Friday, January 13, 2012

Facing the facts: The great EU credit downgrade

Fitch ratings agency said about a month ago they will review France's rating this coming year, but they were beaten to the punch by the S&P. The inevitable downgrade happened even sooner than expected, and in addition to France, with its heavy exposure to Greek debt and significant deficits, S&P downgraded 8 other European nations. S&P lowered its long-term rating on Cyprus, Italy, Portugal and Spain by two notches, and cut its rating on Austria, France, Malta, Slovakia and Slovenia by one notch. The move puts highly indebted Italy on the same BBB+ level as Kazakhstan and pushed Portugal debt into junk status. The US-based credit-rating agency affirmed the current long-term ratings for Belgium, Estonia, Finland, Germany, Ireland, Luxembourg and the Netherlands. S&P put all 14 of the above euro-zone nations — Austria, Belgium, Cyprus, Estonia, Finland, France, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, and Spain — on "negative" outlook for a possible further downgrade. Only Germany was the retained its AAA rating and a stable outlook.

The downgrade has been precipitated by the breakdown of talks between Greece and its creditors over a debt swap seen as crucial to avert a Greek default. Officials said more talks are likely next week, but also mentioned that there's no agreement on any of the issues involved in a voluntary 'haircut', which is a nice euphemism for being fleeced 40-60% on investments. Chances of Greek default in March are significant, so it's understandable that rating agencies will want to get ahead of the curve.

"Today's rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone," S&P said in a press release announcing the downgrade.

S&P is more diplomatic than yours truly. I simply said that the European plan is a smoke screen. This is wishful thinking mascaraing as a policy. No responsible engineer can build a bridge based on hope alone, without adequate calculation. It's unlikely that there's a total lack of understanding for the fundamentals that are apparent even to a layman like me, therefore, I said the leadership (Merkozy and Co.) have been simply lying to the public. Austerity and budget discipline alone were not sufficient to fight the debt crisis and risked becoming self-defeating, the ratings agency said. How much are these people paid? I wrote two months ago: "The idea that austerity alone, or in combination with stricter rules, as Angela Merkel wishes to do, could solve EU's problems, stemming from trade imbalances, is a lie." Almost that far back I also wrote blogging ahead of the curve about the huge cuts such a plan would entail, and the lack of political will for such enormous cuts. I pointed out the inherent weakness of the French AAA credit rating in another article, after UK dissed new EU rules, provoking French comments on the weakness of the British economy, and unsustainability of its credit rating. The goal is not to be self-congratulatory, but merely to point out; once again, the unfolding events were so easily predictable, that the only way to deny them is either total incompetence (which I don't believe) or outright misrepresentation.

The first rule of suicide pact is to lie early and often. Experts agree this is a suicide pact: the chief economist of Commerzbank, Joerg Kraemer, said that the consequence of the downgrade is that the European Financial Stability Facility (EFSF) also will lose its triple-A rating. "That may irritate markets in the short term but wouldn't be a big problem in a world where the U.S. and Japan also don't have a triple-A rating anymore. Triple-A is a dying species," he said.

This is exactly what I mean by the suicide pact in general: a horrible decision taken jointly. This is why Obama's presidency is so favorable for Europe: by following EU's inane pattern of overspending the US has dramatically increased its debts and deficits. European troubles will have been much worse if US had act together, because it would make investments in EU less attractive, and greatly increase its borrowing costs.

The consequence of the downgrade, which was already partially priced into the borrowing rates of soverign nations, is likely to result in additional increase of these costs. The AAA rating is crucial for the functioning of the EFSF, and one of the consequences of downgrade is the need to pump additional money into the bailout fund. At the same time, the downgrades of banks make triggered forced selling of sovereign debt resulting in increased borrowing costs of these nations.

EU monetary affairs commissioner Olli Rehn called S&P’s decisions “inconsistent” and suggested they ignored the “decisive action” taken by the eurozone to commit to budget, structural and banking-sector reforms, and to a more powerful rescue fund.

The German government said the Eurozone’s determination to overcome the debt crisis stood “beyond question”, echoing the sentiments expressed by other countries. At the same time, in Frankfurt, the ECB criticized the draft of a new fiscal discipline treaty for the euro area, saying that the latest version amounted to “a substantial watering-down” of tough deficit levels that could allow “easy circumvention of the [deficit] rule” by struggling governments.

So, there you have it. The leaders are proclaiming piety, while their bean counters are noting that the proposed strict rules are simply wishful thinking. Lies, actually.

No comments:

Post a Comment