Kevin M Warsh: Remarks on covered bond framework
Speech by Mr Kevin M Warsh, Member of the Board of Governors of the US Federal
Reserve System, at the US Department of the Treasury Press Conference on Covered Bond
Framework, Washington DC, 28 July 2008.
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On behalf of the Federal Reserve, I am pleased to join Secretary Paulson and my fellow
bank supervisors today.
Financial markets continue to show the ill effects of turmoil triggered by mortgage losses.
The real economy is underperforming in terms of growth and job creation, a result in part of
financial strains. And financial institutions themselves are affected by the generalized
pullback in liquidity and deteriorating credit quality. Nearly one year after the onset of
financial market distress, many financial institutions have retreated from certain business
lines, limited their participation in markets for some financial products, delevered their
balance sheets, and taken other actions aimed at balance sheet repair. These developments
are both necessary and expected.
But, the path to a new financial market architecture, however uneven and improvised, will not
only be marked by the forces of retrenchment. The path should equally, in my view, be
distinguished by the creative impulses that drive product and market innovation. It is perhaps
too convenient to denigrate the attributes of dynamism and ingenuity, particularly late in
economic cycles, when the forces of innovation can disappoint and weaken the real
economy. Policymakers and market participants alike should recognize that innovation--in
our product markets, labor markets, and yes, our financial markets--is likely to prove a
necessary net contributor to economic growth in the coming period. We should also be
reminded that financial innovation need not be equated with product complexity.
While some take comfort in the presumption that global economies have decoupled, I would
note that our global financial markets are more integrated than ever. Financial products
successfully developed in a single geography often can be readily exported to another;
readily, that is, if the new product export befits investor preferences and policymakers
remove barriers to their adoption. Today's introduction of the Treasury Covered Bond
Framework may be illustrative of the benefits of product innovation in globally connected
financial markets.
Treasury's discussions with market participants suggest that a covered bond framework may
attract investor interest and facilitate greater access to mortgage credit. High-quality assets
might be financed if banks are allowed to manage pools of loans, substituting new loans into
the pool as others become delinquent. Newly issued covered bonds backed by high quality
mortgage loans and issued by strong financial institutions may find a growing investor base
in the United States.
The Federal Reserve has long accepted a broad range of high-quality collateral from
depository institutions at its discount window. Highly rated, high-quality covered bonds would
generally fall within that broad range as eligible collateral. Private lenders also are likely to
find such bonds attractive as collateral for credit extensions.
Financial innovation, properly understood, can increase the diversity of funding sources,
improve the distribution of risks, and provide incentives to monitor such risks--all helping to
promote economic growth. The Federal Reserve seeks to encourage new and innovative
sources of funding, and will continue to work with other policymakers and market participants
to accomplish this important objective.