acts the same as a traditional bond, with coupons and a bullet when the bond reaches maturity. "But if there are defaults, prepayments or events that affect the assets in the pool, the obligations under those covenants are to maintain the level of the collateral in the pool"

Advantageously, covered bonds deal with a dynamic pool of assets, as opposed to a static pool for CMBS. If a single property in the pool defaults, it can be switched out for a performing unit that matches the standards of the pool

Covered bond pools are also kept on the balance sheet of the issuer for the maturity of the bond, but remain segregated from the issue's other assets. CMBS' off-balance sheet assets provide cash flow to investors, while the sequestered covered-bonds pool serves only as collateral, letting the issuer's cash flow payout the dividends. These key elements create a situation where covered bonds can be more flexible and, with to day's renewed push for due diligence, transparent.

It appears straightforward on paper, as Charles Lansden, a partner at Katten Munchin Rosenman, points out. "It's a simpler structure, it's simpler to understand and, among the players involved in it, there will be more known about them." he says. "It will be a cleaner way to provide mortgage financing, albeit with the current obstacles that need to be overcome." However, legislation is anything but straightforward.

The dynamic nature of the covered bond pools allows for non-performing or under-performing loans to be switched out. However, this flexibility does not extend to the entirety of the pool or the issuer itself. For investors, one of the great advantages of a covered bond pool is that, since the assets are collateral, if the issuer defaults then the pool goes to the investors, which can then use the possible sale of those assets as recompense. If that does not fulfill the debt owed, then investors can take an unsecured claim against the issuer. This dual recourse lowers the risk for investors.

The FDIC, naturally, sees things a little differently. While this is all well and good for investors' security, it leaves the FDIC holding the bill for backstopping the bank. "There are concerns from the FDIC regarding what happens if an issue of a covered bond becomes insolvent or gets placed in receivership or conservatorship by the FDIC, what happens then, concerning its obligation to taking the loss to the FDIC Fund and the taxpayers?" asks Lansden.

However, Hinton sees a solution for the FDIC, which already exists on the federal level: the Federal Home Loan Bank. The FHLB advances are essentially loans secured by collateral segregated in a pool on a borrower's balance sheet, he explains, which meet FHLB standards similar to a covered bonds' dynamic pool restrictions. "What's unusual about the FDIC throwing up its arms about the covered bonds legislation is it's already granted a super lien over the segregated assets that provide collateral for the FHLB advances." Hinton notes. "While it makes perfect sense for the FDIC to be concerned that it doesn't want to create more special classes of super-senior liens on bank assets, the covered bond framework is not different than what they have agreed to for years through the FHLB system."

There is a political motivation, as well, for establishing a robust covered bonds market, which has been a long point of contention in the multifamily sector: GSE reform. A new, more conservative Congress, which rhetorically shies away from European solutions, could find them in Europe's home-lending framework. "There are European institutions that look a little bit like the FHLBs and issue covered bonds instead of home-loan bank advances." Hinton explains. "They offer a mechanism for smaller issuers to get together and pool their assets and essentially achieve some of the public-policy objectives that motivated the conception of the FHLB system."

Lansden suggests that Fannie Mae and Freddie Mac see covered bonds as somewhat "poaching on their traditional territory." More specifically, Lansden says, "I don't know of any European governments that have anything akin to Fannie Mae or Freddie Mac. Traditionally they've utilized this covered bond structure to assist mortgage loan financing."

Hinton doesn't see a radical change coming to the GSEs any time soon

but points out that creating traditional FHLB-style financing instruments attractive to private investors will add competitive pressure. Lansden concurs that, backed by adequate legislation, a covered bond program "would provide a complement to Fannie Mae and Freddie Mac, in terms of funding." He suggests that residential mortgage loans would be the most readily helped, but that any collateral loan would be assisted by covered bonds, including commercial mortgage and auto financing.But, there is a catch for commercial use. It essentially revolves around transparency issues of covered bond pools. "Residential mortgage loans are pretty fungible." Lansden explains. "The documentation is pretty standard. However, when you get to commercial mortgage loans, you have variations in terms of the quality of the underlying property and, right now, a lack of standardization of loan documentation." Lansden says that there would have to be movement toward more standardization, which has stalled during the intervening troubles of the past two years. For now, the industry will just have to wait.

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