July 28, 2008 (LPAC)--Treasury Secretary Henry Paulson held a press conference today to tout his plans to revive the mortgage market with "covered bonds." Joining him were representatives from the Fed, the FDIC, J.P. Morgan Chase, Citigroup, Bank of America and Wells Fargo. The move is a desperate effort to find an alternative to the dead mortgage-backed securities market as a way to stop the hemorrhaging losses in the U.S. banking system.

Covered bonds differ from mortgage-backed securities in that both the mortgages and the bonds backed by them stay on the balance sheets of the issuers. A bank would pool mortgages into what is called a cover pool, and then issue bonds on which the mortgages in the pool serve as collateral. In the event of a default, the bondholders would be able to take the mortgages in the pool, whereas, in a mortgage-backed security, they can not. Covered bonds (known as pfandbriefs in Germany) are a $3 trillion market in Europe, and up until the losses of the past year they were considered safe.

Mortgage-backed securities (MBS), and the securities created from them like CDOs, helped push U.S. real estate to record highs, creating trillions of dollars of artificial real estate valuations, and record levels of mortgage debt. When the MBS market died last summer, the money flows for new mortgages dropped substantially, and housing prices began to decline. The values of MBS and CDOs plummetted, causing hundreds of billions of dollars of losses for the institutions holding them. (For example, Merrill Lynch announced today that it would take a 78 percent loss on some of its asset-backed CDOs, selling securities with a face value of $30.6 billion for just $6.7 billion.) The hope is that the use of covered bonds could revive the mortgage market, and stop the vaporization of both the values of the paper already issued, and of the banks holding that paper.

The plan is too little, too late. The banking system is already dead, and real estate values are falling, so the added protection of covered bonds over mortgage-backed securities is illusory. Guarantees from the dead are worthless.