From Freddie Mac to Frederick the Great? Fannie Mae and its brother are the central pillars of America's mortgage market. Their role has become even more important during the credit crisis, thanks to the moribund private-securitisation market (see chart). If they were eventually to disappear, what might take their place? One alternative is covered bonds-Prussia's legacy to modern finance.rnFirst issued by the German kingdom in 1770, covered bonds have grown into a $3 trillion asset class, dominated by issuers in Europe. The instrument is a form of senior debt that is paid back from the issuer's cash flows but is also secured against a ring-fenced pool of assets, such as mortgage loans, in the event of default. That makes it safer than unsecured debt. But covered bonds also offer more protection to investors than asset-backed securities, because the issuer retains the credit risk, rather than securitising it away, and must also keep the cover pool up to snuff by replacing non-performing loans with performing ones. For extra safety, the pool contains more collateral than the value of the bond.
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