January 15, 2011 – Standard & Poor’s Downgrades European Union Countries Credit Ratings: Standard & Poor’s downgraded the credit ratings of France, Italy and seven other European countries, a move that may have more symbolic than fundamental financial impact but served as a reminder that Europe’s economic woes were far from over.
Another memory jog came Friday from Greece, the original source of Europe’s debt troubles. Talks hit a snag between the New Greek government and the banks and other private investors that Athens hopes will agree to take losses on their debt so that Greece can avoid a default.
Together, those developments underscore that even as Europe’s debt turmoil enters its third year, no clear solutions are yet in sight — despite recent signs that a new lending program by the European Central Bank might be easing financial market pressures.
The euro zone’s problems are propelling Europe toward its second recession in three years.
European politicians, in turn, criticized S. & P.’s downgrade plans as providing no meaningful new information to investors but simply stoking a sense of crisis.
To some extent, the prospect of rating downgrades has already been priced into recent bond auctions by Italy, Spain and other countries. Italy, in fact, completed another fairly successful bond auction on Friday, even as rumors of the downgrades had begun to swirl. However, European banks probably purchased most of the debt using billions they got from the U.S. Fed. The charade continues.
But the downgrades may now add to the borrowing costs of the nations affected. Some commercial banks that are required to hold only the highest-rated government securities will have to replace French bonds with other assets, like bonds of Germany.
And the downgrades cannot help but add to the gloom pervading Europe’s economic climate.
“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.
Finance Minister François Baroin of France said Friday that the loss of his country’s pristine AAA rating, cut a notch to AA+, was “not good news” but was “not a catastrophe.” He insisted that the country was headed in the right direction and that no ratings agency would dictate the policies of France, which has Europe’s second-biggest economy, behind Germany’s.
But the downgrades pose fresh challenges for Europe’s political leaders, particularly President Nicolas Sarkozy of France, who is expected to run for re-election this spring and had long cited his country’s AAA credit rating as a badge of honor.
In August, when S. & P. cut the United States a notch from its top-rank AAA rating, markets briefly plunged. But bond investors have continued to flock to the debt of the United States, which as the world’s largest economy has retained the perception of a financial safe haven. That has kept the United States government’s interest rates at very low levels. But none of the countries downgraded on Friday can necessarily count on such a reaction.
After Friday, the only euro zone nations retaining their top AAA ratings are Germany, the Netherlands, Finland and Luxembourg.
Italy and Spain, which are considered the two big euro-zone economies most vulnerable to an escalation of debt problems, both were downgraded two notches, Italy to BBB+ and Spain to A. It will make it harder to erect firewalls around struggling euro zone economies and convince investors that things are more sustainable.
Stocks were down broadly if not deeply in Europe and the United States on Friday, as rumors of the downgrades preceded S. & P.’s announcement, which came after the close of trading on Wall Street. And the euro fell to a 16-month low against the dollar.
Just as significant as the ratings downgrades may be the suspension on Friday of the creditor talks in Greece — whose debt S. & P. long ago gave junk status.
In October, the European Union pledged to write off 100 billion euros ($127.8 billion) of Greece’s debt if bondholders would agree to voluntarily accept 50 percent losses on their Greek holdings. Such an arrangement, known as private-sector involvement, or P.S.I., has been pushed by Chancellor Angela Merkel of Germany as a way of forcing banks, not only European taxpayers, to foot the bill for bailing out Greece.
But talks broke down on Friday between Greece and the commercial banks.
“Discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach,” the Institute of International Finance, which negotiates on behalf of the banks, said in a statement on Friday, after its leader, Charles Dallara, left Athens.
“Unfortunately, despite the efforts of Greece’s leadership, the proposal put forward,” the statement added, “has not produced a constructive consolidated response by all parties.”
The reference to a “voluntary approach” might be a not-so-subtle message that if Europe pushed too hard on this point, then the creditors could no longer accept the agreement as a voluntary one. That is crucial, because an involuntary debt revamping would be seen by creditors as a default — a step Greece and Europe are trying hard to avoid.
If Greece defaults, it could set off the activation of credit default swaps — a type of financial insurance. If the issuers of that insurance have to start paying up, many analysts fear the same sort of falling dominoes of i.o.u.’s that cascaded through the financial industry after the subprime mortgage market collapsed in the United States in 2007 and 2008.
Talks are expected to resume next week. If Greece fails to persuade enough bondholders to take voluntary losses, it may pass a law activating clauses in the bonds that would force creditors to take losses.
“We should be ready, if we don’t have 100 percent participation and if Europe doesn’t want to give us more money,” Christos Staikouras, a member of the Greek Parliament from the center-right New Democracy opposition party and its economic spokesman, said in an interview.
The tense negotiations over Greece’s debt come as the Greek government struggles to find a consensus to pass the budget reforms demanded by its so-called troika of lenders — the European Central Bank, European Union and International Monetary Fund — in exchange for releasing the next installment of bailout money, a 30 billion euro ($38.3 billion) payout scheduled to be released in March.
The Greek uncertainties only add to the regional doubt that helped set off the S. & P. downgrades. Europe’s economy, having barely clawed its way out of a recession three years ago, is again tipping into a new one. France, Spain, Greece and Portugal are already in recessions, and Italy is expected to head into one as a result of belt-tightening measures being pushed by its new prime minister, Mario Monti.
Austria, the other country whose AAA rating was cut a notch on Friday, could be in for trouble if the political turmoil in neighboring Hungary affects Austrian banks, S. & P. said.
Even mighty Germany, with most of its neighbors in a downturn, is also expected to slip into a shallow recession this year. On Friday, S. & P. kept Germany’s ratings untouched, citing its continued competitiveness and financial rigor. But it said it could lower Germany’s rating if its debt, now 80 percent of gross domestic product, reached 100 percent.
The Master of Disaster