The Real Dark Horse - S&P's Mass Downgrade FAQ May Have Just Hobbled The European Sovereign Debt Market

All your questions about the historic European downgrade should be answered after reading the following FAQ. Or so S&P believes. Ironically, it does an admirable job, because the following presentation successfully manages to negate years of endless lies and propaganda by Europe's incompetent and corrupt klepocrarts, and lays out the true terrifying perspective currently splayed out before the eurozone better than most analyses we have seen to date. Namely that the failed experiment is coming to an end. And since the Eurozone's idiotic foundation was laid out by the same breed of central planning academic wizards who thought that Keynesianism was a great idea (and continue to determine the fate of the world out of their small corner office in the Marriner Eccles building), the imminent downfall of Europe will only precipitate the final unraveling of the shaman "economic" religion that has taken the world to the brink of utter financial collapse and, gradually, world war.

Here are the key take home messages from the FAQ (source):

• We believe that as long as uncertainty about the bond buyers at primary auctions remains, the risk of a deepening of the crisis remains a real one. These risks could be exacerbated should renewed policy disagreements among European policymakers emerge or the Greek debt restructuring lead to an outcome that further discourages financial investors to add to their positions in peripheral sovereign securities.
• The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers, lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. According to our assessment, the political agreement reached at the summit did not contain significant new initiatives to address the near-term funding challenges that have engulfed the eurozone.
• Instead, it focuses on what we consider to be a one-sided approach by emphasizing fiscal austerity without a strong and consistent program to raise the growth potential of the economies in the eurozone.
• Financial solidarity among member states appears to us to be insufficient to prevent prolonged funding uncertainties. Specifically, we believe that the current crisis management tools may not be adequate to restore lasting confidence in the creditworthiness of large eurozone members such as Italy and Spain. Nor do we think they are likely to instill sufficient confidence in these sovereigns' ability to address potential financial system stresses in their jurisdiction. In such a setting, the prospects of effectively intervening in the feedback loop between sovereign and financial sector risk are in our opinion weak.
• Despite these encouraging developments on domestic policy, we downgraded both sovereigns by two notches. This is due to our opinion that Italy and Spain are particularly prone to the risk of a sudden deterioration in market conditions.
• While we see a lack of fiscal prudence as having been a major contributing factor to high public debt levels in some countries, such as Greece, we believe that the key underlying issue for the eurozone as a whole is one of a growing divergence in competitiveness between the core and the so-called "periphery."
• We believe that the risk of a credit crunch remains real in a number of countries as economic conditions weaken and banks continue to consolidate their balance sheets in light of tighter capital requirements and poor market conditions in which to raise additional equity
• We estimate a 40% probability that a deeper and more prolonged recession could hit the eurozone, with a likely reduction of economic activity of 1.5% in 2012.
• We believe an even deeper and more prolonged slump cannot be entirely excluded. We expect this weak macroeconomic outlook if realized would complicate the implementation of budget plans, with slippages to be expected, which would likely further dampen confidence and potentially deepen the recession, as funding and credit is curtailed and the private sector increases precautionary savings.
• Reports indicate that many investors had hoped that a breakthrough at the December summit would have enticed the ECB to step up its direct government bond purchases in the secondary market through its Security Market Program (SMP). However, these hopes were quickly deflated as it became clearer that the ECB would prefer to provide banks with unlimited funding, partly with the expectation that those liquid funds in banks' balance sheets would find their way into primary sovereign bond auctions. This indirect way of supporting the sovereign bond market may yet be successful, but we believe that banks may remain cautious when being faced with primary sovereign offerings, as most financial institutions have aimed at shrinking their balance sheets by running down security portfolios in order to comply with higher capital requirements, which become effective in 2012.

Shockingly, S&P dares to challenge not only the status quo, but "powerful national interest groups" - easily the first time we have seen something like this out of a "status quo" organization, let alone a rating agency.

• Governments are also aiming to put greater focus on growth-enhancing structural measures. While these may contribute positively to a lasting solution of the current crisis, we believe they could also run counter to powerful national interest groups, whose resistance could potentially jeopardize the reform momentum and impede the recovery of market confidence.

Why it is all a Catch 22 and why the LTRO "carry trade" has failed:

• Recent Italian and other primary auctions suggest to us, however, that banks and other investors may still only be willing to lend longer term to governments facing market pressure if they are offered interest rates that, all other things being equal, will make fiscal consolidation harder to achieve.

Let's not forget the EFSF:

• We are currently assessing the credit implications of today's eurozone sovereign downgrades on those institutions and will publish our updated credit view in the coming days.

And probably the most important observation of the night:

• As we noted previously, we expect eurozone policymakers will accord ESM de-facto preferred creditor status in the event of a eurozone sovereign default. We believe that the prospect of subordination to a large creditor, which would have a key role in any future debt rescheduling, would make a lasting contribution to the rise in long-term government bond yields of lower-rated eurozone sovereigns and may reduce their future market access.

The S&P itself warns that the entire basis of the European bailout will create a split market in sovereign bonds, in which pari passu treatment will be a thing of the past, and in which buyers will have no clue what treatment awaits them in a worst case scenario. If anyone thought that ISDA's idiotic attempt to kill the CDS market caused a collapse in demand for sovereign paper, just wait until potential buyers comprehend they could be primed every step of the way and the market is effectively two tier.

S&P may have just killed the European sovereign market by saying out loud what only "fringe bloggers" dared suggest in the past.

From S&P

FRANKFURT (Standard & Poor's) Jan. 13, 2012--Standard & Poor's Ratings Services today completed its review of its ratings on 16 eurozone sovereigns, resulting in downgrades for nine eurozone sovereigns and affirmations of the ratings on seven others.

We have lowered the long-term ratings on Cyprus, Italy, Portugal, and Spain by two notches; lowered the long-term ratings on Austria, France, Malta, the Slovak Republic, and Slovenia, by one notch; and affirmed the long-term ratings on Belgium, Estonia, Finland, Germany, Ireland, Luxembourg, and the Netherlands. All ratings on the 16 sovereigns have been removed from CreditWatch where they were placed with negative implications on Dec. 5, 2011 (except for Cyprus, which was first placed on CreditWatch on Aug. 12, 2011).

The outlooks on our long-term ratings on all but two of the 16 eurozone sovereigns are negative; the outlooks on the long-term ratings on Germany and Slovakia are stable. See "Standard & Poor's Takes Various Rating Actions On 16 Eurozone Sovereign Governments," published today for full details.

This report addresses questions that we anticipate market participants might ask in connection with our rating actions today.

WHAT HAS PROMPTED THE DOWNGRADES?

Today's rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone. In our view, these stresses include: (1) tightening credit conditions, (2) an increase in risk premiums for a widening group of eurozone issuers, (3) a simultaneous attempt to delever by governments and households, (4) weakening economic growth prospects, and (5) an open and prolonged dispute among European policymakers over the proper approach to address challenges.

The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.

We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the EMU's core and the so-called "periphery". As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.

Accordingly, in line with our published sovereign criteria, we have adjusted downward our political scores (one of the five key factors in our criteria) for those eurozone sovereigns we had previously scored in our two highest categories. This reflects our view that the effectiveness, stability, and predictability of European policymaking and political institutions have not been as strong as we believe are called for by the severity of a broadening and deepening financial crisis in the eurozone.

In addition to our assessment of the policy response to the crisis, downgrades in some countries have also been triggered by external risks. In our view, it is increasingly likely that refinancing costs for certain countries may remain elevated, that credit availability and economic growth may further decelerate, and that pressure on financing conditions may persist. Accordingly, for those sovereigns we consider most at risk of an economic downturn and deteriorating funding conditions, for example due to their large cross-border financing needs, we have adjusted our external score downward.

WHY WERE SOME EUROZONE SOVEREIGNS DOWNGRADED BY TWO NOTCHES AND OTHERS BY ONE NOTCH?

We believe that not all sovereigns are equally vulnerable to the possible extension and intensification of the financial crisis. Those we consider most at risk of an economic downturn and deteriorating funding conditions, for example due to the large cross-border financing needs of its governments or financial sectors, have been downgraded by two notches, as we lowered the political score and/or the external score reflecting our view of the risk of a marked deterioration in the country's external financing.

On the other hand, we affirmed the ratings of sovereigns which we believe are likely to be more resilient at their current rating level in light of their relatively strong external positions and less leveraged public and private sectors. These credit strengths remain robust enough, in our opinion, to neutralize the potential ratings impact from the lowering of our political score.

In this context, we would note that the ratings on the eurozone sovereigns remain at comparatively high levels, with only three below investment grade (Portugal, Cyprus, and Greece). Historically, investment-grade rated sovereigns have experienced very low default rates. From 1975 to 2010, the 15-year cumulative default rate for sovereigns rated in investment grades was 1.02%, and 0.00% for sovereigns rated in the 'A' category or higher.

WHY DO THE RATINGS ON MOST OF THESE SOVEREIGNS HAVE NEGATIVE OUTLOOKS?

For those sovereigns with negative outlooks, we believe that downside risks persist and that a more adverse economic and financial environment could erode their relative strengths within the next year or two to a degree that in our view could warrant a further downward revision of their long-term ratings. We believe that the main downside risks that could affect eurozone sovereigns to various degrees are related to the possibility of further significant fiscal deterioration as a consequence of a more recessionary macroeconomic environment and/or vulnerabilities to further intensification and broadening of risk aversion among investors, jeopardizing funding access at sustainable rates. A more severe financial and economic downturn than we currently envisage (see "Sovereign Risk Indicators," published Dec. 28, 2011) could also lead to rising stress levels in the European banking system, potentially leading to additional fiscal costs for the sovereigns through various bank workout or recapitalization programs. Furthermore, we believe that there is a risk that reform fatigue could be mounting, especially in those countries that have experienced deep recessions and where growth prospects remain bleak, which could eventually lead to lower levels of predictability of policy orientation, potentially leading to another downward adjustment of the political score, which might lead to lower ratings.

We believe that important risks related to potential near-term deterioration of credit conditions remain for a number of sovereigns. This belief is based on what we see as the sovereigns' very substantial financing needs in early 2012, the risk of further downward revisions of economic growth expectations, and the challenge to maintain political support for unpopular and possibly more severe austerity measures, as fiscal targets are endangered by macroeconomic headwinds. Governments are also aiming to put greater focus on growth-enhancing structural measures. While these may contribute positively to a lasting solution of the current crisis, we believe they could also run counter to powerful national interest groups, whose resistance could potentially jeopardize the reform momentum and impede the recovery of market confidence. In our view, it also remains to be seen whether European banks will indeed use the ample term funding provided by the ECB (see below) to purchase newly issued sovereign bonds of governments under financial stress. We believe that as long as uncertainty about the bond buyers at primary auctions remains, the risk of a deepening of the crisis remains a real one. These risks could be exacerbated should renewed policy disagreements among European policymakers emerge or the Greek debt restructuring lead to an outcome that further discourages financial investors to add to their positions in peripheral sovereign securities.

For two sovereigns, Germany and Slovakia, we concluded that downside scenarios that could lead to a lowering of the relevant credit scores and the sovereign ratings carry a likelihood of less than one-in-three during 2012 or 2013. Accordingly we have assigned a stable outlook.

HOW DO WE INTERPRET THE CONCLUSIONS OF THE DECEMBER EUROPEAN SUMMIT?

We have previously stated our belief that an effective strategy that would buoy confidence and lower the currently elevated borrowing costs for European sovereigns could include, for example, a greater pooling of fiscal resources and obligations as well as enhanced mutual budgetary oversight. We have also stated that we believe that a reform process based on a pillar of fiscal austerity alone would risk becoming self-defeating, as domestic demand falls in line with consumer's rising concerns about job security and disposable incomes, eroding national tax revenues.

The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers, lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures. Instead, it focuses on what we consider to be a one-sided approach by emphasizing fiscal austerity without a strong and consistent program to raise the growth potential of the economies in the eurozone. While some member states have implemented measures on the national level to deregulate internal labor markets, and improve the flexibility of domestic services sectors, these reforms do not appear to us to be coordinated at the supra-national level; as evidence, we would note large and widening discrepancies in activity and unemployment levels among the 17 eurozone member states.

Regarding additional resources, the main enhancement we see has been to bring forward to mid-2012 the start date of the European Stability Mechanism (ESM), the successor vehicle to the European Financial Stability Fund (EFSF). This will marginally increase these official sources' lending capacity from currently €440bn to €500bn. As we noted previously, we expect eurozone policymakers will accord ESM de-facto preferred creditor status in the event of a eurozone sovereign default. We believe that the prospect of subordination to a large creditor, which would have a key role in any future debt rescheduling, would make a lasting contribution to the rise in long-term government bond yields of lower-rated eurozone sovereigns and may reduce their future market access.

We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the EMU's core and the so-called "periphery." In our opinion, the eurozone periphery has only been able to bear its underperformance on competitiveness (manifest in sizeable external deficits) because of funding by the banking systems of the more competitive northern eurozone economies. According to our assessment, the political agreement reached at the summit did not contain significant new initiatives to address the near-term funding challenges that have engulfed the eurozone.

The summit focused primarily on a long-term plan to reverse fiscal imbalances. It proposed to enshrine into national legislation requirements for structurally balanced budgets. Certain institutional enhancements have been introduced to strengthen the enforceability of the fiscal rules compared to the Stability and Growth Pact, such as reverse qualified majority voting required to overturn sanctions proposed by the European Commission in case of violations of the broadly balanced budget rules. Notwithstanding this progress, we believe that the enforcement of these measures is far from certain, even if all member states eventually passed respective legislation by parliaments (and by referendum, where this is required). Our assessment is based on several factors, including:

• The difficulty of forecasting reliably and precisely structural deficits, which we expect will likely be at the center of any decision on whether to impose sanctions;
• The ability of individual member states' elected governments to extricate themselves from the external control of the European Commission by withdrawing from the intergovernmental agreement, which will not be part of an EU-wide Treaty; and
• The possibility that the appropriateness of these fiscal rules may come under scrutiny when a recession may, in the eyes of policymakers, call for fiscal stimulus in order to stabilize demand, which could be precluded by the need to adhere to the requirement to balance budgets.

Details on the exact content and operational procedures of the rules are still to emerge and -- depending on the stringency of the rules -- the process of passing national legislation may run into opposition in some signatory states, which in turn could lower the confidence of investors and the credibility of the agreed policies.

More fundamentally, we believe that the proposed measures do not directly address the core underlying factors that have contributed to the market stress. It is our view that the currently experienced financial stress does not in the first instance result from fiscal mismanagement. This to us is supported by the examples of Spain and Ireland, which ran an average fiscal deficit of 0.4% of GDP and a surplus of 1.6% of GDP, respectively, during the period 1999-2007 (versus a deficit of 2.3% of GDP in the case of Germany), while reducing significantly their public debt ratio during that period. The policies and rules agreed at the summit would not have indicated that the boom-time developments in those countries contained the seeds of the current market turmoil.

While we see a lack of fiscal prudence as having been a major contributing factor to high public debt levels in some countries, such as Greece, we believe that the key underlying issue for the eurozone as a whole is one of a growing divergence in competitiveness between the core and the so-called "periphery." Exacerbated by the rapid expansion of European banks' balance sheets, this has led to large and growing external imbalances, evident in the size of financial sector claims of net capital-exporting banking systems on net importing countries. When the financial markets deteriorated and risk aversion increased, the financing needs of both the public and financial sectors in the "periphery" had to be covered to varying degrees by official funding, including European Central Bank (ECB) liquidity as well as intergovernmental, EFSF, and IMF loans.

HOW HAS THE EUROPEAN POLICY RESPONSE AFFECTED THE RATINGS?

We have generally adjusted downward our political scores (one of the five key factors in our published sovereign ratings criteria) for those eurozone sovereigns we had previously scored in our two highest categories. This score change has been a contributing factor to the rating actions on the relevant sovereigns cited above. Under the political score, we assess how a government's institutions and policymaking affect a sovereign's credit fundamentals by delivering sustainable public finances, promoting balanced growth, and responding to economic or political shocks. Our political score also captures the potential effect of external organizations on policy settings.

It is our view that the limitations on monetary flexibility imposed by membership in the eurozone are not adequately counterbalanced by other eurozone economic policies to avoid the negative impact on creditworthiness that the eurozone members are in opinion view currently facing. Financial solidarity among member states appears to us to be insufficient to prevent prolonged funding uncertainties. Specifically, we believe that the current crisis management tools may not be adequate to restore lasting confidence in the creditworthiness of large eurozone members such as Italy and Spain. Nor do we think they are likely to instill sufficient confidence in these sovereigns' ability to address potential financial system stresses in their jurisdiction. In such a setting, the prospects of effectively intervening in the feedback loop between sovereign and financial sector risk are in our opinion weak.

HOW DO YOU EXPECT MACROECONOMIC DEVELOPMENTS WILL AFFECT THE REFORM AGENDA?

We believe that the elusiveness of an effective policy response is likely to add to caution among households and investors alike, weighing on the growth outlook for all eurozone members. Our base case still assumes that the eurozone will record moderate growth in 2012 and 2013, i.e. 0.2% and 1%, respectively -- down from 0.4% and 1.2% according to our early December forecast, with a relatively mild recession in the first half of 2012. Nevertheless, we estimate a 40% probability that a deeper and more prolonged recession could hit the eurozone, with a likely reduction of economic activity of 1.5% in 2012. Furthermore, we believe an even deeper and more prolonged slump cannot be entirely excluded. We expect this weak macroeconomic outlook if realized would complicate the implementation of budget plans, with slippages to be expected, which would likely further dampen confidence and potentially deepen the recession, as funding and credit is curtailed and the private sector increases precautionary savings.

WHAT IS YOUR VIEW OF THE LATEST DEVELOPMENTS IN GREECE AND WHAT IMPACT DO THEY HAVE YOUR ANALYSIS?

We did not change the rating on Greece, which had been downgraded to 'CC' in July 2011, indicating our view of the risk of imminent default. Negotiations with bondholders have taken longer than originally anticipated and we believe may now run close to a large redemption of €14.5 billion on March 20, 2012, raising the specter of a disorderly default. Such an event would in our view further complicate the restoration of affordable market access for other sovereigns experiencing market stress. We understand that the main unresolved issues are related to the treatment of holdouts, the participation of official creditors, and the coupon of the new bonds that will be offered (which partly determine the effective recovery, which we continue to expect to lie between 30% and 50%). We do not believe that private-sector involvement will necessarily be a one-off event in the case of the Greek restructuring and would not be sought in possible future bail-out packages in a future case of sovereign insolvency or prolonged loss of market access. All the more so as official lenders are less likely to bear any future losses as their lending will be channeled through the ESM, a privileged creditor that is expected to be senior to bondholders in any future restructuring.

HOW DOES STANDARD & POOR'S VIEW THE ECB's RESPONSE TO DATE?

In our view, the actions of the ECB have been instrumental in averting a collapse of market confidence. We see that the ECB has eased its eligibility criteria, allowing an ever-expanding pool of assets to be used as collateral for its funding operations, and has lowered the fixed rate on its main refinancing operation to 1%, an all-time low. Most importantly in our view, it has engaged in unprecedented repurchase operations for financial institutions. In December 2011, it lent financial institutions almost €500 billion over three years and announced further unlimited long-term funding auctions for early 2012. This has greatly relieved the funding pressure for banks, which will have to redeem over €200 billion of bonded debt (excluding in some jurisdictions sizeable private placements) in the first quarter alone. By lowering the ECB deposit rate to 0.25%, we believe that the central bank has implicitly tried to encourage financial institutions to engage in a carry trade of borrowing up to three-year funds cheaply from the central bank and purchasing high-yielding government bonds. Recent Italian and other primary auctions suggest to us, however, that banks and other investors may still only be willing to lend longer term to governments facing market pressure if they are offered interest rates that, all other things being equal, will make fiscal consolidation harder to achieve.

Reports indicate that many investors had hoped that a breakthrough at the December summit would have enticed the ECB to step up its direct government bond purchases in the secondary market through its Security Market Program (SMP). However, these hopes were quickly deflated as it became clearer that the ECB would prefer to provide banks with unlimited funding, partly with the expectation that those liquid funds in banks' balance sheets would find their way into primary sovereign bond auctions. This indirect way of supporting the sovereign bond market may yet be successful, but we believe that banks may remain cautious when being faced with primary sovereign offerings, as most financial institutions have aimed at shrinking their balance sheets by running down security portfolios in order to comply with higher capital requirements, which become effective in 2012. We believe that the ECB has not entirely closed the door to expanding its involvement in the sovereign bond market but remains reluctant to do so except in more dramatic circumstances. In our view, this reluctance is likely prompted by concerns about moral hazard, the ECB's own credibility (particularly should losses mount), and potential inflation pressures in the longer term. We think it may also be the case that the ECB (as well as some eurozone governments) is concerned that governments' reform efforts would falter prematurely if market pressure subsides.

We believe that the risk of a credit crunch remains real in a number of countries as economic conditions weaken and banks continue to consolidate their balance sheets in light of tighter capital requirements and poor market conditions in which to raise additional equity. However, the monetary policy actions described above may mitigate the risk of a more extreme tightening of credit conditions, which, if it were to come to pass, could put further pressure on economic activity and employment.

In summary, while the monetary policy reaction has not been as accommodating as many investors may have anticipated or hoped for, we believe that it has nevertheless provided significant breathing space during which progress on policy reform can be made. Furthermore, the ECB may yet engage in additional supporting steps should the sovereign and bank funding crises intensify further. Therefore, we have not changed our monetary score on eurozone sovereigns.

HOW DOES STANDARD & POOR'S ASSESS THE REFORM EFFORTS OF THE NEW GOVERNMENTS IN ITALY AND SPAIN?

In our view, the governments of Mario Monti and Mariano Rajoy have stepped up initiatives to modernize their economies and secure the sustainability of public finances over the long term. We consider that the domestic political management of the crisis has improved markedly in Italy. Therefore, we have not changed our political risk score for Italy because we are of the opinion that the weakening policy environment at the European level is to a sufficient degree offset by Italy's stronger domestic capacity to formulate and implement crisis-mitigating economic policies.

Despite these encouraging developments on domestic policy, we downgraded both sovereigns by two notches. This is due to our opinion that Italy and Spain are particularly prone to the risk of a sudden deterioration in market conditions. Thus, we believe that, as far as sovereign creditworthiness is concerned, the deepening of the crisis and the risks of further market dislocation that could accompany an inconclusive European crisis management strategy more than offset our view of the enhanced national policy orientation.

WHY WAS IRELAND THE ONLY SOVEREIGN AMONG THE SO-CALLED "PERIPHERY" NOT
DOWNGRADED?

We have not adjusted our political score backing the rating on Ireland. This reflects our view that the Irish government's response to the significant deterioration in its public finances and the recent crisis in the Irish financial sector has been proactive and substantive. This offsets our view that the effectiveness, stability, and predictability of European policymaking as a whole remains insufficient in addressing the deepening financial crisis in the eurozone. Excluding government-funded banking sector recapitalization payments, the authorities have adjusted Ireland's budget by almost 13% of estimated 2012 GDP since 2008 and plan additional fiscal savings of close to 8% of GDP for 2012-2015. All other things being equal, we view the government's fiscal consolidation plan as sufficient to achieve a general government deficit of about 3% of GDP in 2015. In our view, there is currently a strong political consensus behind the fiscal consolidation program and policy implementation so far has been extremely strong.

In our view, Ireland has the most flexible and open economy among the "periphery" sovereigns. We believe that Ireland's economic adjustment process is further advanced than in the other sovereigns currently experiencing market pressures. This is illustrated by the 25% depreciation in the trade-weighted exchange rate since May 2008 and Irish exports growth contributed positively to the muted Irish economic recovery in 2011. However, in our view this also leaves the Irish economy and, ultimately, the Irish government's fiscal consolidation program susceptible to worsening external economic conditions, which is reflected in our negative outlook on the rating.

WHAT ARE THE IMPLICATIONS FOR THE EFSF AND OTHER EUROPEAN MULTILATERAL LENDING INSTITUTIONS?

Following our placement of the ratings on the eurozone sovereigns on CreditWatch in December, we also placed a number of supranational entities on CreditWatch with negative implications. These included, among others, the European Financial Stability Fund (EFSF), the European Investment Bank (EIB), and the European Union's own funding program. We are currently assessing the credit implications of today's eurozone sovereign downgrades on those institutions and will publish our updated credit view in the coming days.

Comments

[RiverRoad]

Suck up a Tobin Tax or swallow sky high rates, either way it's Shit City for Europe.

[mendolover]

"Markets can stay irrational longer than you can stay solvent."

[hooligan2009]

couple of thoughts ....

one on the solution to the debt solution = 8% increase in personal and corporate tax rates of 10% p.a. until the debt to GDP gets to 40%; given taxes account for around 30% of GDP in most countries, this 10% of 30% = 3% and given debt to gdp is 100% for most countries (200% Japan) this will take around 25 years.

second, the likelihood of investors purchasing Italian, French and Spanis debt alluded to by S&P, is linked to the risk free rate  german government bond yield ARE NEGATIVE up to two year. the risk free rate is that rate that can be earned with certainty and no risk of default. so, you are certain to lose money, risk free...thus endeth the world of economics. We can now match the choices available to us via our central banking system and replicate the outcomes, simply by taking a part of our money and destroying it, so that no-one can use it again.

To take things further, lets assume your risk free horizon (bond investors risk free choice) is ten years and you have to either own a risk free rate equiavlent to ten year Bund of 1.8% or other European debt. What running yield do you need on the other debt? The bund yield is manipulated to bail out banks and make the present value of debt outstanding a monster number (the value of debt outstanding with a 5 year duration and a 1.8% yield is 15% bigger than it is at 4.8% yield = 3% yield difference times five years duration, significant when the debt is 100% of GDP). In other words, if a "fair yield" for ten year government debt is equal to 2% (to compensate for return volatility) above 2.8% current inflation the ECB itself has added 15% to Germany's debt burden by not allowing fair value for existing debt). Remember that the duration of a ten year bond is 9 years, requiring a yield movement of just 0.22% (from 1.80% to 2.02%) to wipe out that yield for a single year.

If you think that ALL countries' bond yields might easily go up 0.2% in the next year, the compensation from taking advantage of carry against the riskiness of a widening of the credit spread above risk free is material. an extra 5% carry can be blown away by a 5% carry/9 yearsduration change in spread, or just 0.55% increase in spreads. the likelihood of a 0.55% increase in spreads for italy, spain and france (and the UK, Belgium and eastern european states, let alone portugal greece and ireland) is probably around a third, with 20% for a contraction of this size and c. 50% for a continuation. would you take the risk at current spreads or after a sell-off to this level? where do you say, i have thrown 5 consecutive heads in a toin coss, at the start, the probability of throwing 6 consecutive heads at the outset was remote, the chances of throwing 6 consecutive heads are now one in 2. 

Thinking out loud over!

[Sandmann]

given taxes account for around 30% of GDP in most countries

http://en.wikipedia.org/wiki/List_of_countries_by_tax_revenue_as_percent...

You are thinking of Greece and the US again......in most OECD countries taxes are 40%+ in GDP with Sweden and Denmark c. 48%, France 43%.

Corporate Tax Rates are much much lower than Personal Tax Rates. So you suggest the US imposes European levels of Tax on Gasoline and Aviation Fuel ? Maybe European levels of sales Tax in the US ? Do you prefer 15% or 25% ?

Raising Taxes does not impair economic activity though in your book !  Why not simply seize all the 401Ks and IRAs and Pension Funds as in Ireland or effectively the UK. The latest wheeze here is to abolish inflation linking in Private Sector Pension Funds (but isn't inflation very low ?) So why now ?

[hooligan2009]

Thanks for the correction and the link. You are right, accuracy is key, but principles remain intact...regardless of the precise current tax rate to GDP in whichever country, underlying the numbers is the truth...Europe has been living beyond its means for many decades (since socialism became the norm), the US has been following the path into socialism for one or two decades via debt accumulation rather than welfarism, yet has arrived at the same tipping point via spending money on wars and pork.

My book says that living beyond your means either involves eventually "stealing" from those you have borrowed from by not paying back, or, paying back.

Second order effects have already been gained on the way into this "debt trap" and will have to be absorbed on the way out. I agree that “austerity” has second round effects, but only because of people benefitting from the bad behaviour of the state living beyond its means.

Lastly, when is it ever a good time to stop taking a harmful drug? You needn’t stop at all and just live a shortened and lower quality of life, shrugs.

[evolutionx]

Euro Collapse Explained in 3 Minutes

Reflections on Europes financial woes. Special subject: the economies of the European Community. Which debt is owed by whom? Who will pay the bill?

3 minutes worth watching:

http://www.webcompact.net/index.php/news/4795-euro-collapse-explained-in-3-minutes-

[LouisDega]

I have an appointment with the Toyota dealer tomorrow. I am buying a new car. Should i tell the sales rep im cancelling because of uncertainty beyond my control?  

[AC_Doctor]

Buy a 1 or 1 1/2 year old car used and save 25%.  Put the saved 25% into silver and your fucking set buddy!

P.S.  Who the hell makes appointments to see the new car dealer WTF? 

[youngandhealthy]

Tyler....absolutely the most blatant update you have presented so far. Obvioulsy Daniel Ivandjiiski is possitioned short euro and euro banks. And since funding of the ZH blogg is coming from God knows who but I guess it comes from the TeaP or RP

Here is an excerpt from the ZH charter: 

"You should assume that at all times we are so totally just talking our book it would shock and awe you like the unexpected, early-morning arrival of a cluster of BGM-109C Tomahawks (were you a believer in the importance of "optics" that is)."

[Molon Labe]

Two-tiered is the new democracy.

[hooligan2009]

no taxes....no vote (federal workers dont pay taxes, they just take an adjustment for higher welfare checks).

[sudzee]

Biggest fear facing euroland is that Greece will exit and do very well once they are out from under the debt ball and chain leaving Germany and France in a financial straitjacket. If Greece leaves so will Portugal, Spain and Ireland. Iceland set a good example of how it's done. 

[youngandhealthy]

I can tell you Sudzee....I belong to the still AAA (3 rate angencies) countries in the world. 

They will not do very well...they would suffer hell. 

[Bazza McKenzie]

They are suffering hell now, and it will continue as long as Greece remains in the euro.

Exiting the euro will not immediately produce happy times but it will allow Greece to return to being a workable society.

Greece's interest on its sovereign debt currently exceeds the value of its exports, so it can never work its way out while having to repay interest and capital on those debts, much of which have now transferred to EU institutions and the ECB.

Default on 100% of its debt, including that now held by the ECB and EU is a corollary of exiting the euro.  Then suddenly Greece does not need more debt.  Its exports will more than pay for its current imports once that export revenue does not have to be all used for interest on debts.

Of course when Greece defaults on its debts to the ECB, the latter implodes, which is why the EU powers are desparate to keep Greece (and the rest of the PIIGS) in perpetual servitude.

[SamAdams1234]

http://youtu.be/xmczkkw6OZI

Kinda says it all.

[EndTheMedia]

US is next. What would the Federal Government's budget look like if it was a household budget? http://bit.ly/xhwij9

[hooligan2009]

listen to the sound of silence...testis sum agnitio!

[falak pema]

I find it difficult to assimilate the current private central bank FED led world construct, of which ECB is now a total surrogate, qualified as "Keynesianism". I dont see any historical evidence that Keynes, who preferred fiscal measures to monetary ones, and demand side stimulation to supply side (consumer demand), UNDER CERTAIN HISTORICAL CONDITIONS, would have done what Greenspan and Bernanke have done over twenty years; with Us Presidents, from RR to BO, allowing WS banks to benefit from deregulation and laxist monetary policy. Apart from Clinton's spell of fiscal virtuous play, thanks to cut backs in Defense spending, all other Presidents were fiscally profligate and as well as actively fiat currency print mad hand over fist.

How does that relate to Keynes and what he did and taught in his iconic treatise?

As for the Bretton Woods legacy, he was for Bancor and sterilising the role of a single national currency. It would have avoided "exorbitant privilege" right from start. And the debt mountain buildup strategy that started with RN in 1971.

[BeeTee]

This guy has a point.

Zerohedge used to be cutting edge.  It is still a good site, but in the currency war between the USD and EUR, there does seem to be an obvious bias.....

[the tower]

Of course there's a bias, 1st cause most here seem to come from the US and 2nd because the US will stop at nothing to make they sure out they come a winner... 

When the Swiss defend their currency - yes it's THEIR currency - it's blasphemy, but when the US dumps dollars on Europe to export US inflation it's A-OK. When the Chinese manipulate oil prices the MSM are all about human rights in China or even WW3, but when the US does it - with war after war after war - we call it the spread of democracy.

The rating agencies are US and UK centric, so, from an investment point of view, the US is #1, and since this is a trading blog we don't care about people, but about $$$. Just sayin.

[FunkyOldGeezer]

So the USA has every chance of paying back its debt and is therefore ranked accordingly by the ratings agencies? Give us a break. The USA should be rated junk by now, as every man and his dog must know there is not a hope in hell of the $15.2 Trillion ever being paid back, except for in heavily devalued Dollars. A default by any other name and yet it's only a small slither away from being a 100% guaranteed, bona fide sovereign, according to the (US) ratings agencies?

There's a very fishy smell around here. What a joke it all is!

[Heyoka Bianco]

Someone please to be expalining how any of this trash paper gets sold, especially to people we are consistently told are so "smart" (mostly by the people themselves, true enough), when even the most lumbering slope headed knucle-dragging humunculus knows that 100% of 0 is always 0? Even the Nigerian princes go fishing for suckers anonymously. These mickyfickies are doing it in full view of the entire nothingdamned world!

[Paul Bogdanich]

A long list of logic that presuposes that the markets are "free"  and mild for "efficient" which are both errors.  The downgrades will make a difference but the "difference" will be very short lived and over 60 days time completely inconsequential unless you are more than 30X levered, a.ka. a poor or greedy person. 

[Smiddywesson]

• According to our assessment, the political agreement reached at the summit did not contain significant new initiatives to address the near-term funding challenges that have engulfed the eurozone.
• Instead, it focuses on what we consider to be a one-sided approach by emphasizing fiscal austerity without a strong and consistent program to raise the growth potential of the economies in the eurozone.

LOL, we are WAY past the point where any iniative will fix this.  The IMF Chief Economist, Olivier Blanchard, said in his 2011 year end speech, that fiscal austerity just further inhibits growth, thereby scaring away the bond purchasers.  Damned if you do, damned if you don't.

They waited too long to stop spending.  It's over.

We who follow this stuff have them in a bind.  The only remaining thing they can do is devalue their fiat, all at once, all over the world, by pegging to the SDR and pegging the SDR to gold.  Those countries with a common currency like the Euro will suffer while they each issue a domestic currency like the drachma or the lira, but they should have thought of that before they trusted bankers.  Gold and silver for the win.  Dump your bonds now or take a 50% haircut overnight.

The deflationists tell us the USD will ramp to the sky now.  How'd that work out for people holding Swiss francs?  Countries can't allow their currency to ramp to  the sky.  They have to devalue together.

[Smiddywesson]

Reports indicate that many investors had hoped that a breakthrough at the December summit would have enticed the ECB to step up its direct government bond purchases in the secondary market through its Security Market Program (SMP). However, these hopes were quickly deflated as it became clearer that the ECB would prefer to provide banks with unlimited funding, partly with the expectation that those liquid funds in banks' balance sheets would find their way into primary sovereign bond auctions. 

Translation:  Rampant looting.  Nobody wants our soverign debt, so rather than buying it ourselves, we throw money at the banks and they refuse to buy it too.  Looting.

[covert]

no, they made no difference and you don't even come close to understanding the market.

http://expose2.wordpress.com