1. Treasury Secretary Henry Paulson said today they are going to create a new “Covered Bond Market” to help with the mortgage mess going on in the U.S economy. By going to a covered bond market it really puts the weight on two financial institutions not just one to make sure the loan is good.
2. Under the new housing bill what would happen is a larger bank would invest money to a smaller local bank, credit union, mortgage lender, etc to do the loans and in turn they would put up some collateral to receive the money.
3. The collateral would be any asset that the bank has on their balance sheets. So if the homeowner defaults on their mortgage and is put into foreclosure the larger bank that invested the money could choose from something on the smaller banks asset sheet to make up for the lost income.
4. It really becomes a win-win situation for both financial institutions. The investors lend the money to the mortgage companies who in turn originate the loan and then sell it on the covered bond market or keep it and earn interest on it.
5. If the originating company goes bankrupt then the investors get to choose from anything that is on the bankrupt companies list of assets.
6. This covered bond market will force mortgage companies to write better 30 year fixed mortgages because if the loan they write goes in default the investor can basically get something back in return.
7. Before, the mortgage company that originated the loan was off the hook as soon as the mortgage was sold on the secondary market. When the mortgage company sells your mortgage they receive a quick profit and the investor earns the interest. The investor does not do all of the underwriting with the mortgage and accepts a bunch of loans based on basic guidelines.
8. It works out that the investor gives the originating company some money to make some money with the request of making their money back plus interest. The originating company makes a quick buck as almost like a referral fee. The loan can go back to the investor or they can even sell it themselves of the covered bond market.
9. What is nice about the new housing bill and the covered bond is that the government is not getting in the middle of it by lending tax payers money or money created out of air but creating a market for big companies to trade at. The covered bond market will be companies that like the money they can earn with with mortgages but without the risk of the secondary market as it stands now.
10. Even Treasury Secretary Paulson said this is not a cure all because this does not cover what has already happened but its a step forward to making it a more standardized financial market with stricter underwriting guidelines. The new housing bill will probably eliminate all of the shady mortgage brokers and companies that practice bad lending. No investor will want to work with them and the small mortgage companies do not want to have any of their assets taken from them. These assets include loans that are in their portfolio which have people with 720 credit scores, 50% equity in the home, $100k in the bank, and have been at their jobs for 10 years. The banks know these people will keep paying their loan and it is a cash cow for them. You are going to see a lot more people that might be trying to refinance their mortgage with a mortgage application like this due to the new housing bill.