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Capital Markets

Covered bonds: Covered bonds catch credit crunch cold

Market-making commitment is under pressure.

Although it is unlikely that troubles stemming from US sub-prime mortgages will have any seriously long-term detrimental effects on the covered bond market, nervousness among market participants completely drained liquidity from the sector at the height of the crisis. Participants found a fig leaf to disguise the breakdown in trading in the decision by market makers (meeting via a conference call arranged by the ACI financial markets association) to triple bid-offer spreads in late August. Although this did stabilize the market, subsequent trading of covered bonds was minimal. "The decision to triple bid-offer spreads was a necessity, as all other markets are out of line," says a covered bond analyst.

But at least one senior DCM banker thought the decision was wrong. "Covered bond liquidity! This is a joke!" he says. "These guys got together via the ACI and said ‘there is a breakdown, let’s agree not to quote each other.’ But nobody is calling anybody – there is nothing happening. People are scared to quote their clients because they feel they can’t flip the stuff. All this forced market-making is bullshit..." According to insiders most big banks were not making real prices because capital was needed elsewhere, for instance proprietary trading desks.

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