NEW YORK�(Fortune) -- The government is reaching across the Atlantic in its latest bid to revive the U.S. housing market.
On Monday, Treasury Secretary Henry Paulson laid out guidelines for banks seeking to issue so-called covered bonds as a way to finance home mortgages. Four big U.S. lenders - Citi (C, Fortune 500), Bank of America (BAC, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and Wells Fargo (WFC, Fortune 500) - said they support the venture.
By issuing covered bonds, a bank borrows money from investors, using assets on its balance sheet - such as home mortgage loans - as collateral. Until now, covered bonds haven't been issued in the U.S., though the concept has long been in use in Europe.
But with the housing bust threatening to push the economy into recession - the International Monetary Fund warned Monday that "a bottom for the housing market is not visible" - policymakers and financial institutions have been trying out new ideas in hopes of making mortgages more available, while breaking the cycle of falling house prices and rising foreclosures.
"I believe covered bonds have the potential to increase mortgage financing, improve underwriting standards, and strengthen U.S. financial institutions by providing a new funding source that will diversify their overall portfolio," Paulson said. The efforts of the big banks would "kick-start" the development of the U.S. covered bond market, he added.
"We believe a robust U.S. covered bond market would provide an additional stable and cost-effective funding source for banks to originate and hold mortgages on their balance sheet," the banks said in a joint statement. "We look forward to being leading issuers as the U.S. covered bond market develops, with programs consistent with the FDIC and Treasury statements."
The move comes as shares of banks and brokerage stocks posted their latest sharp decline and investors fret over the fallout of falling house prices on the health of financial institutions. While the Federal Reserve has slashed short-term interest rates over the past year, partly in response to the sharp decline of house prices, mortgage rates recently soared to highs last seen at the turn of the century.
Banks in Europe have used covered bonds as a primary source of mortgage finance for many years, and the market for covered bonds is worth more than $3 trillion.
Until recently, American lenders have preferred to sell their mortgage loans to investors as securities, in the process known as securitization. But when loans to borrowers with poor credit histories started souring at unusually rapid rates last summer, investors fled the market for mortgage-backed securities - a trend that marked the beginning of a credit crisis that has choked off lending in the housing market and, increasingly, elsewhere in the economy.
Monday's move comes on the heels of the Senate's approval of a bill that gives the Treasury the authority to buy shares in two struggling U.S. mortgage firms: Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500). Fannie and Freddie are the biggest providers of mortgage finance in the nation, through their guarantee of mortgage-backed securities issued by others and the purchase of mortgages for their portfolios.
With U.S. house prices having plunged at a double-digit percentage rate over the past year, fears have arisen on Wall Street that Fannie and Freddie will face losses that will eat through their thin capital cushions. At the end of last quarter, Freddie held some $800 billion in mortgage loans and other assets against shareholder equity - a measure of net worth - of just $16 billion.
Paulson said in a speech before the Federal Insurance Deposit Corp. earlier this month that the use of covered bonds might be one way to "increase the availability and lower the cost of mortgage financing to accelerate the return of normal homebuying activity."
Still, while Europe's covered bond market is certainly large, it's no stranger to the fears that have shaken other debt markets around the world. The yield on covered bonds sold in Europe by the two U.S. banks that have sold the bonds - Washington Mutual (WM, Fortune 500) and Bank of America - have soared since those offerings were made in 2006, Bloomberg reports.
Paulson said he sees the expansion of covered bond sales into the U.S. as just one part of the government's effort to bolster market confidence. "There is no silver bullet here," Paulson said Monday.
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[Via Home Mortgage Rates and Real Estate News]
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