Basel Admitting Mistake Making Sovereign Risk-Free

Even I think anyone should realize
politics is a dangerous profession
and they should not have given the
politicians a blank check as in the
Basel Framework. Of course that
would lead to a public debt
bubble sooner or later. 

Bank of International Settlements in Basel, the mother of the Basel Framework recently (October 2011) admitted the large mistake to zero risk sovereign debt. In this paper they describe the problem and that "the regulatory treatment of sovereign risk could be seen as supporting “financial repression” (ie policies that require private savings to be invested in government bonds and are likely to end up with a long-term misallocation of capital)". Then the paper goes on and on describing that it has definitely not been the case and it is only a misperception by some that the Basel Framework did promote sovereign risk at all. 

Anyway the paper concludes: "Moving from denial to recognition of sovereign risk in bank regulation is one key element that will help to restore confidence and to foster fiscal discipline" and a "Need to put an end to the fiction of a uniform zero risk weight for sovereigns" thus admitting its fatal mistake.

The key question is what did the notion came from that politics is risk free and how did it end up as a cornerstone in the financial regulation? Maybe because the Framework was created in Europe in the 80-ties, when we still had the Iron Curtain and we were overly confident of the benefit of large public sectors. That would fit with introducing the highest capital requirements for corporates, since they were not overly popular at the time.

The paper defines the way forward : "[We] Need to put an end to the fiction of a uniform zero risk weight for sovereigns."