Covered Bond Misrepresentations Have Already Begun!

From the New York Times today:

The covered bond markets in some European countries have suffered to some extent from house price declines, but the markets have not closed down as the private-label securitization market has in this country.

From the Financial Times last November:

Volatility is virtually unknown in the near 240-year-old market for Pfandbrief – or covered bonds as they are now more commonly named.

These mortgage and public sector loan backed bonds are seen as ultra-safe because of strict rules about the quality of their collateral and because investors also have recourse to other assets on the issuers’ balance sheets.

So when the industry’s governing council suspends market-making obligations between banks due to the rapidity of spread widening on such debt – as it did this week – observers are bound to fear the worst.

Jim Reid, credit strategist at Deutsche Bank, called the suspension of trading in the roughly €2,000bn market a “rather frightening spectacle” and said it was “cast-iron proof that we are in a credit crunch”.

Consider further that the Times was presumably referring to new issues. Cessation of secondary trading is a far more serious sign of disfunction than an inability to issue new paper.

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  1. Stuart

    Somewhere, somebody is in Europe is smiling in amusement tonight as we give our briefs a try on for size. Sadly, I fear those smiles will escalate into outright laughter (schadenfreude) soon enough.

    Sign of the times: Caveat Emptor

  2. doc holiday

    There really is no misunderstanding, in this deja vu @ Nakedcapitalism:

    FRIDAY, NOVEMBER 30, 2007
    Paulson Promoting Rescue Program for Subprimes

    Do we see a pattern here? The much-covered, little-loved SIV rescue program (formally known as the Master Liquidity Enhancement Conduit and informally called the Entity or Super SIV) was announced prematurely, didn’t clearly solve the problem it was meant to address, involved a lot of failing around to try to resolve irreconcilable interests (those of the SIV sponsors versus the investors who would eventually fund it) and appears to be stillborn (despite the expectation that a structure would have been announced and syndication of the credit enhancement would be underway, we’ve heard nada, presumably because HSBC’s decision to rescue its own troubled SIVs has put a damper on the MLEC plan).

    Paulson seems unable to learn from his own experience. He is swinging for the fences with another Big Scheme That (Purports To) Fix The Problem With A Master Stroke. His track record here is not encouraging.

  3. Henri Tournyol du Clos

    Misrepresentations indeed.

    Yves, I fear you are mixing up the way a bond market

    a) is sometimes officially supposed to be organized (childish knock-for-knock market-making rules for small sizes, which are usually a nuisance dating back to the market’s infancy and are kept on only at the insistence of one or two large houses, which like their manipulative powers, and all the insignificant ones, which otherwise would not see any business);

    b)and how the market really works (real transactions between consenting, adult banks).

    In the Pfandbrief market, the knock-for-knock system is still officially in place because of Germany’s failure to simplify its overly numerous, over-complicated and over-regulated banking system – a long overdue task it cannot achieve thanks to its consensus-based Federal structure and which it has effectively delegated to outside banking crises, like that subprime thing we’ve been in for a year.

    A knock-for-knock market-making suspension is as relevant to real market liquidity as the raising of a “No swimming” flag on a beach is to the state of international shipping lines.

  4. Yves Smith


    Thank you for your comment. However, the Financial Times quoted a DeutscheBank credit strategist who saw the suspension as a alarming event. This product originated in Germany, and banks are not generally in the business of fanning fears. There were also widespread indications of trading of all sorts grinding to a halt in November of last year. Thus the suspension by the agency may well have been an ex post facto admission of extreme illiquidity in the market.

  5. Henri Tournyol du Clos


    1 – a lot of that “market” is artificial because of too many would-be market participants and their wearing the wrong hat : most German market-makers are in fact primarily issuers or/and holders of the said bonds, not dealers;

    2 – “because the FT said it” is NOT a valid argument : on fixed income markets, people that actually talk to newspapers are usually those that know least about the subject and have the time to do so. The others are either busy or anxious not to let out anything that might jeopardize the recycling of what is in their book. In the unlikely event that someone knowledgeable accidentally picks up the phone and gets interviewed, you can anyway usually rely on journalists to misunderstand it or mess it up…

  6. Henri Tournyol du Clos

    3 – as you yourself rightly say, “trading of all sorts” actually came to a halt last November : govvies, swaps, agencies, liquid corporate bonds, whatever, you name it, unissued bonds, redeemed bonds and, yes, even covered bonds.

    I would take the offizielle market-making rules of the European covered bond market Vereinigung for no more than froth.

  7. Ginger Yellow

    It’s also worth remembering that in November banks were still making markets for clients, just not for other market makers.

  8. Yves Smith


    People can and do call the press and demand retractions if they are misquoted. This was from the Web version and presumably would have been corrected if there were an error.

    Journalists who burn or misquote sources have a very short lifespan in the business. And analysts, unlike, say, business unit managers, talk the media with some frequency and presumably know the drill.

    This was not the FT offering its own opinion or making observations from unnamed sources. It cited a specific person who covers that area and can be presumed to be knowledgeable and quoted him. As noted earlier, he would be less rather than more likely to say the market was having trouble. If you had bothered reading the article, it quoted other market participants who also said that marketmakers were unwilling to increase inventory, and also commented on fundamental flaws in the trading system. The Deutsche quote does not appears to be an isolated misquote, as you try to suggest.

    Ginger Yellow, multiple markets were hit by illiquidity in November and December of last year. That was the impetus for the creation of the TAF, which at the time was seen as a radical measure.

    What made the evaporation of liquidity alarming was that it went further, deeper, and started earlier than the usual end-of-year drying up that occurs starting mid-December because banks are squaring their books. It went so far as to affect even Eurozone government bonds. Oh, and multiple real experts commented on this one, not possible no-nothing journalists.

  9. Henri Tournyol du Clos

    “Yves Smith said… Henri, People can and do call the press and demand retractions if they are misquoted. “

    On general market commentaries? In what Wikipedia-like fantasy world do you live? Fixed income market professionals don’t even bother with answering phone calls from journalists for a start, since the opportunity cost might be just too expensive. And you want them to 1 – read the uninformed commentaries in the actual paper the next morning and 2 – call back the journalist and try to explain to her/him again what she/him misunderstood?

    Journalists are only picked up by eager trainees, blabbering middle managers whose job it is to let nothing of importance out or bored traders from third rate institutions.

    You seem to have no understanding whatsoever of how a fixed income market works – a liquid market in illiquid products. As usual with markets and other human ventures, 80% of market volume will be seen by 20% of market participants – most of which will then be perfectly fit for delivering a perfectly inept commentary. The other 20% will keep mum, because, again, what they might say can harm their book.

    Now, to come back to your initial comment : liquidity – ie REAL liquidity – evaporated from ALL bond markets at the end of last year, as it usually does at year end, but probably to a level unseen since the darkest days of 1998 from what I hear. It did so too on the covered bond market. It has nothing to do with covered bonds themselves – although there is a real problem with some of them having been issued by institutions, often German state-sponsored, with little economic purpose. But this has NOTHING to do with the silly “official market-making rules”.

    Oh, and also, the only reason I have time to comment is that I am retired (and thus cannot know exactly from first hand experience about what may be really have been happening on the markets last November).

  10. Henri Tournyol du Clos

    Yves, anyway, don’t take my comments that rashly – I am just trying to correct what I think is a rare misrepresentation on your part. Covered bonds ARE potentially a real improvement over the “originate and flush down” American model – at least if they are issued by large institutions.

    Many thanks for your daily submissions. They are invaluable. Trying to follow the markets from the outside is an impossible task, but you make it much easier.

  11. Ginger Yellow

    “Ginger Yellow, multiple markets were hit by illiquidity in November and December of last year. That was the impetus for the creation of the TAF, which at the time was seen as a radical measure.”

    Of course. My point was that covered bonds remained among the most liquid markets around at the time (still not very liquid), and far more liquid than European mortgage backed securities. A look at the bid/offer spreads available then would tell you that. Even at the height of the liquidity scare in November/December, a few issuers temporarily postponed deals, only to issue them a few weeks or a month later. It doesn’t even bear comparison with the ABS market.

    I’m not saying that the covered bond market is impervious to liquidity crises, but banks have to fund somewhere, and covered bonds have proven more reliable and cost effective than pretty much any other wholesale funding source.

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