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At a hearing over a measure to provide a legislative backdrop for covered bonds, Republicans and Democrats raised the possibility that the securities could provide funds in a housing market where Fannie Mae (FNM.P) and Freddie Mac (FRE.P) may be forced to adopt new business models in coming years.

Lawmakers voiced support for a measure presented by U.S. Republican Representative Scott Garrett last month to set up a statutory framework for covered bonds.

Unlike traditional mortgage-backed securities, which are frozen blocks of home loans, covered bonds allow banks to manage a dynamic pool of mortgages. They remain on the bank's balance sheet rather than being packaged up and sold to other banks or investors, or securitized.

Covered bonds are seen safer than a risky type of private mortgage bond that fueled the housing boom since the issuing bank is held responsible for payments to investors.

The $5 trillion part of the mortgage bond market dominated by issuance from Fannie Mae and Freddie Mac, which guarantee payments to investors, thrives but Congress is faced with fixing the firms' public-private model after billions of dollars in taxpayer-funded bailouts.

The degree of U.S. taxpayer backing to Fannie Mae and Freddie Mac securities will be hotly debated.

Congress should explore "all avenues to start leveling the playing field and transitioning Fannie Mae and Freddie Mac back to a competitive marketplace," said Jeb Hensarling, a Texas Republican.

Illinois Democrat Bill Foster said covered bonds could "provide a path forward out of the situation we have with Fannie Mae and Freddie Mac."

Covered bonds are popular in Europe but few have been issued in the United States, and none since the credit crisis hit. The bonds were initially seen a threat to Fannie Mae and Freddie Mac and the Federal Home Loan Bank financing programs.

The Garrett measure last month was presented as an amendment to a wider bill on regulating systemic risk in the U.S. economy, but then withdrawn in the face of more pressing business. Despite support, lawmakers on Tuesday gave no indications the amendment would be attached to legislation.

To move forward, the House committee would likely have to hear views on the securities from bank regulators and mortgage banking groups next month, said Jerry Marlatt, an attorney at Morrison & Foerster LLP.

"People are positive about it, and hoping that Chairman Frank keeps his interest in the bill," Marlatt said, referring to Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee. (Reporting by Al Yoon; Editing by Leslie Adler)

http://www.reuters.com/article/idCNN1522843020091215?rpc=44