Australia recently adopted covered bond legislation. New Zealand is also reviewing new legislation. Countries seem to be able to adopt covered bond statutes in a single legislative session. But not in the U.S. We have been introducing covered bond legislation in the U..S Congress since 2008. Why is U.S. legislation taking so long? Why does the U.S. not see the benefit to covered bond legislation? Given its long, untroubled history, why are covered bonds not seen in the U.S. as an attractive remedy for the toxic securitizations that triggered the financial crisis?

The answer is complex and related to the unique US history of housing finance. Two major US legislative initiatives of the Great Depression addressing a severely damaged housing market created the Federal Home Loan Bank (FHLB) system, to support banks providing mortgage finance, and the Federal National Mortgage Association (FNMA), to support the secondary market in market in mortgage loans. These actions provided an implicit federal government guarantee to residential mortgage loans, which over time came to dominate housing finance and planning. It also installed the 30 year fixed rate mortgage as the standard for the market. Over time there developed a TBA (to be announced) market, permitting prospective purchasers to lock in a mortgage rate prior to committing to purchase a house. The 30 year mortgage and the TBA market have become such staples of U.S. housing finance that it seems no alternative market architecture will be acceptable without them.

In Europe covered bonds provide the primary means of accessing the capital markets to finance residential mortgage loans. Generally, there are no government agencies similar to FNMA and FHLMC. Thus in Europe there is an urgency to covered bond legislation that is not present in the U.S.

During the financial crisis, FNMA and FHLMC (established in 1970 to provide competition for FNMA) were used as instruments of government policy to prevent a total collapse of prices in housing, even though they were insolvent and in receivership. At the high point, they provided financing for about 95% of all new mortgage loans. The private RMBS market disappeared and hasn’t returned. By some, FNMA and FHLMC are viewed as saviors of the housing sector.

The receivership of FNMA and FHLMC and their proposed dissolution are driving an intense debate (see GSE Reform) over how to reform U.S. housing finance while preserving the TBA market and the 30 year mortgage. While the dialog refers to the need to restore private financing to the housing market, the primary focus is on reforming the role of the government in housing finance and preserving the benefits provided by FNMA and FHLMC. It seems that most of the participants in the housing sector would prefer to have a government guarantee on every mortgage, including home builders, home buyers, bond traders, housing advocates and lenders. It would provide the cheapest financing for home buyers, it would provide a very broad, uniform secondary market and it would provide support for low income families. As with any addiction, it is habit forming and the participants will struggle to avoid recovering from it.

At the same time, banks are not experiencing funding pressure for new mortgage loans; FNMA and FHLMC still provide financing for about 90% of new mortgage loans and the balance can be comfortably funded with deposits. General economic growth is moderate enough that other lending activity is not putting competing pressure on mortgage funding.

This plays out against the backdrop of implementing the new Basel III capital requirements, Volker Rule prohibition on proprietary trading, special requirements for systemically important financial institutions, sharply expanded CFTC regulation of swaps and derivatives and CFPB regulation of mortgage lending and servicing.

The net result is little time or attention at the major mortgage lenders being directed at alternative mortgage finance, including covered bonds. Hopefully in 2014 this will begin to change as many of those crisis related changes are implemented and settle in.