The ratings firm put Germany, France and 13 other euro-area nations on review for a downgrade yesterday, saying “continuing disagreements among European policy makers on how to tackle” the region’s debt crisis risk damaging their financial stability. The move came four months after S&P cut the U.S. to AA+, saying “extremely difficult” political discussions over how to reduce America’s more than $1 trillion budget deficit tainted the credit quality of the world’s largest economy.
Bondholders questioned the timing of S&P’s move, with European Union leaders planning to meet Dec. 8-9 in Brussels to end a crisis that led to bailouts of Greece, Ireland and Portugal, and now threatens to engulf Italy. German Chancellor Angela Merkel and French PresidentNicolas Sarkozy presented a plan earlier in the day to rewrite the EU’s governing treaty to allow tighter economic cooperation.
“S&P should back off,” Anthony Valeri, a market strategist with LPL Financial in San Diego, which oversees $330 billion, said in a telephone interview yesterday. “It complicates the job of the EU leaders to resolve the debt problem.”
$8.1 Trillion
Grades may be lowered by one level for Austria, Belgium, Finland, Germany, Netherlands and Luxembourg, and as many as two steps for the other governments if the summit results don’t satisfy S&P’s criteria, the firm said. More than $8.1 trillion of government debt would be affected if S&P does downgrade all the nations, according to data compiled by Bloomberg. Germany and France are rated AAA.
“The upcoming European summit,” S&P said in a report, “provides an opportunity for policy makers to break the pattern of what we consider to have been defensive and piecemeal measures to date, overcome individual national interests and preferences, and advance a credible response to the crisis that would go far towards restoring investor confidence.”
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 in an interview that it “highlights the problem that rating agencies increasingly are assuming a political role.”
‘Increasingly Problematic’
“There is no doubt that rating agencies have an economically important role to play, but the way in which this is happening at the moment is increasingly problematic as it creates pro-cyclical effects, that means effects that make the crises worse,” Nowotny said yesterday in Vienna.
S&P said in a statement yesterday that it decided to review the region’s ratings before the summit because the risks of a deepening crisis have “risen markedly.”
“Policy makers appear to have acted only in response to mounting market pressures,” S&P said, declining to comment beyond the statement.
Finding a solution to Europe’s debt crisis took on greater urgency last month as yields on Italy’s surged past the 7 percent threshold that led Greece, Ireland and Portugal to seek aid. Italy has 500 billion euros ($669 billion) of bonds maturing in the next three years, more than the current size of the EU’s rescue fund.
U.S. Downgrade
The yield on Italy’s 10-year bond fell 73 basis points, or 0.73 percentage point, yesterday to 5.95 percent before S&P’s announcement, the lowest level since Oct. 27 on a closing basis.
In a joint statement, the governments of France and Germany said they “recognize” the move by S&P and “affirm their conviction that the common proposals made today will strengthen coordination of budget and economic policy, and promote stability, competitiveness and growth.”
New York-based S&P, a unit of McGraw-Hill Cos. (MHP), downgraded the U.S. to AA+ on Aug. 5 from AAA, saying the U.S. government is becoming “less stable, less effective and less predictable.”
While the S&P 500 Index of U.S. stocks plunged 6.7 percent on the first trading day after the downgrade, Treasuries rallied, sending yields to record lows. Treasuries due in 10 years or more are 2011’s best-performing sovereign securities, returning 26 percent as of Nov. 30, according to Bloomberg/EFFAS indexes.
‘Quadruple-A’
The ratings company’s decision on the U.S. was flawed by a $2 trillion error, according to the Treasury Department. S&P disputed the Treasury’s assertions and said using the department’s preferred spending measures in its analysis didn’t affect its credit grade.
Buffett, the billionaire chairman of Berkshire Hathaway Inc. and the world’s most successful investor, said S&P erred and the U.S. should be rated “quadruple-A.” Buffett is also the largest shareholders of Moody’s Corp. (MCO), the parent of Moody’s Investors Service.
Downgrades of Germany and France would affect the rating of the 780 billion euro European Financial Stability Facility, the bailout fund for struggling euro member countries that has funded rescue packages for Greece, Ireland and Portugal partially through bond sales.
If the EFSF has to pay higher interest on its bonds, it may not be able to provide as much funding for indebted nations. Yields on the EFSF’s 3.375 percent bonds due in July 2021 rose 2 basis points yesterday to 3.6 percent, according to Bloomberg prices.
‘Tremendous Pressure’
The outlook change is “disastrous for Europe,” Mark Grant, a managing director at Southwest Securities Inc. in Fort Lauderdale, Florida, said in an interview yesterday on Bloomberg Television’s “Street Smart” with Lisa Murphy and Adam Johnson.
“Every bank now in Europe is also going to be downgraded as the sovereigns are downgraded, many corporations in Europe will be downgraded, the euro is going to come under tremendous pressure worldwide,” Grant said. “There’s just a whole lot of dominoes that are going to fall because of this report.”
Regulators have tried and failed to rein in credit-rating companies, which the U.S. Congress has said helped fuel the worst financial crisis since the Great Depression by assigning top grades to subprime mortgage bonds, Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said in a telephone interview.
Proposed Rules
“Why are they pulling the trigger now?” Rupkey said yesterday in a telephone interview. “There’s a danger of putting too much power in the hands of these institutions and causing in effect a race to the bottom.”
The EU proposed rules last month to increase regulation of the credit-rating companies while postponing plans to ban them from giving assessments of countries negotiating international bailouts.
S&P also cited “high levels of government and household indebtedness across a large area of the eurozone” and the increased risk of a recession in 2012 as reasons for yesterday’s change in outlook. The firm said economic output in Spain, Portugal and Greece will likely fall next year, and that there’s now a 40 percent chance of a decline for the entire region.
The “negative” outlook on CC rated Greece, which is 10 steps below investment quality, wasn’t changed, as its grade “connotes our belief that there is a relatively high near-term probability of default,” S&P said. The firm kept its “negative” outlook on Cyprus’s long-term rating and placed its short-term rating on “creditwatch with negative implications.”
‘Credible Backstop’
Europe may stem its debt crisis by moving to a “full fiscal union” in which all countries assume responsibility for the euro area’s sovereign debt or by “a much larger commitment” by the ECB to support sovereign-debt markets, Goldman Sachs Group Inc. said Nov. 30 in a research note.
The threat of a downgrade may make it more difficult for Merkel to convince the German people that supporting peripheral nations is in their interest, Noel Hebert, a credit strategist at Mitsubishi UFJ Securities USA Inc. in New York, said yesterday in a telephone interview.
“If it starts threatening the creditworthiness of the country itself, that’s a much harder row to hoe for Germany,” Hebert said. “It heightens the internal tensions that Merkel has politically.”
Sovereign Issuer: Ratings Placed on Watch: Austria AAA Finland AAA France AAA Germany AAA Luxembourg AAA Netherlands AAA Slovenia AA-/A-1+ Slovakia A+/A-1 Portugal BBB-/A-3 Ireland BBB+/A-2 Malta A/A-1 Italy A/A-1 Spain AA-/A-1+ Estonia AA-/A-1+ Belgium AA
To contact the reporters on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net; Zeke Faux in New York at zfaux@bloomberg.net
To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net
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