US and European regulators are essentially forcing banks to buy up their own government's debt—a move that could end up making the debt crisis even worse, a Citigroup analysis says.
Regulators are allowing banks to escape counting their country's debt against capital requirements and loosening other rules to create a steady market for government bonds, the study says.
While that helps governments issue more and more debt, the strategy could ultimately explode if the governments are unable to make the bond payments, leaving the banks with billions of toxic debt, says Citigroup strategist Hans Lorenzen.
"Captive bank demand can buy time and can help keep domestic yields low," Lorenzen wrote in an analysis for clients. "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," Lorenzen adds, "having banks loaded up with domestic sovereign debt will only increase the domestic fallout if the sovereign ultimately reneges on its obligations."
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