2013-05-27 — voxeu.org
``Government bailouts after the 2008-2009 financial crisis left the European banking sector highly under-capitalised relative to other Western economies such as the US and UK, where banks were re-capitalised and partly nationalised. Not only did the bailouts make the sovereigns riskier as they took on additional debt burdens (Acharya, Drechsler and Schnabl 2013), but leaving the European banking sector under-capitalised in 2008 --2009 led to a persistence in bank holdings, and even active seeking, of risky government bonds. This induced a strong nexus -- the ‘doom loop' -- between the financial sector and sovereign credit risks. Substantial bank recapitalisations against sovereign bond losses (some estimates are provided in Acharya, Schoenmaker and Steffen 2011) could be a prudent way to break this nexus: this would restore bank incentives to avoid undertaking carry trades using sovereign bond positions and in turn induce the governments to take measures for improving their access to bond markets''
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