Shouldn’t the last thing we do be to stimulate more lending?
Someone’s gonna have to fire up the old printing presses...
Covered bonds are a good move...and if Paulson will just push Congress to make them tax-free like muni-bonds the Secondary Market will return to a level of robustness that is compatible with prosperity without a looming threat of a boom/bust hangover.
This makes sense, so the Rats will try to stop it.
I think it is one of the first semi-sound ideas by Paulson in this entire mess, but it doesn’t get us out of the current mess.
There are significant barriers to acceptance by the banking industry, however. Here’s a couple I can think of off the top of my head:
1. The accounting. In the German style of covered bonds (and most of the covered bonds in the EU are issued by German banks, last I looked), the bank has to keep the covered bond on their books. This runs counter to what banks have wanted to do over the last 10+ years here in the US — ie, move illiquid assets off their balance sheets into this “Level III” asset bucket that is off their balance sheet.
2. As a result of (1) above, the bank is keeping the risk, or at least some component of the risk. The all-too-common practice in the US markets just now has been to try to sell off risk through derivatives, or to offset it with thimblerigging, etc. Bankers have to be pimp-slapped and taught about risk, ie, that they minimize their risk by minimizing risky loans. (duh!). There can be no hiding from systemic risk posed by lending money to people who can’t/won’t repay said loan.
3. In terms of market perception, I see covered bonds as nothing more than the current RMBS with a wrap. The difference here is that the wrap depends on the bank, not a bond insurer. So now the credit ratings agencies have to work even harder at a function in which they’ve proven themselves incompetent, ie, rating the creditworthiness of the wrap.
Well, we know the monolines are screwed. And we know that most of the banks issuing RMBS paper are in very precarious shape as well. So... we’re going from a single wrapper failure to many banks needing to fail to induce the same problems as a single wrapper failing. OK, that’s an improvement in that we no longer have single points of failure as we have in the monolines just now, but the current market probably would see no upside because the banks are in such hard shape.
Net:net, I don’t see anything here in covered bonds that is going to help us right now, because so many components of our financial system are broken: the ratings agencies, the bond market, the derivatives on credit, bank accounting, bank liquidity, bank solvency, etc.
They *could* be a useful tool to migrate the mortgage market away from dependence upon Fannie/Freddie/FHA in the future, and for that reason, they deserve some thought and evaluation.