Tuesday, January 17, 2012

Does Anyone Care About Eurozone Downgrades?

Lots of news coming out of Europe over the last few days, most of it negative.

As you no doubt read, last Friday Standard & Poor's not only downgraded several eurozone countries, but also the European Financial Stability Facility (EFSF). 

Another ratings agency - Fitch's - announced that it was almost certain that Greek would be defaulting on its debt by the end of February, and Greek debt is now trading at 30% of face value in the secondary market.

Interestingly, though, the markets took all of the news with a collective shrug.  It appears that the term I mentioned last week - Eurofatigue - remains firmly in place in the market's collective psyche.

It could just be that no one really cares all that much about what American rating agencies think about the debt markets; after all, interest rates on US Treasury 10 year notes have fallen by nearly 100 basis points since the US was downgraded by S&P last July.

European political reaction to the credit downgrades was outrage, as could be expected.  However, rather than argue with the S&P analysis (as the US did last summer), the Europeans want to take it a step further; they want to regulate the agencies, according to Reuters:

LONDON, Jan 16 (Reuters) - Standard & Poor's credit rating downgrades of nine euro zone countries will fuel attempts by European Union lawmakers to slap stricter curbs on sovereign ratings...

...the EU is going further than the United States or what was agreed globally by the G20 to rein in agencies. The bloc's latest legislation is largely directed at the global market dominance of the "Big Three" ratings agencies: S&P, Moody's and Fitch Ratings.

{European Union financial servies chief Michel} Barnier said in a speech in Hong Kong on Monday he wanted to see rating agencies operate in full transparency.

"I am surprised time and time again by the timing agencies choose to make such announcements," Barnier said. "I think it would be right for agencies to take better account of the unprecedented efforts being made by government".


The markets may not care now, but it seems likely that unless current trends change, they will eventually.

Writing in the Financial Times over the weekend, columnist Wolfgang Munchau points out the true significance of the rating changes;  eurozone policy makers seem helpless to stop the downward spiral of many of its members:

Even economic reforms, necessary as they may be for other reasons, cannot solve this problem.  This is another European illusion.  We are now at the point where effective crisis resolution would require a strong central fiscal authority, with the power to tax and allocate resources across the eurozone.  Of course, it will not happen.

This is the ultimate implication of last week's rating downgrades.  We have moved beyond the point where a technical fix would work.  The toolkit is exhausted.