Today we see that banks are worried about their exposures to sovereign debt from Europe, especially now that Italy is wavering.
Yesterday, we saw that banks owned so much sovereign debt because it was well-rewarded in the regulatory code. Of course that happened because governments write the regulatory rules, and governments want to stack the deck to make sure they have access to plenty of cheap funds with which to fund spending programs. They do that by privileging sovereign debt in the regulatory requirements, specifically the risk-weights given to debt assets in the capital adequacy standards.
This is no surprise, but it's worth taking a step back every now and then to consider what's going on.
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