Bailout

Give covered bonds a chance

By Felix Salmon

It’s good news that Tim Geithner is throwing his weight behind efforts to build a US market in covered bonds. This made sense back in 2008, when I did my best to explain what exactly covered bonds are, and it makes sense today as well. The more different ways that mortgages can be funded, the less pressure there is on the US government and government-owned agencies like Fannie Mae and Freddie Mac to fund just about everything.

The problem is that the government has lots of different arms, and one such arm — the FDIC — has issues with covered bonds. At the moment, the FDIC can wipe out billions of dollars in unsecured bank debt when it takes over a failing institution, like we saw with WaMu. If banks moved to a covered-bond system, then a lot of bank debt might be secured rather than unsecured, which raises the prospect of bigger losses for the FDIC.

My feeling is that the importance of fixing the broken mortgage-funding system is more urgent, right now, than shoring up the FDIC — especially given that the covered bond market, if and when it emerges, will in the first instance be very small and pose little systemic risk. Covered bonds have an important role to play, here, so let’s at least make them possible. They might well never really take off. But it’s worth a try.

Full post as published by Macroprudential on March 16, 2011 (boomark / email).