Bernanke: covered bonds "attractive" replacement for GSEs

Government-sponsored enterprises (GSEs) could be replaced by a US mortgage-backed covered bond market, Federal Reserve chairman Ben Bernanke suggested on Friday.

Speaking at a Berkeley conference on the subprime mortgage crisis, Bernanke outlined three alternative replacements for the GSEs Fannie Mae and Freddie Mac, which were taken under government control in September.

Privatising them - either en bloc or broken up into parts - was possible, he said, but some sort of continuing government presence in the market would be needed. Bernanke said that with the GSEs idle, almost no securitisation issuance is occurring.

He suggested the privatised GSEs would need to be backed up by a federal bond insurance provider, which would provide guarantees - for a charge - on mortgage-backed securities. "That approach would clearly limit the government's exposure while making the benefits of explicit government support available to the market," Bernanke argued - but he did not explain why an explicit government guarantee for GSE-created MBS would create any less exposure than the implicit guarantee for the GSEs themselves.

An alternative, he went on, would be the development of a US covered bond market: "generally speaking, European banks have been able to find buyers for these bonds. For example, issuance of covered bonds totaled more than $16 billion in September 2008. Moreover, interest rate spreads on covered bonds have typically been much narrower than the comparable spreads on senior unsecured debt and mortgage-backed securities".

But state intervention in the US market would restrict covered bond issuance. "The Federal Home Loan Banks (FHLB) can tap capital markets and provide cost-effective funding for mortgage assets. In addition, as a source of financing, covered bond issuance today is not generally competitive with FHLB advances," Bernanke said.

He also suggested the complete nationalisation of the GSEs "along utility grounds" or even a cooperative structure.

See also: US authorities step in to rescue GSEs