Treasury Secretary Henry Paulson on Tuesday supported expanding the use of covered bonds by U.S. institutions to provide alternative sources of liquidity.

The bonds are more popular in Europe, but with a recent ruling from the Federal Deposit Insurance Corp. (FDIC) easing bond investors access to collateral in the case of a bank failure, institutions hope they become more popular here.

"As Treasury seeks to encourage new sources of mortgage funding in the United States, improve underwriting standards and strengthen financial institutions' balance sheets, covered bonds have the potential to serve these purposes and reduce the costs for first-time home buyers, and for existing homeowners to refinance," he said.

In response to a question, Paulson said there are limits to a covered-bond system. Despite some industry hopes that the FDIC would expand its ruling to provide more support for covered-bond use, he said the regulator's move was appropriate. "I don't think … we can replicate the European market," he said.

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