Downgraded sovereign debt collateral trapped leveraged European banks in a funding spiral

Evidence

As investors fretted about European sovereigns, credit-ratings agencies started to downgrade those sovereigns, and their bonds went from AAA to BBB and worse. As such, you needed to pledge more and more of these sovereign bonds to get the same amount of cash in a repo. Unfortunately, with around 80 percent of all such repo agreements using European sovereign debt as collateral, when those bonds fell in value, the ability of European banks to fund themselves and keep their highly levered structures going began to evaporate. — Mark Blyth, Austerity, 238

Categorization

• XREF: The haircut-spiral mechanism mirrors the US repo story in 2008; ties to Gorton’s work on the run on repo. — connects to: The sovereign debt crisis is a transmuted and camouflaged banking crisis — Mark Blyth, Austerity: The History of a Dangerous…, 35; Falling collateral values triggered Bear Stearns’ liquidity crisis. — Mark Blyth, Austerity: The History of a Dangerous…, 83; High bank leverage turns small asset declines into instant illiquidity and insolvency. — Mark Blyth, Austerity: The History of a Dangerous…, 84 (+8 more)

Broader Connections

• The European debt crisis resulted from banking losses, not sovereign overspending #qualifies (0.78) — Mark Blyth, Austerity, 40
• Debt forms cascading chains that transmit creditor pressure downward #expands (0.75)