S&P Tells It Like It Is in Europe

Posted by: Andy Reinhardt on December 6, 2011

In some ways it wasn’t surprising when Standard & Poor’s warned late on Dec. 5 that it was putting 15 of 17 countries using the euro on negative credit watch. The euro zone members could see their ratings lowered by one or two notches within 90 days, pending the outcome of a summit of European leaders on Dec. 8 and 9. Amid the ongoing European sovereign debt crisis and an earlier warning that France could lose its coveted AAA status, S&P’s move seemed prudent and defensible—if not overdue.

More surprising is that Germany was among the countries put on notice—not due to a lack of fiscal rectitude but for its exposure to less solvent euro zone members such as Greece and Portugal. Yet investors had already tipped at this possibility in their lukewarm reception towards a €6 billion German bond sale on Nov. 23. Even Europe’s gold standard is now tarnished.

Market reaction to the downgrade threat wasn’t too dire. The Euro Stoxx 50 index was down just a half-percentage point and major European bourses closed anywhere from slightly up to the DAX’s 1.27 percent fall, the worst of the bunch. This despite the fact that S&P issued an additional statement on Dec. 6 cautioning that if any of the euro zone members are downgraded, the European Financial Stability Facility rescue fund also could lose its AAA status.

Among critics, there was an unmistakable sense that S&P—which came under heavy criticism for not spotting the U.S. mortgage crisis earlier—had taken what amounted to a political stance. In an article called “S&P Jumps Into Politics Again With EU Warning,” Bloomberg News reported today that observers ranging from bondholders to politicians questioned the timing and motives behind the downgrade threat.

The move to tie ratings to the outcome of the summit drew criticism from European Central Bank Governing Council member Ewald Nowotny of Austria, who said today at a conference in Vienna that S&P was “politically motivated” with its announcement. “The timing and the scope of this warning has a clearly political context—a rating agency has entered the political arena,” he said.

Nowotny was echoed by European Central Bank governing council member Christian Noyer, who accused S&P of basing its judgment more on political factors and less on fundamentals. “The rating agencies fueled the crisis in 2008 and we can question whether they’re not doing the same thing in the current crisis,” Noyer said at a conference in Paris.

Others were more sanguine. German Finance Minister Wolfgang Schaeuble said on Dec. 6 that the S&P warning provided the “best encouragement” to drive leaders toward a solution at the Brussels EU summit. “The truth is that markets in the whole world right now don’t trust the euro area at all” Schaeuble said today in Vienna, as quoted by Bloomberg News. S&P’s statement, he said, will prompt European leaders “to do what we’ve promised, namely to take the necessary decisions step-by-step and to win back the confidence of global investors.”

Outsiders also praised the move as a necessary dose of realism. Ambrose Evans-Pritchard, international business editor and blogger for the London-based Telegraph, stated simply, “Standard & Poor’s is of course right,” adding:

It was well-timed to drop this bombshell on Monday night after the Merkozy fudge (though S&P made the decision earlier), since the duumvirate yet again failed to offer any meaningful way out of the impasse.

The most crucial issue, in S&P’s view, is that European leaders fearful of bond vigilantes are relying too much on austerity and not enough on stimulus to address their economic woes. Coupled with a simultaneous shift to higher capital ratio requirements for European banks, the across-the-board tightening is setting off a new credit crunch and recession.

In an FAQ released along with the credit watch notification, S&P put it directly:

As the European economy slows, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand shrinks in line with citizens’ concerns about job security and disposable incomes, eroding the revenue side of national budgets.

This is a problem that could also surface outside the euro zone, in Britain and even in the U.S., where the budget deficit is exacerbated by poisonous politics. Europe may have brought some of the pain upon itself by dithering and denying—but nobody else can afford to be smug that they’re immune from the same fate.

The attached video of Philippe D’Arvisenet, global chief economist at BNP Paribas, lends further insight to the issue.

Photo by Sean Gallup/Getty Images