Monday, January 16, 2012

Another shoe drops: EFSF downgraded

This was fast. On the Martin Luther King day, a holiday in the US, the US-based S&P downgradedthe European Financial Stability Facility (EFSF) from AAA to AA+, even sooner than I expected

Just last Friday Standard & Poor downgraded 9 European economies by one or two notches, and had a negative outlook for every EU economy, except Germany. I wrote that these downgrades would inevitably result in the downgrade of the EFSF and contribute to a vicious cycle of negative feedback, because lower ratings ultimately require more money for bailouts, and also deplete the state coffers.

Nicolas Sarkozy desperately tried to avoid the downgrade of France, before the upcoming elections, which he is likely to lose. After the loss of the coveted rating he said "my conviction is that it changes nothing". 

The chief executive of EFSF, Klaus Regling, said: "The downgrade to 'AA+' by only one credit agency will not reduce EFSF's lending capacity of 440 billion euros". Is this an example of the "too big to fail" mentality, or at least "too big to be affected by a downgrade of only one of the three ratings agencies". Neither. Regling added "EFSF has sufficient means to fulfill its commitments under current and potential future adjustment programs until the ESM becomes operational in July 2012". The previous two years averaged transfers of about 300 billion euros from the EU core to the periphery. It seems that Klaus is merely saying that 400 billion should be enough this year.

Sarkozy's motives for a sudden change of attitude for manipulating the public opinion are transparent. Regling's statement is no less disingenuous, because it attempts to hide a long term problem behind 'solution by redistribution', a short-term and short-sighted strategy. 

Also today Germany refused to boost the funding of EFSF, just as the bankruptcy of Greece this spring is beginning to look inevitable. Germany was pushing private creditors to accept new bonds the planned swap to carry that would increase the banks' effective losses to 75 percent. Those private lenders recently turned down the offer to 'voluntarily' accept 50 percent losses. Klaus Regling, as an major economist and a German, cannot be unaware how this very day his country's policies are making Greek default a certainty, barring some miracle. Greek default will have a devastating effect on the French banks, while Germany hold relatively little Greek sovereign bonds. In addition Germany is benefiting politically as its neighbors and competitors in Europe weaken economically. However, is Europe ready to accept this soft, insidious form of German hegemony?

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