The banking crisis as a giant carry trade gone wrong

A pernicious aspect of the Eurozone crisis is the ‘doom loop’ linking European banks and governments. This column argues that poor European policy choices in the wake of the 2008 Global Crisis worsened the problem. Rather than being forcefully recapitalised as in the US and UK, many Eurozone banks were left undercapitalised and free to gamble for redemption. In what may be the greatest carry trade ever, they borrowed cheap, first in short-term debt markets and then from the ECB, to invest in high-yield but risky sovereign debt. Substantial bank recapitalisations against sovereign-bond losses is the way forward.

Steffen, Sascha and Viral V. Acharya (2013), The banking crisis as a giant carry trade gone wrong,