Covered Bonds - The next speculation tool

Why does this not surprise me from this administration, they have never been on top of a single thing, and if it can cost taxpayers, they are going to try for it.

 

This board is often an interesting illustration of human behavior....

The basic problem is this... Because banks gave mortgages to people who shouldn't have qualified for them, we've had a string of foreclosures along with a series of financial institution/bank collapses or closures. This has made investing in mortgages much more risky than it had been and therefore the investors, who actually provide the money (through bonds) that is loaned out in the mortgages, are a little gun shy and are reluctant to invest their money in mortgages. Bonds are generally supposed to be low risk investments and as the risk of bonds increases, there are better places to invest that will get higher returns for the same risk. This has caused a shortage in money to lend for mortgages, even to fully qualified potential homeowners. Therefore, middle class people who are fully qualified to borrow money and are fully capable of paying it back on time, are having a harder time finding mortgages.

So, this covered bond thing simply reduces the risk to the investors that are providing the mortgage money, thereby making it easier for (hopefully qualified) potential homeowners to find mortgages.

I honestly don't know whether it's a good idea or a bad idea. However, here's what I find amusing. If the Bush Administration was resisting the idea of covered bonds and the article was written from the point of view that the middle class was being hurt because of the lack of covered bonds... I would expect your response to be something like:

"Why does this not surprise me from this administration, they have never been on top of a single thing, and if it helps the middle class, they are not going to try for it."

 

You mean like government guarenteed student loans and government guarenteed home loans for low income families, right? Aren't things like government guaranteed student loans an example of shifting the risk of high-risk loans (ie investments) from the investors to tax payers?

Mortgages are bundled together and are sold as bonds to investors. These bonds don't have a high return on investment, but historically have been lower risk, so they have been attractive to investors as part of a balanced, diversified investment plan.

However, in recent years, due to stupidity and mismanagement of mortgage lenders, mortgage bonds have been considerably risker than the past, and the potential returns have not increased. So now these mortgage bonds must now compete with investments that used to be riskier than mortgage bonds but have much higher returns.

So, when investors choose where to invest their money, they see mortgage bonds on one hand, and equally risky by higher return investments on the other hand. More and more of the investors are choosing the higher return investments. This results in a shortage of money to lend out, even to fully qualified and capable borrowers.

So, how do you solve this in the short term? A long term solution is obviously to settle down the mortgage industry so that the risk drops, but that's a 5+ year down the road solution. But what do you do in the mean time?

One approach is to say to say "the hell with the middle class, they can wait 5 to 10 more years to buy a home". Another way would be to force investors to invest in mortgage bonds. A third way would be to use governement money to fund the loans (which would cost more than just insuring them, as covered bonds do). A fourth way is to make mortgage bonds more attractive to investors.

But how do you make mortgage bonds more attractive? You could either increase the returns or decrease the risk. Increased returns means higher interest rates for borrowers, who fund the returns. That wouldn't be a good idea. The other way would be to reduce the risk by insuring the principal, or a portion of the principal. In other words, covered bonds.