Is Greek Debt Risk-Free? European Banking Officials Think So

New York Times
July 21, 2011

When European banks bought loads of Greek bonds over the years, making themselves more vulnerable to default and amplifying the current crisis, they were just doing what regulators encouraged them to do — and, indeed, still encourage them to do.

Despite the threat to the banking system caused by Greece and huge markdowns on Greek bonds in the market, European banking regulations maintain the fiction that Greek debt is risk-free. The same holds true for bonds from Ireland, Portugal or any other European Union country.

The regulations, left intact by new European Commission bank rules issued Wednesday, provide a strong financial incentive for banks to buy government debt. Because the risk of losses is officially zero, banks do not need to set aside additional reserves when they buy government debt. That effectively lowers the price.

“The assumption was that states don’t go bankrupt, which is obviously not true,” said Bert van Roosebeke, a banking expert at the Center for European Policy in Freiburg, Germany. “It’s totally crazy.”

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