The phrase “doom loop” will induce a nervous eye-twitch for most bank shareholders in Europe. Now, some investors are asking whether U.S. banks are about to get uncomfortably familiar with the same idea.
So what’s a doom loop? When bond yields rise, their prices fall, which means a loss for the owners if they mark them to market. For a bank, those losses eat into its capital base, the foundation of its balance sheet. In the euro-zone crisis a decade ago, weak government finances, especially in Italy and Greece, led investors to sell their bonds, which local banks also owned in spades. Bond prices tumbled and local banks suffered heavy losses, raising the risk they might need to be bailed out. That threatened a further strain on government finances, making their debt more risky, pushing yields higher and feeding back into more losses for banks. It’s a vicious circle that still haunts Europe.