates to capital charges. Because covered bonds remain on an institution’s balance sheet, the institution must hold more capital 

than in a typical securitization. In addition, new accounting rules, 

upcoming changes in capital rules that may require higher levels 

of capital for assets held on a bank’s balance sheet, and risk-retention provisions in the recent Dodd-Frank Wall Street Reform and 

Consumer Protection Act, could constrain the growth of the covered-bond market. 

Q.3. If simply a shift, where do you see the shift occurring and why 

do you believe it beneficial, or not, under those circumstances? 

A.3. As noted in the response to the previous question, the introduction of covered bonds would lead to a shift in the funding mix, 

to the extent that covered bonds present issuers with a less expensive alternative to existing funding vehicles. This shift likely would 

be away from all other alternatives to at least some degree, but the 

shift is likely to be relatively larger for alternatives that are closer 

substitutes, such as securitization. 

However, in addition to such a shift in the mix of financing vehicles used by issuers, the availability of covered bonds as a funding 

alternative would also likely lead to an overall expansion of funding activity and credit extension by bond issuers. 

Q.4. The implicit guarantee provided to Fannie Mae and Freddie 

Mac ultimately cost the American taxpayer hundreds of billions of 

dollars. Any changes we make to our home finance system must 

ensure that the taxpayers never again are exposed to this kind of 

a danger. If a covered-bond system was to be designed and enacted, 
129 

what components would be essential to ensure that the system did 

not carry this same implicit guarantee? 

A.4. A critical component in designing a U.S. statutory coveredbond program is determining the consequences of a default of a 

covered-bond issuance or the failure of a covered-bond issuer. With 

respect to an issuing institution’s insolvency, it is important that 

the legal framework clarify and specifically address what would 

happen to the cover pool, including the operation and management 

of the pool; the rights of the covered bondholders; and the responsibilities and obligations of the covered-bond regulator. The absence 

of any Government backing or guarantee could be affirmatively 

provided in the statutory framework creating tile resolution process. 

Covered bonds provide for payment without any implicit or explicit Government involvement or guarantee because of their ‘‘dual 

recourse’’ feature. Covered bonds are backed by the issuing institution’s promise to pay and by a dynamic pool of assets pledged as 

collateral, referred to as the cover pool. The collateral underlying 

this pool is actively managed to ensure ongoing performing assets, 

and segregated and managed for the benefit of covered bondholders. In a default or issuer insolvency situation, investors would 

look first to the institution to make payments on the bonds, but 

they also would have a claim against the cover pool that has priority over unsecured creditors. The covered bonds would not automatically accelerate if the issuing institution goes insolvent. If appropriate, issuers could be required to provide disclosures that covered-bond issuances are not guaranteed, insured, or backed by the 

U.S. Government. 

Q.5. Many experts feel that it would be economies of scale that 

could make covered bonds a viable tool for liquidity. Therefore, 

there is some debate as to how or if community and regional banks 

would be able to participate in the covered-bonds market. 

What is your opinion on the likelihood that covered bonds could 

be an effective tool for them and why do you believe this to be the 

case? 

A.5. Similar to other funding sources, the institution’s decisionmaking process should consider all costs and benefits of a coveredbond program relative to its potential issuance size. As noted in the 

OCC testimony, various types of standards could be embodied in a 

covered-bond regulatory framework that would remove obstacles to 

the development of this market. These standards and framework 

would naturally include compliance costs and burdens. For example, covered bonds should have minimum eligibility criteria setting 

asset quality standards to promote the inclusion of high quality assets in the cover pool. Requiring meaningful disclosures and making detailed information available about assets in a cover pool is 

essential to provide consistency and transparency across coveredbond issuances. Another important standard may include a designated minimum amount of overcollateralization and an asset coverage test and independent ‘‘asset monitor’’ to confirm on a periodic 

basis whether the asset coverage test is satisfied. My testimony 

notes that covered-bond regulators should have the authority to impose a cap in the percentage of particular asset types that issuing 
130 

institutions could use for the covered-bond program. In addition, an 

issuer’s total covered-bond obligations as a percentage of the 

issuer’s total liabilities also could be limited. 

For a quality lender with prudent underwriting standards and 

sound risk management practices already in place, the incremental 

costs of a covered-bond program would likely be less. In general, 

the larger the issuance relative to these incremental costs, then the 

greater the potential benefit to the issuer. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER 

FROM JULIE L. WILLIAMS 

Q.1. What challenges are there to creating a resolution procedure 

in the case where an issuer fails? 

A.1. The resolution procedure for the failure of a covered-bond 

issuer is a critical component in designing a U.S. statutory coveredbond program. Without a U.S. legal framework addressing the operation and management of the cover pool in the event of an issuer 

insolvency U.S. covered bonds will continue to lack predictability 

and clarity compared to other jurisdictions. With respect to an 

issuing institution’s insolvency, it is important that the legal 

framework clarify and specifically address what would happen to 

the cover pool and the rights of the covered bondholders. In particular, if the issuer is an insured depository institution then consideration must be given to the FDIC’s statutory role as conservator or receiver. 

A statutory framework could create a structure with the following general components when the FDIC is appointed as conservator or receiver for an insolvent issuer: (1) creation of a separate 

estate and provision to the FDIC of an exclusive right for a certain 

designated period of time to transfer the issuer’s covered-bond program to another eligible issuer; and (2) a requirement that the 

FDIC as conservator or receiver, during the time period, perform 

all monetary and nonmonetary obligations of the issuer until the 

FDIC completes the transfer of the covered-bond program, the 

FDIC elects to repudiate its continuing obligations to perform, or 

the FDIC fails to cure a default (other than the issuer’s conservatorship or receivership). If the FDIC as conservator or receiver, does not timely effect a transfer of the covered-bond program to another eligible issuer, repudiates its continuing obligations to perform, or fails to cure a default, then the statutory 

framework could provide for the automatic creation of a separate 

estate and attendant responsibilities. 

Specific challenges in creating a statutory framework relating to 

the resolution procedure include addressing the preservation of deficiency claims against the issuer, the creation of a residual interest that represents the right to any surplus from the cover pool, 

and the obligation of the issuer to transfer applicable books, 

records, files, and other documents to the covered-bond regulator or 

another designee. Consideration also should be given to statutory 

provisions providing that the covered-bond regulator may elect for 

an issuer to continue servicing the cover pool for some reasonable 

and operationally practical period of time, and whether the framework should provide for the Federal Reserve Banks or others to 
131 

make advances to the estate. If Federal Reserve advances are permitted, they should be for liquidity purposes, and should be subject 

to Federal Reserve rules that limit credit risk exposure. 

A further specific challenge is determining the appropriate treatment of any excess amounts from the cover pool once the covered 

bondholders have been paid in full. For example, if a residual interest is created in the estate that represents the right to any surplus 

from the cover pool after the covered bonds and all other liabilities 

of the estate had been paid in full, should the FDIC or the covered 

bondholders receive the excess collateral? 

Q.2. Who should be in charge of that resolution process? 

A.2. A comprehensive approach for covered bonds that reflects a 

consistent and predictable process across the Federal financial regulators would serve to provide certainty and predictability to investors and the marketplace in cases of default and issuer insolvency. 

This type of framework would require the covered-bond regulator 

to act as or appoint a trustee of the separate estate, and to appoint 

and oversee a servicer or administrator for the cover pool held by 

the estate. If the issuer is an insured depository institution then 

consideration must be given to the FDIC’s statutory role as conservator or receiver. Given the nature of the events triggering resolution procedures under a covered-bond framework, litigation by unhappy private parties could attempt to draw in the covered-bond 

regulator. As such, careful consideration should be given to addressing limitations on actions against, and recognition of sovereign immunity for, the covered-bond regulator acting in its statutorily designated capacities. 

Q.3. How can that process be structured in order to prohibit losses 

from being absorbed by the taxpayer? 

A.3. By structuring the resolution process to involve the creation 

of a separate estate that would exist and be administered separately from the issuing institution, the legal framework would not 

involve recourse to U.S. taxpayers. Covered bonds do not involve a 

Government guarantee or subsidy, and payments to the covered 

bondholders are not insured deposits. The distinctive features of 

covered bonds, unlike other secured debt, include backing by both 

the institution’s promise to pay and a dynamic pool of assets 

pledged as collateral that comprises the ‘‘cover pool.’’ The underlying assets are typically high quality assets, subject to various eligibility criteria and must be replaced by the institution should they 

fail to meet specified criteria. While investors look first to the institution to make payments on tile bonds, the investors also have a 

claim against the cover pool. In the event of insolvency, the separate estate is comprised of the applicable cover pool and assumes 

liability for the covered bonds and any related obligations secured 

by that cover pool. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM MICHAEL H. KRIMMINGER 

Q.1. In response to questioning during the hearing you indicated 

that the FDIC would price the additional risk posed by covered 
132 

bonds into the assessment fees the FDIC would charge institutions 

that issued covered bonds. 

Does the FDIC believe issuing covered bonds increases the risk 

of failure to an institution? If so, please describe how the FDIC arrived at this decision, including a description of any data examined 

as part of the analysis. 

A.1. If structured correctly, covered bonds could provide another 

tool for banks to either bolster liquidity or increase lending. However, overreliance on any type of secured borrowing, including covered bonds, makes it difficult for an institution to borrow in other 

ways. Overcollateralization requirements can increase the difficulty. Inability to borrow can cause liquidity problems that may 

make the institution more prone to failure during a significant 

downturn in the banking industry. 

If a covered-bond transaction requires that an institution substitute good collateral for defaulting collateral, an increase in defaulting collateral will leave the institution with the defaulting 

loans, which will increase its risk of failure. With an 

overcollateralization requirement, either an increase in defaulting 

collateral or a decrease in the institution’s general credit quality 

may trigger requirements for additional overcollateralization, again 

increasing the risk of failure. 

Allowing an institution to include too wide a variety of assets as 

collateral in a covered-bond program (e.g., collateral other than 

home mortgage loans) may encourage the institution to originate or 

acquire assets without proper underwriting and in businesses in 

which it has no experience, thus increasing the risk of an institution’s failure. In particular, permitting derivatives or a large percentage of structured securities (such as collateralized debt obligations) as collateral can increase the risk of failure. Both derivatives 

and structured securities have been implicated in institution failures in recent years. Covered bonds secured by structured securities would be particularly risky if the collateral backing the structured securities were of a type not directly permitted as collateral 

for the covered bonds. This increased risk could come from either 

the collateral backing the structured securities itself or from a lack 

of knowledge concerning the underwriting standards for the collateral. 

Q.2. Does the FDIC believe issuing covered bonds increases losses 

to the Deposit Insurance Fund (DIF), given a failure of an institution? If so, please describe how the FDIC arrived at this decision, 

including a description of any data examined as part of the analysis. 

A.2. Unless covered-bond transactions are structured according to 

the principles contained in the FDIC’s testimony, covered bonds 

could increase losses to the DIF. As discussed in response to the 

previous question, an improperly structured covered-bond transaction or overreliance on failure and the structured bonds or other 

secured financing can increase an institution’s risk of risk of DIF 

losses. 

Covered bonds also can increase the DIF’s losses in the event of 

an institution’s failure, if the covered-bond transaction is not structured according to the principles contained in the FDIC’s testi-
133 

mony. An increase in secured liabilities will increase losses to the 

DIF because it reduces the unpledged assets available for sale by 

the FDIC as receiver to repay the DIF for its insured depositor protection. As a result, if bondholders retain the excess collateral, this 

will further decrease the assets available for sale and thereby increase the losses that must be covered by the DIF. Specifically, if 

bondholders are given the option of retaining the collateral securing the covered bonds (rather than accepting payment) when an institution fails, the FDIC would only receive a residual certificate. 

As the result of its experience with asset securitizations and structured finance programs, the FDIC has discovered that it is difficult 

to sell residual certificates, even at deeply discounted prices. In 

contrast, when the FDIC pays secured creditors the secured value 

of their claim and redeems collateral after an institution fails, the 

DIF’s losses are reduced. 

Moreover, because losses would be allocated first to the residual 

certificate and because the retained collateral would be managed 

by an asset manager appointed by the bondholders for their benefit 

rather than the residual holder’s benefit, the DIF could be exposed 

to additional losses. To forestall these possibilities, the FDIC as receiver should retain the ability to repudiate the covered bonds, pay 

the bondholders the outstanding principal and interest up to the 

date of payment, and take control of the collateral. 

Finally, regardless of the structure of a covered-bond transaction, 

to the extent that an institution borrows on a secured basis rather 

than through unsecured, nondeposit borrowing, the DIF will suffer 

larger losses if the institution fails, all else equal, because of the 

priority of claims in a receivership. Secured liabilities must be paid 

in full before the FDIC receives any payment on its subrogated 

claim as the deposit insurer. Unsecured claims, on the other hand, 

receive no payment unless the FDIC has been completely reimbursed on its subrogated claim. 

Q.3. If the FDIC prices any increased risk appropriately (whatever 

the rationale for the increase in risk) in the deposit insurance assessments, why would this not be sufficient to cover assets that 

would not be available to the FDIC if a covered-bond issuing institution were to be placed into receivership? 

A.3. Because of the large number of insured institutions and because of the detailed information that institutions would have to 

provide the FDIC, the FDIC generally cannot determine assessment rates for an institution based on individual assets or liabilities and generally must rely on supervisory appraisals and statistical methods to price for risk. Thus, for example, while heavy reliance on secured borrowing will increase an institution’s assessment 

rate, it would be difficult, and likely impossible, for supervisory appraisals or statistical methods to price for risk based on individual 

instances where an institution has borrowed on a secured basis, 

such as a specific covered-bond transaction. For the 100 or so largest institutions, the FDIC relies on a more detailed analysis of each 

institution’s specific risk, but, even in these institutions, the FDIC 

cannot price for individual instances where an institution has borrowed on a secured basis. 
134 

Moreover, even if the FDIC was able to fully price for risk based 

on each instance where an institution has borrowed through a covered-bond transaction, the resulting assessment rate could be prohibitively high. 

Q.4. In Mr. Campo’s testimony he states that it is his belief that 

covered bonds will not lead to new lending, but rather banks would 

simply replace some of their whole loans activities with covered 

bonds. There also has been speculation, given the similarities between covered bonds and advances from the Federal Home Loan 

Banks, that a covered-bonds system simply would replace a portion 

of those advances. 

Based upon your studies and experiences, do you believe a properly designed covered-bonds system to be a tool that will allow financial institutions to shift existing activity, or do you see this as 

additional activity that will increase funding, and thus lending? 

A.4. Covered bonds could provide a useful alternative to traditional 

off-balance sheet funding, such as asset backed securitizations. 

However, the FDIC has not undertaken a formal study of this 

issue. The banking industry is currently highly liquid, thus liquidity issues are not restraining lending. In the future, if liquidity reverts to lower levels, covered bonds could have a more realistic 

chance of spurring lending or having a positive impact on banks’ 

liquidity. 

Q.5. If simply a shift, where do you see the shift occurring and why 

do you believe it beneficial, or not, under those circumstances? 

A.5. It is difficult to isolate the effect of a single funding source on 

a bank’s ability or willingness to lend. The extent that covered 

bonds would replace existing sources of liquidity, or will serve as 

a complimentary source, will depend on a wide variety of factors 

such as balance sheet capacity, accounting standards, investor appetite, the housing market, and the cost of unsecured sources of liquidity, including deposits and unsecured commercial paper. It is, 

however, reasonable to conclude that covered bonds are likely to 

substitute for other liquidity sources if they provide cheaper funding because the absolute volume of covered bonds for any institution is limited by its balance sheet since covered bonds are an onbalance sheet funding source. 

Q.6. The implicit guarantee provided to Fannie Mae and Freddie 

Mac ultimately cost the American taxpayer hundreds of billions of 

dollars. Any changes we make to our home finance system must 

ensure that the taxpayers never again are exposed to this kind of 

a danger. 

If a covered-bond system was to be designed and enacted, what 

components would be essential to ensure that the system did not 

carry this same implicit guarantee? 

A.6. Unlike the bailouts of both Fannie Mae and Freddie Mac, resolutions of failed insured depository institutions as well as the DIF 

itself are not funded by taxpayers, but by the banking industry. 

The FDIC would support covered-bond legislation that allows the 

receiver to essentially prepay the bonds (or repudiate) by paying 

the par value of outstanding bonds plus interest accrued through 

the date of payment. This provides a remedy that fully reimburses 
135 

the covered-bond investors. In return, as in any other repudiation, 

the FDIC as receiver would be entitled to retain the collateral in 

the cover pool after payment of those damages. 

Similarly, balanced covered-bond legislation should avoid excessive governmental or regulatory involvement in protecting coveredbond investors. For this reason, the FDIC has recommended that 

legislation not have regulators enforcing overcollateralization or 

other covered-bond standards for the benefit of investors, rather 

than to preserve the safety and soundness of financial institutions. 

Similarly the FDIC has recommended that legislation not give regulators the duty to control any postdefault estate for the benefit of 

investors. Such entanglements provide a level of governmental protection for investors that could imply implicit guarantees—as has 

been the perception in some European covered-bond regulatory regimes. 

The FDIC believes that transfer of covered bonds would minimize the disruption in the covered-bond markets. Therefore, legislation should provide for the authority to continue to perform 

under the covered bond until it can sell the program to another 

bank. This would not expose the investors to any loss, by definition, 

since the FDIC would meet all requirements of the covered-bond 

program, including replenishment of the cover pool and 

overcollateralization. As long as the FDIC is performing under a 

covered-bond agreement, covered-bond legislation should not limit 

the time in which the FDIC has to decide how best to proceed. 

Any legislation that fails to preserve these important receivership authorities makes the FDIC the de facto guarantor of covered 

bonds and the de facto insurer of covered-bond bondholders. 

Q.7. Many experts feel that it would be economies of scale that 

could make covered bonds a viable tool for liquidity. Therefore, 

there is some debate as to how or if community and regional banks 

would be able to participate in the covered-bonds market. 

What is your opinion on the likelihood that covered bonds could 

be an effective tool for them and why do you believe this to be the 

case? 

A.7. Economies of scale are needed in most existing covered-bond 

models. This suggests the principal users of covered bonds will be 

the largest institutions for the foreseeable future. 

Q.8. There are many differences between the U.S. and European 

housing markets, which raises the question as to whether covered 

bonds would work as well in our markets as they have in Europe. 

What do you see as the primary differences between European 

and U.S. markets that this Committee must be aware of, and thoroughly examine, prior to the enactment of any policies in this area? 

A.8. Until the past decade, most pfandbriefes (the German form of 

covered bonds) were issued by the Landesbanks, which in turn 

were supported directly by the respective local governmental authorities. Even without direct support, there is significant indirect 

Government support for the European banking sector. By contrast, 

in the U.S., the Dodd-Frank Wall Street Reform and Consumer 

Protection Act aims to reduce the support given by the taxpayers 

to the banking sector. 
136 

Assets securing European covered bonds have different terms 

and structures than U.S. assets. Residential mortgages, for example, in many jurisdictions, permit banks to reset interest rates, are 

of short duration (5 years), and have loan to value ratios that are 

low. Similarly, use of European models to use as a basis or even 

justification for use of other types of assets to secure covered bonds 

is not wise. For example, while public debt instruments have been 

used as collateral in European covered-bond programs, public debt 

instruments have very different characteristics and risks in the 

U.S. In European jurisdictions, public entities generally are not 

subject to an insolvency regime similar to Chapter 9 bankruptcy for 

local governments in the U.S. They also benefit from a fair amount 

of sovereign support and are unlikely to issue complex or shortterm instruments such as tax anticipation notes or variable rate 

demand obligations. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER 

FROM MICHAEL H. KRIMMINGER 

Q.1. What challenges are there to creating a resolution procedure 

in the case where an issuer fails? 

A.1. First and foremost, the flexibility of the FDIC as receiver in 

dealing with covered bonds must be maintained to avoid a subsidy 

of the covered-bond investors. That flexibility includes the ability 

to control a pool of collateral securing the covered bonds (the cover 

pool) as long as the FDIC performs under the covered bond. It also 

includes the authority to repudiate the covered bond (after paying 

par plus accrued interest) to maintain control of the cover pool. The 

Statement of Policy adopted by the FDIC’s Board of Directors in 

2008 provides a clear guide to the treatment of covered bonds in 

a receivership. The market’s reaction to this Statement was very 

positive, and most commentators at the time it was proposed stated 

that it provided a solid foundation for the covered-bond market. At 

a minimum, the FDIC suggests that its Statement of Policy should 

serve as a framework for any legislation. 

Q.2. Who should be in charge of that resolution process? 

A.2. As we have consistently stated, we believe that resolution of 

a covered-bond program should not be separate from the resolution 

of the entire operations of the failed institution itself. The FDIC 

should retain its current flexibility to maximize recovery for the 

benefit of depositors and all creditors. If, in any resolution of an 

issuer, the FDIC determines to turn over the collateral to the investors, the administration of the collateral should remain a matter 

of private contract. 

Q.3. How can that process be structured in order to prohibit losses 

from being absorbed by the taxpayer? 

A.3. As noted above, to protect taxpayers and the bank-funded DIF, 

any legislation or regulatory initiative must maintain the FDIC’s 

current flexibility in dealing with covered bonds, whether the FDIC 

is acting as receiver of insured depositories or systemically significant financial companies. Additionally, regulation of covered-bond 

programs should not entangle the Federal Government in the private contracts between issuers and investors to such an extent that 
137 

1Wayne Passmore, et al., Federal Reserve Research on Government-Sponsored Enterprises: 

Presentation at the Federal Reserve Bank of Chicago Bank Structure Conference 11 (May 18, 

2006). A copy is attached as Exhibit A. 

would imply a guarantee by the Government, as is the case in Europe. 

We believe that H.R. 5823 creates a structure of regulation and 

oversight for the benefit of the investors that could imply that Federal regulators are responsible for ensuring that the issuing banks 

live up to their agreements under covered bonds. Moreover, H.R. 

5823 also would make the Federal prudential regulators the appointing and supervising authority of trustees that would operate 

the covered-bond separate estates. This level of Government entanglement in private contractual matters could lead to the perception 

or even reality of an implied Government guarantee of covered 

bonds. An implied guarantee of covered bonds would put covered 

bonds on a near par with the Government sponsored enterprises— 

a status that should not be granted without strong policy reasons 

because of the risk posed to taxpayers. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM SCOTT A. STENGEL 

Q.1. Mr. Stengel, some experts have pointed to Fannie Mae and 

Freddie Mac as major obstacles to covered bonds establishing a 

foothold in this country. 

With that in mind, what changes do you feel would need to occur 

in any new secondary market structure to better allow for competition by covered bonds with the agency MBS market? 

A.1. In May 2006, economists at the Federal Reserve valued the 

implicit Federal subsidy backing Fannie Mae and Freddie Mac at 

$189 billion. 1 At the time, only two U.S. financial holding companies even had market capitalizations in excess of that amount— 

Citigroup at $240 billion and Bank of America Corporation at $220 

billion. 

We can say without hyperbole, therefore, that no private-sector 

security of any kind can compete on an equal footing—in either the 

primary market or the secondary market—with the debt securities 

or the mortgage-backed securities of Fannie Mae, Freddie Mac, or 

any other Government-Sponsored Enterprise (GSE) that enjoys an 

implicit full-faith-and-credit guarantee. 

Looking ahead to GSE reform, we believe that two principles 

should be observed in the context of U.S. covered bonds. 

First, with nearly every reform proposal contemplating some 

form of Federal subsidy for the secondary mortgage market, the 

legislative framework for covered bonds must optimize cost efficiency in order to level the playing field. This implicates all of the 

structural elements that were proposed in my written testimony, 

with a particular emphasis on the following: 

• a broad range of eligible asset classes (including ones that encompass consumer loans like credit-card loans and auto loans), 

• a separate resolution process that is unequivocal and nondiscretionary, that cannot be undermined by conflicts of interest 

(including the FDIC’s inherent conflict with covered-bond in-
138 

2The Future of Housing Finance: A Review of Proposals To Address Market Structure and 

Transition Before the House Committee on Financial Services, 111th Congress (2010) (statement 

of Michael J. Heid, Chairman, Housing Policy Council of the Financial Services Roundtable). A 

copy is attached as Exhibit B. 

vestors), and that permits nondiscriminatory access to liquidity 

from the Federal Reserve Banks, and 

• a seamless incorporation of relevant tax and securities laws. 

Such a framework, in our view, is essential to achieve several 

public-policy objectives that are crucial to financial stability: (1) 

more stable long-term liquidity, (2) less expensive and more available credit for consumers, small businesses, and the public sector, 

(3) diversified and additive funding for financial institutions, (4) 

private-sector capital with no taxpayer support, (5) more strongly 

aligned incentives, and (6) increased transparency and uniformity 

in the capital markets. 

Second, if Congress were to enact a catastrophic Federal-guarantee program like that suggested by the Housing Policy Council 

in its reform proposal, covered bonds should be eligible alongside 

securities issued by the newly created mortgage-securities insurance companies. 2 As already noted, private-sector securities can 

never be positioned to compete fully with those that carry either 

an explicit or an implicit Federal guarantee. While we expect traditional nonguaranteed covered bonds to flourish in the United 

States, they will be in their infancy when GSE reform is implemented. Uncertainty about the interaction of these two markets, in 

our view, counsels in favor of preserving optionality. In what will 

be a radically reshaped environment for mortgage finance, there 

might well be systemic value in covered bonds that can be guaranteed against catastrophic macroeconomic risk. 

Q.2. In Mr. Campo’s testimony he states that it is his belief that 

covered bonds will not lead to new lending, but rather banks would 

simply replace some of their whole loans activities with covered 

bonds. There also has been speculation, given the similarities between covered bonds and advances from the Federal Home Loan 

Banks, that a covered-bonds system simply would replace a portion 

of those advances. 

Based upon your studies and experiences, do you believe a properly designed covered-bonds system to be a tool that will allow financial institutions to shift existing activity, or do you see this as 

additional activity that will increase funding, and thus lending? 

If simply a shift, where do you see the shift occurring and why 

do you believe it beneficial, or not, under those circumstances? 

A.2. Each individual decision to lend is a function of return on capital, business strategy, and risk management. 

Covered bonds enable financial institutions (1) to lower the cost 

of funding, which increases the return on capital, (2) to augment 

rather than cannibalize their funding sources, which provides the 

fuel for business lines to innovate and boost lending, and (3) to better match assets and liabilities, which reduces the risk of providing 

longer-term closed-end loans (like residential mortgage loans) and 

revolving lines of credit (like credit-card loans). 

As a result, we must respectfully disagree with the belief that 

covered bonds will not contribute to increased lending. That, in our 
139 

3 12 U.S.C. §§1716-1717 (Fannie Mae), 1452–1454 (Freddie Mac), and 1423–1430c (FHLBs). 4 12 U.S.C. §§1719(c) (Fannie Mae), 1455(c) (Freddie Mac), and 1431(i) (FHLBs). 5 12 U.S.C. §§1723a(c)(2) (Fannie Mae), 1452(e) (Freddie Mac), and 1433 (FHLBs). 6 12 U.S.C. §355(2) and 12 C.F.R. §201.108(b) (Fannie Mae, Freddie Mac, and FHLBs). 7 12 U.S.C. §§1723c (Fannie Mae), 1452(g) (Freddie Mac), and 1435 (FHLBs). 8 12 U.S.C. §§1723c (Fannie Mae), 1452(g) (Freddie Mac), and 1435 (FHLBs); see also 15 

U.S.C. §77r-1(a) (preempting any contrary State law in connection with the securities of Fannie 

Mae and Freddie Mac). 

view, is not supported by the microeconomic incentives that drive 

the business of banking or by any empirical data. 

We also must take issue with the premise that covered bonds are 

similar or equivalent to advances from the Federal Home Loan 

Banks (the FHLBs). First, covered bonds will fund a much broader 

range of asset classes than the FHLBs typically accept in the normal course of business. Second, covered bonds will supply fixed-rate 

liquidity with maturities that the FHLBs generally do not offer to 

their member institutions. For these reasons, we envision covered 

bonds as a private-sector complement, rather than as a substitute, 

for federally subsidized FHLB advances. 

All of this being said, we can foresee financial institutions reallocating a modest portion of their short- and medium-term funding 

away from existing sources and toward a U.S. covered-bond market 

that is deep and liquid. But this, in our view, is the very macroeconomic objective that policy makers are seeking to achieve. The 

liquidity crisis that began in late 2008 was exacerbated in no small 

part by an overreliance on volatile short-term borrowings to fund 

long-term assets. Covered bonds will provide financial institutions 

with a cost-effective source of fixed-rate funding much farther out 

on the maturity curve than is currently feasible, which will lessen 

systemic risk in the broader financial markets and will bolster riskmanagement frameworks inside individual institutions. 

Q.3. The implicit guarantee provided to Fannie Mae and Freddie 

Mac ultimately cost the American taxpayer hundreds of billions of 

dollars. Any changes we make to our home finance system must 

ensure that the taxpayers never again are exposed to this kind of 

a danger. 

If a covered-bond system was to be designed and enacted, what 

components would be essential to ensure that the system did not 

carry this same implicit guarantee? 

A.3. The implicit Federal guarantee enjoyed by Fannie Mae, 

Freddie Mac, and the FHLBs has arisen from an extraordinarily 

unique set of components: 

• Each GSE has been federally chartered with a targeted publicpolicy purpose. 3

• The U.S. Treasury has been authorized to extend credit to each 

GSE. 4

• Each GSE has been exempted from most State and local income tax. 5

• Each GSE’s debt securities and mortgage-backed securities 

have been made eligible for open-market purchases by the Federal Reserve Banks, 6 for deposits of public funds, 7 and for investments by fiduciaries. 8
140 

9 12 U.S.C. §§24(Seventh), 335, 1464(c)(1), and 1757(7) (Fannie Mae, Freddie Mac, and 

FHLBs). 10 12 U.S.C. §§1723a(g) (Fannie Mae), 1452(d) (Freddie Mac), and 1435 (FHLBs). 

• Each GSE’s debt securities and mortgage-backed securities 

have been exempted from investment limits that are otherwise 

imposed on banks, savings associations, and credit unions. 9

• Each GSE has been entitled to use any Federal Reserve Bank 

as its depository, custodian, and fiscal agent. 10

Under the legislative framework proposed in my written testimony, no issuer of U.S. covered bonds could lay claim to any status 

or preference that even remotely resembles those afforded to the 

GSEs. For example, to the extent that any misguided inference 

could be drawn from a covered-bond estate inheriting an insolvent 

issuer’s access to liquidity from the Federal Reserve Banks, we 

have proposed that legislation expressly provide that (1) no advance can be made by a Federal Reserve Bank for the purpose, or 

with the expectation, of absorbing credit losses on the estate’s cover 

pool, (2) any advance must have a maturity that is consistent with 

an advance for liquidity only, (3) repayment of any advance must 

constitute a superpriority claim against the estate that is secured 

by a superpriority lien on the cover pool, and (4) any Federal Reserve Bank making an advance must promptly report to Congress 

on the circumstances giving rise to the advance, the terms of the 

advance, the nature of the cover pool securing the advance, and the 

basis for concluding that credit losses on the cover pool will not be 

absorbed by the Federal Reserve Bank. 

Some have suggested that the mere existence of a single coveredbond regulator could imply that covered bonds are backed to some 

degree by the U.S. Government. This, in our view, is a questionable 

proposition. After all, a single regulator—the Comptroller of the 

Currency (OCC)—supervises all national banks, but no one could 

seriously argue that the OCC is an implied-in-fact guarantor of 

their obligations. Similarly, the Securities and Exchange Commission regulates all nonexempt offers and sales of securities but certainly could not be perceived as insuring investors against any loss. 

Our reservation about multiple covered-bond regulators, as some 

have proposed, is rooted in a conviction that market fragmentation 

would likely doom U.S. covered bonds from the outset. We cannot 

envision a deep and liquid market developing if national banks, 

State member banks, State nonmember banks, bank holding companies, and other covered-bond issuers are operating under different regulatory frameworks. At a minimum, therefore, we recommend that the Secretary of the Treasury be directed to promulgate a single set of regulations for all covered-bond issuers and 

that each of the individual prudential regulators be tasked with 

implementing them for the issuers under their supervision. This, in 

our view, would not be ideal but at least would allow for the kind 

of uniform legal regime that will be critical to developing a vibrant 

market for U.S. covered bonds. 

We also are aware of the FDIC’s recent assertion that the legislative framework proposed in my written testimony would give covered bondholders ‘‘a superpriority in receivership’’ and would result 
141 

11Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation, Keynote Address to the 

Mortgages and the Future of Housing Finance Symposium (Oct. 25, 2010). 12See, e.g., 11 U.S.C. §364(c) and (d) (in a bankruptcy case, authorizing postpetition loans 

‘‘with priority over any or all administrative expenses’’ and ‘‘secured by a senior or equal lien 

on property of the estate that is subject to a lien’’); 12 U.S.C. §4617(i)(11) (for a limited-life regulated entity created by the Federal Housing Finance Agency with respect to Fannie Mae, 

Freddie Mac, or an FHLB, authorizing loans ‘‘with priority over any or all of the obligations 

of the limited-life regulated entity’’ and ‘‘secured by a senior or equal lien on property of the 

limited-life regulated entity that is subject to a lien (other than mortgages that collateralize the 

mortgage-backed securities issued or guaranteed by an enterprise)’’); Section 210(b)(2) of the 

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) (‘‘In the event that the 

[FDIC], as receiver for a covered financial company, is unable to obtain unsecured credit for the 

covered financial company from commercial sources, the Corporation as receiver may obtain 

credit or incur debt on the part of the covered financial company, which shall have priority over 

any or all administrative expenses of the receiver under paragraph (1)(A).’’); Section 210(h)(16) 

of the Dodd-Frank Act (for a bridge financial company created by the FDIC with respect to a 

covered financial company, authorizing loans ‘‘with priority over any or all of the obligations of 

the bridge financial company’’ and ‘‘secured by a senior or equal lien on property of the bridge 

financial company that is subject to a lien’’). 13See, the authorities cited in note 12. 14 12 U.S.C. §1430(e) (‘‘Notwithstanding any other provision of law, any security interest 

granted to a Federal Home Loan Bank by any member of any Federal Home Loan Bank or any 

affiliate of any such member shall be entitled to priority over the claims and rights of any party 

(including any receiver, conservator, trustee, or similar party having rights of a lien creditor) 

other than claims and rights that—(1) would be entitled to priority under otherwise applicable 

law; and (2) are held by actual bona fide purchasers for value or by actual secured parties that 

are secured by actual perfected security interests.’’); see also 12 U.S.C. §§1821(d)(5)(D) (precluding the FDIC from disallowing any claim asserted by an FHLB) and 1821(e)(14) (exempting 

FHLB advances from the FDIC’s authority to disallow or repudiate contracts). 15 12 U.S.C. §1821(e)(1) and (3). 

in their claims being ‘‘essentially back-stopped by the FDIC.’’ 11

These statements, however, were not substantiated and, in our 

view, reflect a fundamental misunderstanding of the proposal and 

existing law. 

A superpriority claim or a superpriority lien, in the context of an 

insolvency proceeding, is one that has been elevated to a level of 

priority higher than that otherwise afforded by applicable law to 

other claims or liens (including administrative claims or liens). 12

Nothing in our proposed legislative framework, including the 

treatment of any claim or lien of a covered bondholder, would 

change the priority scheme in a conservatorship or receivership of 

the issuing institution. Both before and after the insolvency proceeding, investors would benefit from a first-priority lien on the 

issuer’s cover pool to secure their claims under the covered bonds— 

just like any other secured creditor—and at no time would they be 

entitled to a lien (superpriority or otherwise) on any of the issuer’s 

other assets. In addition, to the extent that the cover pool proves 

insufficient to satisfy their claims in full, covered bondholders 

would fall in line alongside all other general unsecured creditors 

without any enhanced priority or preference of any kind. This 

treatment stands in stark contrast, for example, to the superpriority claims and liens that can arise in connection with 

postinsolvency financing arrangements 13 and to the springing priority of an FHLB’s ‘‘super lien’’ on all of a member institution’s 

property. 14

What our legislative proposal would affect is the FDIC’s power 

to compel an acceleration of the covered bonds and to pay only ‘‘actual direct compensatory damages . . . determined as of the date 

of the appointment of the conservator or receiver.’’ 15 Because a sine 

qua non of covered bonds is their limited risk of prepayment, they 

instead would remain outstanding according to their original terms 
142 

16 12 U.S.C. §1821(e)(3)(C). 17 12 U.S.C. §1821(e)(9) and (11). 18 12 U.S.C. §1821(e)(8)(A) and (E). 19 12 U.S.C. §1821(e)(10)(B). 20 12 U.S.C. §1821(e)(8)(C). 

so long as collections and other proceeds from the cover pool could 

continue to fund all scheduled payments. 

This, however, hardly creates a backstop by the FDIC. To the 

contrary, our proposal is a more modest iteration of the framework 

that currently exists for qualified financial contracts (QFCs) under 

the Federal Deposit Insurance Act (FDIA). One notable similarity 

between them is full restitution, at least to the extent of the posted 

collateral (including any overcollateralization), for damages that result from reinvestment risk. In the context of QFCs, this is picked 

up by the counterparty’s right under the FDIA to ‘‘normal and reasonable costs of cover or other reasonable measures of damages utilized in the industries for such contract and agreement claims.’’ 16

Another similarity is found in carefully drawn limits on the FDIC’s 

ability to repudiate or assign contracts or collateral. 17 But, unlike 

covered bondholders in our proposed framework, a QFC 

counterparty is entitled to even more, including (1) a unilateral 

right to terminate, liquidate, or accelerate the QFC and to exercise 

remedies and rights of setoff under the QFC and against any related collateral, 18 (2) an ability, after the business day following 

the date of the FDIC’s appointment as receiver, to enforce ordinarily nonbinding contractual provisions that are triggered solely 

by the institution’s insolvency or receivership (ipso facto clauses), 19

and (3) immunity from all avoidance actions except for those 

grounded in an actual intent to defraud. 20

Still, as I noted in oral testimony during the hearing, we may be 

able to support a legislative framework for U.S. covered bonds that 

is modeled on these QFC provisions if the use of existing precedent 

would assuage even misplaced concerns. 

Q.4. Many experts feel that it would be economies of scale that 

could make covered bonds a viable tool for liquidity. Therefore, 

there is some debate as to how or if community and regional banks 

would be able to participate in the covered-bonds market. 

What is your opinion on the likelihood that covered bonds could 

be an effective tool for them and why do you believe this to be the 

case? 

A.4. Covered bonds are a conservative and defensive investment 

that appeals to investors only if the secondary market is sufficiently deep and liquid to generate active bids, offers, and trades. 

As a result, each series of covered bonds is typically sized at no less 

than $500 million. 

To ensure that regional and community banks are able to access 

such a market on competitive terms, we have proposed that pooled 

issuances be permitted. Under this arrangement, several institutions would issue more modestly sized series of covered bonds to a 

statutory trust or other separate entity that they have collectively 

sponsored. This entity then would populate a cover pool with the 

multiple series that have been acquired and issue into the market 

a single series of covered bonds backed by all of them together. 
143 

In this way, for example, each of 10 community banks could establish its own separate covered-bond program comprised of the 

commercial-mortgage loans on its balance sheet and issue $50 million of related covered bonds to a jointly sponsored trust. All 10 of 

these separate $50 million series of covered bonds then would fill 

a cover pool established by the trust, and a single $500 million series of covered bonds backed by the entire cover pool would be 

issued by the trust to investors. 

We believe that this approach, which has been used successfully 

in Europe, would open the U.S. covered-bond market to regional 

and community banks in a meaningful way. We also believe that 

the cost-effective, long-term funding that covered bonds can supply 

would be especially valuable to small- and middle-market institutions that historically have been limited to fewer and less diverse 

sources of liquidity. 
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM RIC CAMPO 

Q.1. In your testimony you described a difference in how European 

multifamily properties were built and marketed as compared to 

their U.S. counterparts. 

Could you describe further why this difference is important as it 

relates to covered bonds and multifamily properties? 

A.1. NMHC/NAA Response: The basic issue for the multifamily industry is the limited information about covered-bond financing for 

multifamily properties that is comparable to how apartments are 

financed in the United States. The development and long-term financing in Europe and the United States is not an apples-to-apples 

comparison due to the fact that in Europe the individual rental 

units in a property are mortgaged, much like a condominium here 

in the United States. Therefore, there is no commercial real estate 

mortgage based on the collective income from the rental units and 

so we can not gain the needed understanding on the impact of covered-bond mortgage financing upon development trends and the 

needed financing needs to support the asset base over a long-term 

hold period. 

Most European countries, and in general most countries outside 

of the United States, rely on a condominium approach to develop 

and for ownership of rental housing. In Europe the development of 

rental apartment properties are typically financed based on presale 

of the units and what would be an end-loan/construction loan. This 

short term loan is made and secured on the capital from the 

presale and obligations by the individual unit owners. The role of 

covered bonds in rental housing is in the financing of the individual unit mortgages, which is more analogous to the single-family residential home mortgage market in the United States. 

Q.2. What additional important differences do you see between the 

U.S. and European markets, as it relates to multifamily properties, 

that you would recommend this Committee carefully examine? 

A.2. NMHC/NAA Response: We would urge the Committee to seek 

detailed information from the European Covered Bond Council that 

provides historical loan origination and performance information by 

asset class and in particular commercial real estate to better understand how the loans have performed and the extent of the use 

of covered-bond credit to serve the commercial real estate sector. It 

would be useful to understand how the issuer looks at diversification of assets, how they perform the underwriting associated with 

the commercial real estate and the specific underlying loan terms 

of the covered bonds associated with commercial income properties. 

Q.3. In Mr. Campo’s testimony he states that it is his belief that 

covered bonds will not lead to new lending, but rather banks would 

simply replace some of their whole loans activities with covered 

bonds. There also has been speculation, given the similarities between covered bonds and advances from the Federal Home Loan 

Banks, that a covered-bonds system simply would replace a portion 

of those advances. 

Based upon your studies and experiences, do you believe a properly designed covered-bonds system to be a tool that will allow fi-
195 

nancial institutions to shift existing activity, or do you see this as 

additional activity that will increase funding, and thus lending? 

A.3. NMHC/NAA Response: Our view is the legislative proposal offered creates the opportunity for banks to issue loans, but there are 

issues related to risk-based capital, especially that associated with 

liabilities of replacement assets and funding the transfer in the 

event of financial institution failure. We believe that the institution 

failure can be addressed by the banking regulators, but we do not 

feel the covered-bond issuance is less risky than the whole loan 

execution and as noted the potential replacement of advances of 

FHLBs. 

Our conclusion is that covered-bond issuers would most likely 

transfer credit activity from whole loans to covered bonds rather 

than expanding credit in a heightened environment of risk management. Covered bonds do not dramatically address the ability to reduce risk to the issuer beyond other credit offerings. 

Q.4. If simply a shift, where do you see the shift occurring and why 

do you believe it beneficial, or not, under those circumstances? 

A.4. NMHC/NAA Response: The FHLB system has limited capacity 

to serve the multifamily mortgage market. We see the shift primarily occurring among existing bank loan activities and source of 

capital upon which they extend credit. 

Q.5. The implicit guarantee provided to Fannie Mae and Freddie 

Mac ultimately cost the American taxpayer hundreds of billions of 

dollars. Any changes we make to our home finance system must 

ensure that the taxpayers never again are exposed to this kind of 

a danger. 

If a covered-bond system was to be designed and enacted, what 

components would be essential to ensure that the system did not 

carry this same implicit guarantee? 

A.5. The issue of replacement of credit from Fannie Mae and 

Freddie Mac is the core issue for multifamily as it considers alternative credit in the market. The apartment industry is heavily regulated at the State and local level, it is a fragmented industry composed of thousands of owners large and small and as such relies 

on a variety of sources of credit from private sources, banks and 

thrifts, Wall Street conduits, insurance companies, FHA and 

Fannie Mae and Freddie Mac. Loans to the apartment sector must 

take into consideration the unique and individual circumstances of 

each property, the market, tenancy, ownership structure, and financing needs. Therefore it is very important to have a range of 

credit options that are both national and locally based. 

With the exception of Wall Street conduit loans, the credit 

sources available to the apartment sector have managed their lending activities well and have not contributed to the financial crisis. 

As the impacts of Dodd-Frank improve the oversight and risk mitigation in securities-based credit, the future expectation is for prudent lending to the apartment sector from Wall Street conduits. 

There is no cost to the taxpayer associated with the current financial crisis, as the losses suffered by Wall Street firms; banks, private capital, and even Fannie Mae or Freddie Mac were not a result of multifamily lending. In fact, the Fannie Mae and Freddie 

Mac multifamily programs are a model for prudent risk manage-
196 

ment and underwriting. Seeking a credit replacement should not be 

associated with their past lending practices in multifamily activities. 

Therefore, we would recommend that the covered-bond program 

use the GSE model for multifamily lending and take the policies 

and procedures used to purchase loans from the GSE lenders as a 

way to originate, service and manage risk with Government backing. 

Q.6. Many experts feel that it would be economies of scale that 

could make covered bonds a viable tool for liquidity. Therefore, 

there is some debate as to how or if community and regional banks 

would be able to participate in the covered-bonds market. 

What is your opinion on the likelihood that covered bonds could 

be an effective tool for them and why do you believe this to be the 

case? 

A.6. The question is not an area where NMHC and NAA can offer 

relevant expertise and comment. 
197 

1 ASCE was founded in 1852 and is the country’s oldest national civil engineering organization. It represents more than 146,000 civil engineers individually in private practice, Government, industry, and academia who are dedicated to the advancement of the science and profession of civil engineering. ASCE is a nonprofit educational and professional society organized 

under Part 1.501(c) (3) of the Internal Revenue Code. 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

PREPARED STATEMENT OF THE AMERICAN SOCIETY OF CIVIL 

ENGINEERS 

The American Society of Civil Engineers (ASCE) 1 would like to thank the Senate 

Banking, Housing, and Urban Affairs Committee for holding a hearing today on proposals to create a National Infrastructure Bank. The Society is pleased to present 

to the Committee our views on investing in the Nation’s infrastructure. ASCE supports the creation and operation of a National Infrastructure Bank. 

ASCE’s 2009 Report Card for America’s Infrastructure graded the Nation’s infrastructure a ‘‘D’’ based on 15 categories (the same overall grade as ASCE’s 2005 Report Card), and stated that the Nation needs to invest approximately $2.2 trillion 

over the next 5 years to maintain the national infrastructure in a state of good repair. Even with the current and planned investments from Federal, State, and local 

governments in the next 5 years, the ‘‘gap’’ between the overall need and actual 

spending will exceed $1 trillion in 2014. If the Nation continues to under invest in 

infrastructure and ignores this backlog until systems fail, we will incur even greater 

costs. 

The total of all Federal spending for infrastructure as a share of all Federal 

spending has steadily declined over the past 30 years, according to the Congressional Budget Office. The results of years of under investment can be seen in traffic 

and airport congestion, unsafe bridges and dams, deteriorating roads, and aging 

drinking water and wastewater infrastructure. ASCE is concerned with this accelerated deterioration of America’s infrastructure, with the general reduction in investment for the preservation and enhancement of our quality of life, and with the 

threatened decline of U.S. competitiveness in the global marketplace. 

As Congress is in the process of developing a comprehensive multiyear surface 

transportation authorization, and as President Obama rolls out the Administration’s 

plan to invest $50 billion on the Nation’s infrastructure, our roads, bridges, dams, 

and water systems continue to remain in a state of decline. Aging and overburdened 

infrastructure threatens the economy and quality of life for all Americans. However, 

while the problem may appear staggering, innovative financing such as a National 

Infrastructure Bank, could provide a fiscally prudent means to begin repairing our 

Nation’s deteriorating infrastructure. 

Innovative financing techniques can greatly accelerate infrastructure development 

and can have a powerful economic stimulus effect. Currently, the burden of infrastructure funding is shifting from Federal to State and local resources to fund the 

growing need for improvements. Innovative programs in SAFETEA–LU, such as the 

establishment of the State Infrastructure Bank program, have been a good start, 

but more needs to be done to expand their scope, and new programs or approaches 

must be introduced. The Nation must develop and authorize innovative financing 

programs that not only make resources readily available, but also encourage the 

most effective and efficient use of those resources. Federal investment must be used 

to complement, encourage, and leverage investment from the State and local government levels as well as from the private sector. In addition, users of infrastructure 

must be willing to pay the appropriate price for their use. 

ASCE supports innovative financing programs for transportation projects and believes the Federal Government should make every effort to develop new programs 

or flexibility in innovative procurement approaches. President Obama’s newly released infrastructure investment plan proposes the permanent creation of a national 

infrastructure bank, which could leverage private capital for projects of national and 

regional significance. This sort of proactive thinking toward infrastructure will allow 

States to come together for regional projects such as high speed rail and can move 

the Nation’s infrastructure forward. ASCE applauds President Obama’s leadership 

on the issue and believes that the Administration’s investment plan has great potential to be a part of the solution. In particular, the President’s call to establish 

a national infrastructure bank is a concept ASCE long has supported. 

The National Infrastructure Bank Act of 2009 would begin to address a problem 

that is rapidly approaching crisis levels. Briefly the legislation would establish a National Infrastructure Bank, which would be an independent body designed to evaluate and finance infrastructure projects of substantial regional and national signifi-
198 

cance. Eligible projects would range from mass transit systems, roads, bridges, 

drinking-water systems, and sewage treatment systems. The bill would begin the 

process of meeting the Nation’s broad infrastructure needs, while selecting those 

projects which will be most beneficial. 

ASCE supports the creation and operation of a National Infrastructure Bank, 

which should leverage public funds with private dollars to invest in transportation, 

environment, energy, and telecommunications projects of significance. Each infrastructure system should have a dedicated source of revenue that is independent of 

the Federal Government’s annual appropriations process. This ensures that the 

owners and managers of publicly owned treatment works and other systems will be 

able to finance improvements to their physical infrastructure in a systematic, longterm program that avoids the volatile atmosphere surrounding yearly spending authorizations. 

However, an infrastructure bank should adhere to certain key requirements: 

• The bank should be capitalized initially by general fund appropriations and 

should be self-sustaining after the initial start-up period. 

• The bank should develop financing packages for selected projects which could 

include direct subsidies, direct loan guarantees, long-term tax-credit general 

purpose bonds, and long-term tax-credit infrastructure project specific bonds. 

• The bank should not replace existing infrastructure funding and financing 

mechanisms, but act as a supplement to leverage Federal, State, local, and private infrastructure financing. 

Additionally, ASCE encourages an infrastructure bank where public works 

projects must meet the continuing needs to provide natural resources, industrial 

products, energy, food, transportation, shelter, and effective waste management, 

while at the same time protecting and improving environmental quality. Sustainability and resiliency must be an integral part of improving the Nation’s infrastructure. Today’s transportation systems, water treatment systems, and flood control 

systems must be able to withstand both current and future challenges. Infrastructure systems must be designed to protect the natural environment and withstand 

both natural and man-made hazards, using sustainable practices, to ensure that future generations can use and enjoy what we build today. 

Furthermore, a National Infrastructure Bank should allow States to make the ultimate decision on which projects receive financing from the Federal bank based on 

established priorities. The bank however, should retain sufficient oversight to guarantee an equitable distribution of funds and to ensure that all eligible projects are 

able to compete for financing on a relatively even footing. 

Without long-term financial assurance, the ability of the Federal, State, and local 

governments to do effective infrastructure investment planning is severely constrained. Therefore, in addition to a National Infrastructure Bank ASCE also supports: 

• User fees (such as a motor fuel sales tax) indexed to the Consumer Price Index. 

• Appropriations from general treasury funds, issuance of revenue bonds, and 

tax-exempt financing at State and local levels. 

• Trust funds or alternative reliable funding sources established at the local, 

State, and regional levels, including use of sales tax, impact fees, vehicle registration fees, toll revenues, and mileage based user fees to be developed to augment allocations from Federal trust funds, general treasuries funds, and bonds. 

• Public–private partnerships, State infrastructure banks, bonding and other innovative financing mechanisms as appropriate for the leveraging of available 

transportation program dollars, but not in excess of, or as a means to supplant 

user fee increases. 

• The use of budgetary firewalls to eliminate the diversion of user revenues for 

noninfrastructure purposes. 

ASCE is concerned with the accelerated deterioration of America’s infrastructure, 

with the general reduction in investment for the preservation and enhancement of 

our quality of life, and with the United States’ continued competitiveness in the 

global marketplace. As stewards of the Nation’s infrastructure, civil engineers must 

be a voice in the national debate on infrastructure. ASCE has and will continue to 

support innovative financing programs that not only make resources readily available, but also encourage the most effective and efficient use of those resources. However, financing alternatives such as a National Infrastructure Bank, cannot replace 

a public commitment to funding. Financing by any technique does not supplant the 

need for adequate user fees or other funding sources to eventually pay for projects.