In this environment everyone is cautious on mortgages and justifiably so. But I don’t think Paulson is anointing CBs as our savior. I think he is simply looking ahead and saying there needs to be more secondary support for housing to pickup.

100% financing loans vanishing is a good thing for the EU and CBs. Remember, these are on balance sheet structures, so why hold on to a risky product?

CBs certainly haven’t kept the European real-estate from hitting speed-bumps. Lenders are clamping down all over the place and it is far harder to qualify for loans in most EU nations than it was a couple years ago. Many loan products, with 100% financing, etc, have simply vanished from the EU. Sound familiar?

http://globaleconomicanalysis.blogspot.com/2008/07/paulsons-covered-bond-proposal.html

http://globaleconomicanalysis.blogspot.com/2008/07/paulsons-covered-bond-proposal.html

“….anything in between will go to CB”

Not neccessarily. Remember, GSEs do have limits. They can’t keep on purchasing forever and the government will not want to continue piling on more risk. It is in everyones interest for the banks to shoulder the responsibility and CB is one way to do it. CBs can and will take conforming as well as some other stuff. It is a conservative pool by nature since the banks have an incentive to keep the stuff on balance sheet that performs.

“Interest rates at the retail level will rise”

CBs won’t automatically trigger higher interest rates. In the mix bag of liabilities a bank holds, CBs can help diversify, extend duration (lock up funding for a long time) and create additonal liquidity for mortgages. Let’s face it, the CP, CDO and SIVs won’t prob be around in the new world, so why not CBs? Why not accept something that banks keep on balance sheet anyways? Also, one can argue that rates in the new world should be higher. Probably better for long term market stability.

In order to create the kind of yield needed, that means interest rates at the retail end are going to rise.

Rising rates historically has a negative effect on housing…

The key to the struture is the isolation and ring fencing of the collateral pool. In order to do this the banks create a trust, if you will, that uses a swap to guarantee the payment of cash flows in case the collateral pool does not perform.

So, in this case the investors are first protected by the underlying collateral pool and the banks ability to replace/replenish it and second, the isolation of the trust and the swap. This is key because the isolation must prevent the powers of FDIC to take control of the trust. That is hopefully a big part of Paulson’s effort right now.

Roger, you are right, GSEs will always be safer since they are government backed, but it doen’t mean that CBs will fail simply because they are private. If our government can create legislation to protect the isolation then the investors will always be made whole, which is different than MTM risk.

So, Roger asked why now? Simple, there is no more gain on sale. Before, banks could simply unload loans from their balance sheets. In the new world, loans will become simpler and more generic. Aren’t we already seeing that now? Gain on sale will be minimal. CBs will be another liquidity avenue for banks with large mortgage portfolios like WaMu, Wachovia, etc.

In terms of consolidation, I think it is already happening, but I don’t think it will be because of CBs. It’s more about which bank has sufficient capital to ride out the crisis. Those that run out will be bought up or go bankrupt. CB’s will play a role, if done right to boost the markets recovery.

Well, I may mis-understand how covered bonds work, and would love to have my misconceptions dispelled if you would be so kind.

From what I have heard it sounds as if Covered Bonds are “guaranteed” by 1) the mortgages behind the bonds and 2) the ballance sheet of the particular bank which issues them. If this is the case, then investors would stand to lose if there are both defaults on the mortgages behind the bond AND a bank failure.

Or are is Q-diddy saying that even if the bank which issues the covered bonds goes bust AND all the mortgages in the bond pool default that the CB holders are still made whole? If this is the case, then marvelous. I would LOVE to know how they are structured to provide such guarantees. Are they relying on some kind of bond insurance coverage?

This would seem riskier, by far, to me than GSE bonds. GSEs are backed by the government whereas private banks are not.

I’ve been following this and reading over on CR as well. They seem to be a bit more pessimistic about the initiative, as a whole (well, and frankly about darn near everything that would bring a smile of pleasure to Joe Average).

Who guarantees the payment of the bond? The bank? And who guaratees the bank’s promises? The government?

This seems to be something banks could already do, but chose not to: What would make them choose it now?

Will this further accelerate the consolidation of banking?

You guys ask the right questions, but you’re not seeing the whole picture. Yes, F&F are the preferred paper because of the government backing, but they perform differently. Unlike the implicit and now explicit guarantee of the government, CBs rely on structural mechanics that GAURANTEE payment of interest and principal until maturity regardless of insolvency. In other words, even in recievership, the bond holders are guaranteed the economics. That’s one of the many differences that make CBs attractive.

It’s perplexing to me why F&F stock is being so battered. I don’t see why investors are worried the US government will go under. The MBS after all are stil performing. Perhaps I have too much faith in the Fed not collapsing?

Also, think about asset allocation limitations. All lot of investors are already “full up” on GSE paper. They simply can’t and don’t want to double down. US CBs is a new security and gives investors another avenue to invest.