On Tuesday, the House Financial Services Committee will hold a hearing on covered bonds backed by high-quality mortgages and consumer loans, a European market some U.S. legislators believe could become more influential in the U.S. and help fill in the gap left by the still-moribund MBS market.

Rep. Scott Garrett, R-N.J., is hoping the hearing will lead to legislative action in the spring and help provide liquidity for the U.S. mortgage market. European banks have issued $180 billion in covered bonds backed by high-quality mortgages and consumer loans this year while U.S. mortgage securitization, outside of the government sponsored or guaranteed market, has been virtually nonexistent.

"Because of the problems in the secondary mortgage market," covered bonds offer a way to provide needed liquidity for the U.S. mortgage market, said Garrett. A covered bond market would enable banks and thrifts to tap a low-cost, long-term financing while keeping the mortgage loans on their balance sheets.

Covered bond investors know they have "dual" recourse and they can go after the bank or seize the underlying assets if the bonds go into default.

In Europe, covered bonds have "performed well," despite the financial crisis, Garrett told reporters. (The bonds did suffer during the crisis but not to the extent securitizations did.) In 2008, the Treasury Department and the Federal Deposit Insurance Corp. issued policy statements on covered bonds and a couple large U.S. issuers experimented with them prior to the crisis.

However, legislation is needed to assure investors they will be made whole if an issuing bank fails, according to Tim Skeet, head of covered bonds for Bank of America. "A legal framework is a necessary prerequisite to the establishment of a vibrant U.S. covered bond market," Skeet said at Garrett's press conference.

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