S&P downgrades Europe

By Felix Salmon
January 14, 2012
brought its hammer down on Europe today, with nine -- count 'em -- downgrades of eurozone countries.

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S&P brought its hammer down on Europe today, with nine — count ‘em — downgrades of euro zone countries. The removal of France’s triple-A has been getting most of the headlines, but for me the bigger news is the fact that Portugal has now been downgraded to junk status.

Both of those moves, however, are pretty standard for ratings agencies in general and for S&P in particular: a slightly belated recognition of what has long been obvious to the rest of us. If anybody really thought that French sovereign debt was risk-free, or that Portugal, with its ten-year bond yielding somewhere north of 1,000bp north of Bunds, was investment grade, then they have surely been living under a rock for the past couple of years.

There’s one area, however, where S&P’s actions are going to have a significant and far from positive effect — and that’s the European Financial Stability Facility, or EFSF. The way that the EFSF is structured, its credit rating is particularly reliant on the ratings of the euro zone’s biggest sovereigns. Here’s how S&P put it back on December 6:

Based on EFSF’s current structure, were we to lower one or more of the current ’AAA’ ratings on EFSF’s guarantor members, all else being equal, we would lower the issuer and issue ratings on EFSF to the lowest sovereign rating on members currently rated ‘AAA’.

What this means is that Europe now faces a choice. On the one hand, it can restructure the EFSF so that it retains its triple-A credit rating. That would almost certainly involve shrinking the EFSF in size. Or, it can be sanguine about the EFSF downgrade and just let it happen. But that’s not a pleasant outcome either, given that everybody’s bright idea, when it comes to Europe’s sovereign bailouts, is to leverage the EFSF to some multiple of its present size. Leveraging a triple-A EFSF is hard enough; leveraging a double-A EFSF is pretty much impossible.

My guess is that the EFSF is going to get downgraded very soon — quite possibly on Monday. There’s actually not much point in Europe restructuring it so that it retains its triple-A: the political cost would be huge, and the benefit would be entirely hypothetical. (In theory, the financial markets are happy to lever up triple-A-rated assets. In practice, if those assets are European sovereign debt, not so much.)

Some small part of me thinks it’s a jolly good thing that the world is losing its store of triple-A assets. They’re dangerous things, precisely because we’re given to understand that they’re risk-free. But in this particular context, there are very few ways that today’s news can help Europe, and there are many, many ways that it can hurt. Not least when it comes to the amount of capital that Europe’s banks need to squirrel away against their stocks of sovereign debt.

Europe’s a risky continent; S&P is simply making that fact a little more obvious. In an ideal world, S&P’s opinions wouldn’t carry any more weight or importance than anybody else’s. But this isn’t an ideal world, and they do. And countries like France, which don’t control their own money supply, aren’t as immune to ratings-agency actions as the US turns out to have been.

The immediate ramifications of this announcement, in terms of global stock market reactions, aren’t important. And it’s even possible that if it accelerates the move away from the EFSF and towards the ESM, we could find a little bit of silver lining here. But the fact is that Europe is more fragile, now — more susceptible to changes in sentiment or genuine exogenous shocks — than it was yesterday. And that cannot be a good thing.

11 comments

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Germany of course still has its AAA rating, as does Finland, Holland and Luxembourg. As for those who have fallen two notches, these are the ones we already knew about so it’s no big surprise. Your comparison between France and the US is a little unfair though – the Greenback is a Reserve currency, and the US economy is far more buoyant than France’s. That of course will soon fix the French problem – the wealthier the US feels, the more French wine and luxury goods will be bought.

As for the PIIGS, things do look like they are mounting up against them don’t they?

Posted by FifthDecade | Report as abusive

The whole rating system is crazy. Aisle of Man is a better credit risk than the United States which can print its own money and a senior tranche of an RMBS collection of dodgy loans is a better bet than France in being called “money good”. First off no entity of collection of assets of a country can be a better credit risk than it’s central bank(whoops! S&P seems to have forgotten about the sovereign ratings cap) and the history of defaults in securitized assets suggests the AAA tranche may not be a slam dunk. Time to end ratings.

Posted by Sechel | Report as abusive

Repeat after me… AAA only measures credit risk, even if it 100% accurately measured credit risk it would not mean AAA is “risk-free”. It does not mean it is “information insensitive”.

Only one such product exists – you give me X and I promise to return to you 0 at some time in the future.

The cut to junk status is important because it means that a large slice of institutional investors can now not hold it, no matter what happens, due to regulations.

Posted by Danny_Black | Report as abusive

Sechel, I agree it is time to end the regulatory preference highly rated products get but the idea a country is a lower credit risk than any collection of assets in the country is nonsense. A country can choose not to pay, a trust cannot. A country merely has it is faith and credit behind the debt, a trust has assets. A country is limited to tax collection in a geographic area under a current regime, a company is not.

Posted by Danny_Black | Report as abusive

“The function of a ratings agency is to visit the field at the end of the battle and shoot the wounded.” – John Heimann Comptroller of the Currency
1977 to 1981

Posted by Sechel | Report as abusive

The age of liberal finance came to an end with the Friday January 9, 2011, S&P downgrade of nine European nations.

Our times are best understood through the lens of bible prophecy. The Sovereign Lord God, Psalm 2:4-5, is acting to bring forth a revived Roman Empire, that is a German led Europe.

At the appointed time, He will open the curtains, and out onto the world’s stage will step the most credible leader. This Little Horn, or Little Authority, Daniel 7:25, will work behind the scenes in regional framework agreements to change our times and laws to provide order out of the chaos from a soon coming credit breakdown and financial system collapse. The existing rule of law will be replaced by his word, will and way, Revelation 13:5-10. In the supranational New Europe, national sovereignty will be seen as a relic of a bygone era. The people will be amazed by this, and place their faith and trust in him; they will give their allegiance to his diktat, Revelation 13:3-4.

The Banker regime of Neoliberalism came via the Free To Choose floating currency script of Milton Friedman; but these are now sinking, causing global disinvestment out of stocks and deleveraging out of commodities. The natural result of destructionism is the rise of despotism.

The Beast regime of Neoauthoritarianism, Revelation 13:1-4, is rising in its place. It comes via the 1974 Club of Rome’s Clarion Club for regional global governance. This monster of statism and collectivism is rising from the profligate Mediterranean countries of Italy and Greece. The Beast’s seven heads are rising to occupy in all mankind’s institutions, and its ten horns are rising to govern in all of the world’s ten regions. The Beast system is coming like a terminator that can’t be bargained with. It can’t be reasoned with. It doesn’t feel pity, or remorse, or fear. And it absolutely will not stop, ever until mankind is totally dominated and subdued.

Bank nationalization is coming world wide. Banks will be nationalized in 2012; perhaps better said banks will be regionalized as Bloomberg reports Too-Big-to-Fail Definition May Be Expanded. Global regulators may expand the definition of a too-big-to-fail financial firm, signing up domestic lenders, clearing houses and insurers to capital rules designed for the world’s biggest banks. The “framework should be in place for domestically systemically important banks by the end of the year,” Mark Carney, chairman of the Financial Stability Board, said yesterday after a meeting of the group in Basel, Switzerland. Deutsche Bank AG (DBK), BNP Paribas SA (BNP) and Goldman Sachs Group Inc. (GS) were among 29 banks subject to the so-called capital surcharge on globally systemic financial institutions drawn up by the FSB in November. Banks will have to boost reserves by 1 to 2.5 percentage points above minimum levels agreed on by international regulators. The new banks will be known as government banks.

In a bank insolvent and sovereign insolvent world, regional stakeholders will be appointed to Stakeholder Committees, that is regional public private partnerships, PPPs. Public private partnerships, such as Macquarie Infrastructure, MIC, will take the lead in managing the factors of production. Canadian Energy Income Companies, ENY, and Canadian Oil and Pipeline Companies such as Enbridge, ENB, will for all practical purposes, be regionalized, that is something akin to being nationalized. There will be New Credit for the New Europe, it will be Stakeholder Credit coming from the Stakeholder Committee, as it meets in working group conference. This Stakeholder Credit will complement regional global governance to provide funding for the operations of industry critical to the EU’s security and stability. As for the people, the residents of the New Europe, the prevailing concept will be, let them eat diktat. … http://tinyurl.com/6pptlqw

Posted by theyenguy | Report as abusive

The hell with S&P ratings when comparable UK is rated AAA and France AA. Why?

Is this a anglo-american political game, right after Italian spreads moved down comfortably(!) and Spain fetched double(!)the amount it set out for, to blunt the FX market movement; or is it calculated to stangulate Euro and EU Project?

Posted by hariknaidu | Report as abusive

Thank you, Felix. Your point on the EFSF is very insightful.

Posted by realist50 | Report as abusive

theyenguy – I don’t know what to say after your posting!

Posted by pavlaki | Report as abusive

theyenguy – I don’t know what to say after your posting!

Posted by pavlaki | Report as abusive

You have to wonder what people like ‘theyenguy’ did for an outlet before blog commenting came into widespread use. Were they the guys who liked to wonder around downtown with a sign reading “The End is at hand” and talking loudly to themselves like a paranoid schizophrenic?

Posted by Strych09 | Report as abusive