Covered Bonds: The next fiasco?

Are covered bonds the next fiasco?

The U.S. Treasury Department is continuing to consider ways to resuscitate weak homebuying activity, Treasury Secretary Henry Paulson said Tuesday, highlighting the potential of covered bonds as a “promising” solution.”

Covered bonds are securities created from either mortgage loans or public sector loans and make up one of the oldest and largest sectors of the European bond market. In the past few years, covered bonds have enjoyed a resurgence as investors search for high quality investments with attractive yields and as European banks look to finance the growth in mortgage lending.”

Don’t look now but a way has been found to allow the big banks to compete with Fannie Mae and Freddie Mac on basically an even playing field. But that is not a good thing for taxpayers, because it means that we are now backing big bank mortgage lending similarly to the way that we are on the hook for the excess losses of Fannie and Freddie.

Fannie and Freddie enjoy the implicit full faith and credit of the federal government because they were created by Congress. Rather than being simply created by Congress the FDIC (Federal Deposit Insurance Corporation) is an agency of the federal government.

With covered bonds the banks not only offer a mortgage payment revenue stream to repay the money they borrow as bond issuers, they also offer a full guarantee of repayment. That means that if anything happens to the financial solvency of the issuing bank all bank assets, including depositors funds are available to repay the bond holders. As for the depositors, FDIC pays any of their money that the bank losses on its mortgages, at least to the tune of the insurance amounts. And in the event of large defaults, the good old taxpayer steps up and makes everyone whole.

There won’t be any need for a bailout plan if there is another mortgage crises. The system itself is being retooled to make that automatic. Again the shareholders get the profits and the taxpayers get the losses. But at least it’s being hidden behind a curtain this time so we won’t even know about it until they’ve already gotten our money.

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