Europe's Catch-22 Bond Crisis

Under pressure from regulators, European banks are unloading risky sovereign bonds to shore up their balance sheets. Yet the move to strengthen the banks may have a perverse consequence: raising the cost of borrowing for struggling governments, thereby worsening the region’s debt crisis. “European regulators and leaders are shooting themselves in the foot,” says Otto Dichtl, a London-based credit analyst at Knight Capital Europe. “The downward spiral will continue until policymakers find a backup solution for the sovereigns.”

Banks across the region are reducing their exposure to debt of southern European nations as regulators demand higher reserves to shoulder possible losses. European banks cut their foreign lending to the Greek public sector to $37 billion as of June 30 from $52 billion at the end of 2010, according to the latest data from the Bank for International Settlements. European banks lending to the Irish, Portuguese, and Spanish public sectors also fell, data from Basel (Switzerland)-based BIS show.