If Regulators Will It, It Will Be So

Today, from Bloomberg:

A key factor in the stress tests will be sovereign-bond portfolios. Draghi said this month that banks have used the ECB’s long-term liquidity operations to stock up on government debt, which carries a zero risk-weight under current international rules set by the Basel Committee on Banking Supervision.

Probably this comes as no surprise to people who actually work on this kind of thing for a living (it would be pretty alarming if that were not the case). But I certainly raised an eyebrow and uttered a skeptical, “really, still?” under my breath when I read that all home-country sovereign debt still carries a zero risk-weight (and will under Basel III, too). It seems like there’s pretty good proof now that sovereigns are not risk free at all.*But one wonders if there are not at least one or two countries out there that can sustainably finance themselves only because the regulatory incentives to hold their debt have created enough demand for it to keep rates at viable levels. It’s not like Treasuries are considered risk-free because of regulatory incentives, and no amount of regulatory fiddling was going to turn Greek debt circa 2009 into safe investment. But it doesn’t seem out of the realm of possibility that for some liminal countries, regulators have essentially willed a safe(ish) asset into existence simply by declaring it so.

*The Journal article in the second link explains why technically under certain circumstances it should actually be risk free