- Covered Bonds: An Investing Stalwart Through the Centuries
- Covered Bonds: The Solution to America's Economic Ills
- It Was a Wonderful Life – And Then Came Securitization
- The New Banking Bailout Plan Reconstitutes Some of the Same Ingredients That Touched Off the Financial Crisis
Created in Prussia in 1769 by Frederick the Great, covered bonds have a long history and through the centuries have become a very popular investment instrument in Europe. There, known as Pfandbriefs, these mostly AAA-rated debentures make up the third-largest segment of the German bond market (behind public-sector bonds and unsecured bank debt).
"In the past few years, covered bonds have enjoyed a resurgence as investors search for high quality investments with attractive yields and as European banks look to finance the growth in mortgage lending," fixed-income heavyweight PIMCO wrote in a 2006 research note to investors.
I'm talking about securitization, a masterstroke of financial engineering in which assets are aggregated in order to reduce risk. Once heralded as the greatest financial innovation of modern times, abusive securitization practices instead generated a feeding frenzy of gross excesses that exponentially multiplied risk and drove the world to the brink of financial Armageddon.
Now, a hybrid form of securitization called "covered bonds" may be our only way out.
If nothing else, this landmark court case should make one thing very clear: Securitization - the product of the finest brains of Wall Street for more than two decades - doesn't work as advertised.
Historically, mortgage loans were made by small local institutions, which knew the borrowers personally and took the credit risk themselves.
This time around, someone should take the punch bowl away before the party even gets started. Otherwise, as Yogi Berra once said, it will be "Déjàvu all over again."
The only difference this time around is that the U.S. Treasury Department is calling the plays.