Treasury Secretary Henry “Hank” Paulson is at it again cooking up additional solutions aimed at shoring up confidence in the battered mortgage/ financial market.
His latest recipe calls for an alternative secondary marketplace to supply funding for mortgages. From the looks of it his strategy is designed to instill confidence amongst investors in the mortgage market by offering a second option for the funding of mortgages even if Fannie Mae & Freddie Mac fail (or become nationalized).
As it stands now, Fannie Mae & Freddie Mac are the “only game in town” when it comes to providing liquidity for mortgages on the secondary market (for a detailed explanation of their roles in the mortgage market check this link). If they were to fail or become nationalized then it would likely cause a severe disruption to mortgage funding.
Paulson’s latest plan is to create a covered bond marketplace which would involve the US’s largest financial institutions. Covered bonds are similar to securitized mortgage-backed bonds with a few minor differences which are explained well in this NY Times article.
Covered bond programs are used exstensively in Europe (especially in Germany) to provide liquidity in the mortgage market. The idea is promising but has a long road of development before we could feel the practical impacts of such a program.