The credit rating agency S&P has once again shown its willingness to piss off large swathes of Very Important People.
Just when European spirits, and the price of the 10-year Italian government bond, were soaring high (i.e. bond yields heading lower) the Financial Times broke the story that S&P would place all 17 Eurozone countries on notice for possible downgrade. Hours later S&P issued an official statement confirming that this was almost entirely true. Cyprus was already on negative watch and Greece’s rating is already so low that it’s a moot point. But the rest of the 15 countries do indeed now have a 50% chance of being downgraded by one or two notches. This means that Austria, Netherlands, Finland, France and Germany may lose their prized Triple A ratings in as little as 90 days. It also means that the European Financial Stability Fund, whose own rating and lending capacity rely on the Triple A status of the aforementioned, is now about as potent as a eunuch in a Turkish harem.
And while Moody’s, the other major rating agency, has shown itself to have less bloodlust than its rival it did give a similar warning to France last month and thus may not be so very far behind S&P.
One can imagine the wailing and gnashing of teeth going on in Europe’s capitals at the moment. Why, S&P? Why now? The EU summit to end all summits will be on December 9th. Merkozy have already agreed to propose tough new budget rules to be enshrined in the EU constitution–subject to a slow-ish ratification process to be sure, but it ought to be all over in March. And most promising of all, there are hopes that this plan will fulfill European Central Bank president Mario Draghi’s calls last week for a “new fiscal compact” after which “other elements” (print, print, nudge, nudge) might follow. So what’s S&P thinking?
The rationale
S&P cite five main reasons for this move. And it’s important to note that most of them are factors almost entirely out of the ECB’s control:
- Credit conditions in the eurozone are extremely tight, with banks too scared of their own financial health and that of others to lend
- Bond yields and CDS premiums show that people have already stopped thinking of these as Triple A credits, anyway
- Policy measures taken by European leaders that have always turned out to be contentious, inadequate and lagging
- High indebtedness among households and governments
- An approaching recession that’s now being signalled by deteriorating industrial activity in France, Germany and Italy.
Now, as I mentioned, this story was first broken by the FT. One can imagine that S&P was anxious in preparing to issue the official statement later in the day. In their haste they left one mysteriously empty bullet point in their list of reasons for the move. Anyone care to guess what those omitted line might have read?
The Timing
At least S&P had the vertebrae to address this question head on. The FAQs accompanying their statement includes the following: “WHY ARE YOU TAKING THESE ACTIONS NOW BEFORE A MAJOR SUMMIT?” Their answer seems to boil down to, “Consider yourself warned.”
The confluence of negative developments described above has in our view significantly raised the stakes for the upcoming summit. We believe that the failure to present a strategy that would in scope and content address investors’ concerns could weigh more heavily on financing conditions than what we observed in the aftermath of previous summits and significantly exacerbate recession risks.
The credible response
What must the summit produce in order to address these and help solve the Europe crisis once and for all? The answer is very much in keeping with Wolfgang Munchau’s excellent take in his column in yesterday’s FT. Hopes have coalesced around the idea of a fiscal union. The budgetary surveillance that Angela Merkel and Nicholas Sarkozy now seem to be in agreement on addresses one side of that issue. But what about the other side of the coin? “A greater pooling of fiscal resources and obligations,” as S&P puts it. The current plans seem to be missing that special something that will inch European countries ever closer to joint and several liability, aka, the Eurobond. As Munchau states so well:
Contrary to what is being reported, Ms Merkel is not proposing a fiscal union. She is proposing an austerity club, a stability pact on steroids.
It will be interesting to see if Draghi’s interpretation is similar. Will he stick to his principles or meet Merkozy’s half-hearted efforts halfway? December 9th will be the day of truth. In the meantime however, politicians will put S&P and Munchau in the party-pooper camp. That fact that they’re entirely correct is, of course, irrelevant.
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