In an attempt to breathe life into the credit markets, the last few months have been full of activity designed to encourage the development of a market for "covered bonds" ala the European model. "Covered bonds" are merely borrowings by financial institutions (especially banks) that ultimately are supported as bank obligations, but are first repaid from a pool of specifically identified mortgage loans and their cash flows.
In Europe, the covered bond market has taken off over the last four or five years and is now at $1.7 trillion. The Fed and the Treasury, in attempts to stimulate the credit markets in the United States, have encouraged the development of a covered bond market with the FDIC proposing certain types of accounting and tax treatment to overcome the banking industry’s concern about reserves, etc. At first blush, I thought, "Oh no, here we go, our government is getting involved trying to attempt to create a market after neglecting the abuses in the credit market for a number of years."
However, on closer examination, it would appear that the covered bond concept would address a number of specific abuses that closed down the credit markets in the first place. First, the issuers of the bonds that are "covered," continue to own the underlying pool of mortgages (it is not a sale or securitization of those mortgages, but the pool of mortgages is pledged as security for the repayment of otherwise full bank obligations). In the covered bond structure, the banks still have "skin in the game" and own the mortgages. They are largely able to manage the assets because in fact the bank continues to own them and suffers the consequences of any eroding underlying value in the mortgage pool. Further, having a discreet pool of assets to back the bonds that have been issued, gives the covered bond investors some comfort regarding the overall eroding general credit of banking institutions.
While we should all be wary of our government going too far in "greasing the skids" for these types of investments, they do seem to be addressing the abuses of synthetic and derivative securitizations.
But do you think investors will bite?