From Portfolio (via Megan McArdle):
Last year, Moody’s briefly gave all of Iceland’s major banks, including Glitnir, a triple-A rating, on the grounds that if they ever got into trouble, the Icelandic government would bail them out. After much ridicule, Moody’s changed its mind. Clearly, it was silly to treat Iceland’s banks as though they were just as creditworthy as the sovereign.
Fast-forward to today, and Iceland has indeed bailed out Glitnir. But here’s the thing: Iceland’s credit default swaps are now suggesting that the sovereign itself is a distressed credit.
The problem is that some of these banks are bigger than the economies of the countries in which they are based. UBS, for instance, has assets equal to almost five times Switzerland’s GDP. Santander is about 1.3 times Spain’s GDP and Paribas’s assets are just a shader larger than France’s GDP. Should any of those banks end up needing a bailout, they will probably take their sovereigns’ credit down with them.
What was that about needing European-style bank regulation?