Writing in the Wall Street Journal on Saturday (behind the paywall), Peter Wallison provides a helpful reminder of how regulation incentivized banks to load up with dodgy sovereign debt:
“Under the Basel rules [broadly speaking, the global regulatory system for banks], sovereign debt—even the debt of countries with weak economies such as Greece and Italy—is accorded a zero risk-weight. Holding sovereign debt provides banks with interest-earning investments that do not require them to raise any additional capital.
Accordingly, when banks in Europe and elsewhere were pressured by supervisors to raise their capital positions, many chose to sell other assets and increase their commitment to sovereign debt, especially the debt of weak governments offering high yields…”
Incentives work. Even perverse ones.