What is a Doom Loop in the Context of Economics?
Posted on 03/02/2020
In the context of economics, a doom loop is a negative spiral that can occur when banks hold sovereign bonds and governments with weak public finances bail out such banks. European area governments are growing concerned about the doom loop between large banks and governments. Governments are exposed to bank risk, as well as banks are exposed to sovereign risk by holding government bonds in their portfolios. Other names for the doom loop include the “diabolic loop” and “vicious circle”.
European bank regulation still treats government debt as risk-free.
Euro Area Sovereign Debt Crisis of 2011-2012
During the European area sovereign debt crisis of 2011-2012, the doom loop was primarily domestic as banks were home-biased in their asset allocation, making them exposed to domestic sovereign risk. During the sovereign debt crisis, home bias for banks increased. In 2020, Italian banks remain economically vulnerable due to their significant holdings of Italian sovereign debt. In fact, Italy’s government debt to gross domestic product (GDP) ratio is roughly 135%.
The three main types of bank bailouts: guarantees, liquidity assistance, and recapitalizations. The two types of international bailouts are debt forgiveness and international loans.