Wednesday, July 30, 2008

London Banker on Covered Bonds

"Whenever Henry Paulson at Treasury, Ben Bernanke at the Fed and Sheila Bair at FDIC agree on anything, American taxpayers should check their wallets to see if they are being mugged. As a result, my eyebrows rose a bit when these three started pressing in concert for covered bond issuance in US markets some weeks ago. ... Last week the FDIC released a policy statement on covered bonds that provides for 'expedited release of collateral' if an issuing bank is taken into FDIC receivership or liquidation. ... Several of the central players in the recent market dramas--particularly those investment banks and hedge funds on close terms with Mr. Paulson (naming no names, but initials GS comes to mind)--will go strong and aggressive for the covered bond market. ... When the troubled bank nonetheless fails, our golden circle creditors get the good collateral in an expedited release from the FDIC under its new policy statement. ... Covered bonds will be used to render profitable assets off soon-to-be-bankrupt corporates, leaving pensioners and other creditors with the stripped carcass in the liquidation. ... Am I too cynical?", London Banker (LB) at, 25 July 2008.

Thank you LB, this has bothered me for weeks. No, you're not too cynical. You explained it all. I concluded Grupo Mexico did this in the Asarco bankruptcy, see my 17 June 2008 post. Switzer in 1949 made a "good bank-bad bank" split which was found criminal, see my 1 June 2008 post. For a good explanation of a "bust out fraud" read US v. Muhammad, 53 F3d 1426 (7th Cir., 1995). Footnote 1 on page 1430 states, "In general, a 'bust out' scheme involves the planned fraudulent establishment, operation, and demise of a seemingly legitimate business for the purpose of defrauding the business' trade creditors. ... The scheme, described as a 'form of planned bankruptcy,' .... is meant to leave 'the mulcted creditors ... to pick over the meatless carcass of an assetless enterprise'." A bust out fraud can also start with an existing legitimate, but troubled business. I see "covered bonds" as the latest incarnation of MLEC. Remember Paulson's MLEC scheme which fell apart? See my 14 October and 22 December 2007 posts. In MLEC, a bank would put bad assets into an SIV to get them off its balance sheet and let the SIV collapse. Now Paulson et. al., reverse the process and take the good assets out of the bank and put them in a "SIV" and let the bank fail. See also my 20 June 2008 post referring to an old Polish saying.

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