Treasury Secretary Hank Paulson, in cooperation with officials from the Fed and executives from four of the five largest U.S. banks, has outlined his latest plan to save the banking system and housing markets: creating a covered bond market.
What is a "covered bond"?
So covered bonds may provide a less risky means by which to prop up the secondary mortgage market--by doing the same thing that morgage-backed securities used to do before they collapsed. By issuing covered bonds, banks can raise capital from lenders that would have shied away from riskier CDOs, allowing them to leverage their mortgage assets to raise capital. This, theoretically, will inject more liquidity into the system and thereby bolster the secondary mortgage market, making inter-bank lending cheaper and easier and bringing down mortgage rates for home-owners.
Again, sounds great in theory, but covered bonds will likely end up being part of a broader solution, rather than a one-stop panacea that will dissolve all mortgage worries.
How "covered bonds" are different than plain-vanilla mortgage bonds--and how they're supposed to help save the country.