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Economics, Governance

Citigroup Study: Banks Buying “Sovereign Debt” Causing Financial Crisis

Susanne Posel Occupy Corporatism June 2, 2012

According to Citigroup, US and European regulations force banks to purchase government debt; which will only lead to the debt crisis worsening. Citigroup conducted a study that showed regulators mandate banks to buy government debt against internal capital requirements. Yet other rules facilitate the stability of the government bonds market. In this scenario, the government issues more debt that ultimately will result in the economic destruction of governments.

While they are unable to produce bond payments, this leaves banks with the unfortunate reality of billions of dollars of “toxic debt” Hans Larenzen, Citigroup strategist claims. Larenzen maintains: “Captive bank demand can buy time and can help keep domestic yields low. However, the distortions that build up over time can sow the seeds of an even bigger crisis, if the time bought isn’t used very prudently. Specifically, having banks loaded up with domestic sovereign debt will only increase the domestic fallout if the sovereign ultimately reneges on its obligations.” Banks are just unwitting pawns in the “great depression” trap that has become our financial disaster. Lorenzen says that policy makers dangle “the carrot and the stick” before bankers, then cruelly mislead them into buying more “national sovereign debt”. Lorenzen reveals that this bait and switch has been the silent plague that has been haunting the banking industry for years. Since 2008, banks have unfairly been told they have to purchase “comparatively low holdings” from the US Treasury. To date, they now possess $700 billion.

Lorenzen asks: “Why are banks buying sovereign debt when yields are either near record lows, or perhaps more interestingly, when foreign investors are pulling out?” Lorenzen has his own solution Because Long-Term Refinance Operations are essentially financial repression that keep the banks held down. “Banks have ended up buying bonds at yields where they would happily have sold them only a few months prior,” says Lorenzen. Because banks are allotted by law not to declare sovereign debt against their Basel capital requirements , Europeans banks are allowed a reasonable number of illegal financial “mishaps” as long as they keep the crux of the financial debt crisis at bay.

Lorenzen states: “One doesn’t have to be too cynical to hypothesize that all the disclosures on sovereign exposure have become a bit of a political liability at a point in time where the only buyers in size of periphery sovereign debt are periphery banks funded by the ECB. “As long as funding for sovereigns in markets remains in jeopardy, and as long as there is no clear move towards proper fiscal solidarity in Europe, we reckon there will be a strong political incentive to make banks captive buyers. That implies a move away from marking sovereign debt to market, away from raising risk weights, away from capital ratios that don’t risk weight assets and away from stress tests incorporating government bonds.”

This makes bank bonds investors happy. “As long as policy remains to sustain the status quo, bondholders should come out fine. Conversely, if the burden becomes too great, then the alternative will most probably involve a radical departure from current convention — to the detriment of bondholders,” Lorenzen said. “We suspect this binary outcome requires a political judgment that many funds are not particularly well placed to make.” he added. “Instead of those economics, accounting and finance degrees perhaps you should have done political science after all.”

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