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S&P Downgrades Europe Rescue Fund

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This site and many others deemed the European rescue fund, the European Financial Stability Fund, to be unworkable (among other things, the device of having troubled countries on the hook to finance their own rescues seemed absurd). But it’s one thing to have informed critics view this contraption with skepticism, quite another for a ratings agency to ding it formally.

US investors can still treat the EFSF as AAA based on Moody’s and Fitch AAA ratings. But who with an operating brain cell would buy bonds that are so clearly exposed to downgrade risk?

This means that the ECB will have to monetize periphery country debt in a more direct manner that it has been willing to heretofore to keep them afloat.

The Wall Street Journal has just released a news alert, there is no accompanying story yet on its site:

Standard and Poor’s downgraded its credit rating on Europe’s rescue fund one notch to double-A-plus from triple-A, following its decision last Friday to lower ratings on a number of euro-zone states.

S&P said it could cut the rating on the European Financial Stability Facility further if member states’ creditworthiness is further eroded amid the euro zone’s prolonged crisis.

The two other large ratings firms, Moody’s and Fitch, still rate the EFSF at triple-A.

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22 comments

  1. Woodrow Wilson

    “ECB will have to monetize periphery country debt in a more direct manner” -

    Pretty sure it was on CNBC and elsewhere (a more reputable source) some time ago that the amount needed was in the ballpark of $3-4 Trillion? Maybe some printing help of our own Fed to the tune of a trillion?

    1. Yves Smith Post author

      2 to 3 trillion euros, I believe, so with the euro continuing to tank, that is still more or less 2 to 3 trillion dollars (those are various people in the FT, CNBC may have pundits with higher #s).

      The US can’t print on behalf of the ECB. For the dollar swap lines, the ECB still has to provide euros to the Fed to get dollars back.

      1. EricJ

        “The US can’t print on behalf of the ECB.”

        Didn’t the Fed pump a shyteload of dollars into European banks?

        Are you saying that the ECB pumped a reciprocal load of oi-ros back into the U.S. economy?

        I’m sensing a disconnect here, but I am only one of the unwashed.

        Glendower:
        I can call spirits from the vasty deep.

        Hotspur:
        Why, so can I, or so can any man;
        But will they come when you do call for them?

        Glendower:
        Why, I can teach you, cousin, to command
        The devil

        Hotspur:
        And I can teach thee, coz, to shame the devil—
        By telling the truth. Tell truth and shame the devil.

        1. Yves Smith Post author

          No, let me repeat:

          The ECB SWAPPED Euros with the Fed for dollars.

          The ECB will unwind the swap at the same exchange rate later.

          The ECB had to create the euros to swap with the Fed.

          The Fed has the euros as collateral.

          1. EricJ

            “The ECB will unwind the swap at the same exchange rate later.”

            Why would anyone believe that? Wouldn’t they unwind the swap at the prevailing exchange rate, or wait till the most favorable exchange rate they could expect?

            FX is evil, and no, you didn’t ask me.

          2. Yves Smith Post author

            Go read the Fed’s website. These are the terms of these currency swaps, and central bank currency swaps generally.

  2. Jim

    It does not mean that the “ECB will have to monetize periphery country debt in a more direct manner that it has been willing to heretofore to keep them afloat.”

    It can also mean that the ECB will propose the two viable solutions.

    (i) A permanent fiscal transfer from northern European nations to southern European ones, with a federal government and disproportionate (relative to population) control for the North.

    or

    (ii) The orderly transition to sovereign currencies in each of the 17 Eurozone nations.

    1. Yves Smith Post author

      The ECB cannot do either 1 or 2, and 2 is considered the worst possible outcome by pretty much everyone. Even splitting into two currency blocs is considered to be a nuclear winter level outcome.

      1 requires political integration and treaty approvals and will take too long to address the crisis.

      The only party that can intervene on the timetables the markets demand is the ECB, with the IMF providing some support. The IMF does not have remotely enough firepower to do the job alone.

  3. MarkMinter

    I have reading about this situation in Europe for some time now at a deeply technical level. This is the conclusion that I am coming to.

    Europe will not fail. It will not default. Pundits having been claiming the demise of the financial system since 2008. It hasn’t happened. The ECB will print money. Bloggers keep screaming for doom because they want you to readtheir blog. I have been anxiously checking blogs everyday for 3 years expecting the worst. They said Europe would fall by October, then December, then it wouldn’t make it to Christmas, the new year. Now surely March. Then this week Spain and Italy were able to get cheaper rates for bonds. Greece hasn’t revolted yet. I don’t have a blog. I ain’t selling newspapers. I don’t even give a darn if you read my comment. And I don’t think it will fail.

    The bottom of THIS economic crisis has been reached at least for now. Maybe another shock can come along and some people are calling for a head and shoulders, but even if one is coming we are past the first shoulder and the head and into the second shoulder.

    I see it everywhere in little things. The Walgreens where I go for cigarettes always has a line at the register, a ridiculous line with women buying the most useless junk, stuff you wouldn’t buy if you were still worried. Always an annoying long line now. A year ago there was never a line. The line of cars turning left at my major intersection at 5:30pm is much longer now. The supermarket parking lot is fuller. The people have more stuff in the baskets they are pushing around. There are lines at the What-A-Burger drive- thru at 3am. 3am and people got money for a double meat, double cheese What-A-Burger, on Wednesday. There are NO For Sale signs in my neighborhood. The house across the street “for rent” was only vacant for 1.5 months and the rent is $1400 a month and one of those months was December when people typically don’t change houses. There are more jobs in the on-line sites when I search for “Oracle”. My sister works on the phone in Customer Service for a big cable company handling disconnects and termination of service. Last year the stories she told were heartbreaking, lost jobs, lost houses, kids moving back with parents. Now they’re just moving, new job, new house, getting transferred. I know two people personally that bought NEW cars in the past two weeks. One was $45,000 car. Granted I live in Austin,Texas and not Florida or Nevada. You might give anecdotal evidence where you live that things are not getting better. But its gotta start getting better somewhere before it can get better everywhere.

    It is turning. The rule of thumb for a business cycle is ten years with 3 down 7 up. It started in 2008. We did our three down.

    Just think, we have just been through the biggest banking crisis of our lives and not one depositor lost 1 dollar. Europe will not fail. The US Government will not default on securities.

    Let me say. I am a liberal democrat and no friend of bankers, capitalism, corporations or Wall Street. I believe the difference between a bank and a porcupine is that porcupines have pricks on the outside. I have read numerous stories of heinous stuff those bankers did. One thing they didn’t do?

    They didn’t let the banking system fail. And despite the claims of every blogger that wants you to read his post, it won’t. Not here. Not in Europe.

    1. Foppe

      Ooh, business cycle analysis. Great stuff. Might i suggest you read less “deeply technical” sources, and wise up? Because I would hazard a wager that you’re reading the wrong things. As for Walgreens: sorry, don’t have that here in NL. What I *do* see in NL, however, is a PM who is trying to be mini-Reagan, by austerizing the economy with a smile plastered on his face. Exuding “Optimism”, the feckless local press calls it.

        1. Yves Smith Post author

          1. The lending was to banks, not sovereigns, and it was net lending of €235 billion (there was a remarkable press flurry on the gross amount, €489 billion).

          2. It is still not clear the ECB will buy sovereign debt. Per Reuters:

          While a lending crunch may have been avoided thanks to the ECB’s latest move, it is much less certain that banks will use the money to buy Italian and Spanish government debt, as French President Nicolas Sarkozy has urged, given the competing pressures on them to cut risk, rebuild capital and lend to business.

          “While this might help to address recent signs of renewed tensions in credit markets and support bank lending, we remain skeptical of the idea that the operation will ease the sovereign debt crisis too,” said Jonathan Loynes, Chief European Economist at Capital Economics.

          Banks will not increase their exposure to sovereign debt because European Bank Authority (EBA) rules discourage it, Italy’s banking association (ABI) said.

          “The EBA rules are a deterrent for buying sovereign bonds, so not even the ECB’s important liquidity injection … can be used to support sovereign debt,” ABI director general Giovanni Sabatini told reporters.

          http://www.reuters.com/article/2011/12/21/us-ecb-3yr-loans-idUSTRE7BK0MC20111221

          3. I don’t tolerate attacks on anyone who posts here, and that includes me. Casting aspersions at a writer is generally a sign of an inability to mount an argument. Go do your homework. My post on the runup to the crisis and the crisis itself look better and better with the passage of time.

    2. Jim

      So many deeply technical sources and so little hard economic data to support your arguments?

      In any case, so many said the same about Argentina in 2001. I recall Domingo Cavallo, the technocrat who took over Treasury, saying that Argentina will never lose the dollar peg, as it would lead to hemispheric economic chaos.

      Well, Argentina did lose the peg and posted economic growth far superior to even Brazil over the last decade.

      MarkMinter, I’d also like to remind you that per the agreement the ECB made with the German people, it can’t monetize debt, at least not without a national referendum in Germany.

      1. MarkMinter

        Granted there are similarities between this crisis in Europe and Argentina. Argentina was in a credit crisis and the IMF was the “lender of last resort”. Pegging the peso to the dollar costs the Argentine government loss of sovereign control over its currency. It had a high goverment deficit to GDP ratio (gasp 50%) and high deficit spending (gasp 5%). The IMF forced austerity on the Argentine government. There was capital flight from the country, bank runs, some of same stuff Greece is experiencing. They did get tarred with the same brush by investors over problems in other Latin countries, mainly Mexico (From Wikipedia)

        But there are differences. Argentina was in a major change of goverment system after years of dictatorship. Inflation was the problem, not deflation. Argentina was a “third world” country, certainly an upper echelon one, but it was “down there” and the big boys from Europe and the USA could gang up on it. Europe isn’t Argentina. They are a gang and its a lot harder to beat up a gang. (I use that term loosely, maybe team would be more appropriate)

        But here is the key difference. JPMorgan and Goldman Sachs did not stand to lose considerably over Argentina. What happened in Argentina didn’t threaten the world financial system. And the US presidential election was not dependent on it. The joke here is “Who came beat Obama in 2012? Angelea Merkel”.

        I put “print money” in quotes. They can changes ratios. They can change what they accept in collateral. They can continue to dole out things like the $638 billion they did a few weeks ago. They will find a way to keep kicking the can down the road until the news starts coming out that they American consumer has recovered and I don’t care who jumps on me about “hard” data. He is recovering. Slowly but surely. More cars were sold in 2011 than any year since 2008 and 2008 sold a lot of cars. Cars are a good indicator of a lot of stuff, credit, manufacturing, attitudes, confidence. And the cars they bought were big, costly. 60% were SUVs and Pickups. I live in Texas and nobody here buys the base model. No sir. They get Silverados with big V-8s, and RAM trucks with hemi engines. Lots of those up at the Baptist chruch on the corner.

        I have this story. In 1862 Francis Adams was US ambassador to England during the Civil War. England was quite split over the war. Moralists opposed slavery. The manufacturing and textile segments supported the south because the north had closed the southern ports and stopped shipment to cotton to English plants. Adams found out that the British Foreign office was about the recognize the south as a legitimate goverment caving in to pressure from manufacturers. The south had won every military engagement until that point and lots of bloodshed gave them the high moral ground to stop the violence. Adams got to the Foreign Office and got them to delay. The next day the north won the battle of Antietam practically by serendipity. A northern patrol had stumbled on a massing of confederate forces and the north attacked surprising the confederates. The victory was decisive and wounded the south greatly and proved the turning point of the war in the east. Britain delayed in recognition because the no longer was it certain that the south could win against the north or hold out until the north relented. Eventually they dropped plans to recognize the south. The blockade remained in force and rest is history.

        Now how would attitudes about Europe change if it becomes apparent that the US consumer will recover? The worst that could happen has happened and the financial system still hasn’t been flattened. The possibility of bank failure and system failure dominated US news all through 2009. You never hear anything about it now. Actually 2010 was more profitable than 2008 for finance. Corporate profits are as high as in 2008. What if some sort of Antietam has been won and the demise of the world is no longer so certain? The German people worry they will be stuck holding the bill because contraction will continue to occur. Austerity will lead to contraction and reduced revenue in the peripheral countries, driving down credit ratings, forcing up the cost of borrowing, and eventually default will occur. But what if that is not so certain? What if the US consumer gets up from being knocked down and I am telling you he is. He might be taking a standing 8 count right now, but this fight is going to go on. He is not knocked out. I am seeing it with my own eyes. If there came to be an idea that a recovery was coming, would the German people be so quick to let the European idea die and return to a divided Europe? Would this not be their chance for redemption? Imagine history books in 2100 printing that Germany saved Europe?

        Like Angela Merkel said, Europe won’t fail and it will not default. I am certain of it.

        1. MarkMinter

          I’ll add one more thing. Germany has been reluctant to contribute more to EFSF and other LTRO funds because of lack of commitment from other nations. The United States has been loathe to contribute its portion to IMF rescue funds. England has had its policy towards Europe as an “Ostrich” policy. And Germany doesn’t want to bear burdens alone. Nobody wants to take the political heat at this time when domestic issues seem so pressing.

          But what if default seemed imminent?

          I go to back to history again. In 1916 Woodrow Wilson ran for re-election on a platform “He will keep us out of the war”. The United States could not have had a more isolationist attitude about those “European Problems”. Yet on April 6, 1917, 1 year and 1 month after Wilson’s second inauguration, the US declared war on Germany.

          Also the United States stayed out of World War II and entering the war was greatly opposed by the majority of the United States. Of course, the attack on Pearl Harbor was emotional push necessary to cause the US to enter.

          But in both cases, a considerable amount of US treasure and lives were spent in Europe despite the opinion of the US people prior to entry.

          Americans can be jerks for sure and the political environment seems to be extremely divided. But it was also contentious in those days. I promise you, both Woodrow Wilson and Franklin D Roosevelt were just as reviled by conservative and Republican elements in American society as Obama. Wilson had only been elected for his first term because Teddy Roosevelt had pulled Republican votes in 1912. Great segments of American society hated Franklin Roosevelt.

          So who could deny that when confronted with the reality of financial disaster with extreme political upheaval in a lot of the world, that the Americans would not once again, step into the fray? Yeah, there would be a lot of screaming and hair pulling, before, during, and after just like with financial bailouts, tarp, Fannie Mae, etc. But just like with those other bailouts, if every financial leader tells the American leadership that it has to be done, it probably will be.

          I think its being sort of done right now. Bond auctions are going through. Greece, Italy, and Spain have all had auctions. Somebody is buying those bonds. The powers that be are closing ranks and backing up those countries. If push comes to shove, the US government will weigh in. Then the UK, then China, and then any other “coalition of the willing” that is necessary. It might seem remote and unlikely today given the current political discourse. But imagine if the disaster is imminent, and the American president goes before a joint session of congress with TV and spells out the situation, economic and moral imperative for action, with the complete support of the financial community and press, it would probably get done.

  4. Foppe

    Anyone care to guess what their next move will be? They seem to be running out of bigger & better “solutions”.

  5. Loverofham

    Yves, been reading about the possibility of $1 trillion Euro for the next round of LTRO.. Any thoughts about this? Would it help sov debt demand, or would it find it’s way back to the ECB via deposits like the first $489b euro? More can kicking? Will it matter?
    Thx
    Loverofham

  6. Maju

    I for one have the impression of being in the late part of ‘The boy who cried wolf’, when the peasants get out tired and get an arrow in the neck of the “humorist” kid (or at least that’s how it ends in a version I know of).

    It’s blatantly obvious by now that all this is nothing but a choral performance for the imposition of radical neo-Thatcherism. While sacrifices and cuts are imposed on the working class the banks are giving dividends of 15% (Santander, right in the eye of the cyclone) and tomorrow they will command us to “bail out” their luxuries.

    I don’t pay any attention anymore to poor standards’ S&P nor Moody’s the moody. They are just intentionally out of touch with reality and performing a dance of vultures, nothing else. What’s the worst that can happen? Bankruptcy. But bankruptcy has already happened thanks to these morbid dancers, because the states are not able or willing anymore to pay their debts to their own citizens who enable them with their work, taxes and compliance.

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