FRANKFURT, Oct 29 (Reuters) - Germany's $1 trillion covered bond market is in a critical state despite a government rescue to bolster confidence in the financial system, the head of the market's industry association told Reuters.
Banks had been tapping Germany's covered bond market -- the world's biggest -- as a cheap and reliable source of finance until mid September when it too was sucked into the financial storm.
Now the association of banks in this market say it is still in difficulty as investors dump financial instruments and dash for cash. The news bodes ill for banks as their refinancing alternatives evaporate.
"The situation in the covered bond market is critical but not yet dramatic," said Louis Hagen, executive director of the Association of German Pfandbrief Banks.
"The covered bond market is not clinically dead -- the heart is still beating," he said. "The market is still alive but it is not in great shape."
Covered bonds are copper-bottomed because their owners have a claim not only on the assets they are secured against, for example, an office building, but also on the bank that issued them.
The market was typically the first to reopen after periods of deadlock in interbank lending and U.S. Treasury Secretary Henry Paulson had examined introducing covered bonds in the U.S. to revive the country's struggling mortgage market.

The German market had been considered a safe haven before the collapse of Lehman Brothers rattled investor nerves. The freeze up compounded difficulties for property lender Hypo Real Estate which until the credit crisis had relied on this market for finance.
Commerzbank is the biggest player in the German Pfandbrief market -- its Eurohypo business has more than 80 billion euros of covered bonds in circulation, according to official filings.
In the roughly two weeks since Berlin announced its rescue package, 3.8 billion euros of covered bonds have been issued -- 50 percent below normal.
Hagen did not rule out turning to the government for help to rejuvenate the market although he said such intervention now could backfire.
"One should not make use of measures to resuscitate the market too quickly," he said in an exclusive interview with Reuters.
"That damages the image of the Pfandbrief more than it helps. But that does not mean that we would not take advantage of this option (later)."
"It already helps that the government has said it will support the market if it has serious difficulties."
(Editing by Mike Nesbit) ($1=.7845 Euro) Keywords: GERMANY COVERED BONDS

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