Eurozone: 9 December solved nothing

Submitted by Matthew on 18 January, 2012 - 11:49

Four developments in mid-January confirm that the 9 December Euro-summit came nowhere near staving off the twin credit crises plaguing European states and banks.

France and Austria have been downgraded from their top-rank credit rating, and so, in consequence, has the European Financial Stability Facility, the eurozone’s back-up “mini-IMF”.

Seven other eurozone states were downgraded at the same time. Italy, Spain, and Portugal, which had already been removed from the top ranks, were sent down two more notches.

Negotiations over the private-sector share in restructuring Greece’s debt are so badly stalled that Greece may default — become unable to make promised payments — by late March. The deal was supposed to be that a chunk of Greek bonds held by banks and financiers — currently trading way below face-value — would be swapped for new (and hopefully more reliable) bonds of lower face-value, thus reducing a chunk of Greece’s notional debt total by 50%.

But the details weren’t specified. The value of the replacement bonds depends on the “coupon” on them (the interest rate paid, as a percentage on the face-value) as much as on the face-value. The German government is now pressing for a relatively low coupon.

But the swap was supposed to be voluntary, and many bondholders are not volunteering.

Backroom work on the new treaty planned by the 9 December summit is proceeding feverishly, and eurozone leaders hope to have the treaty finalised by the end of January.

The European Central Bank has written an official letter politely declaring the draft worthless. The treaty, a souped-up version of the Maastricht accord of 1992, is supposed to tie eurozone states to more-or-less balanced budgets.

The ECB complains that the loopholes in the treaty (it has to have them: even Germany deliberately ran large budget deficits in 2009-10) are too big, and the plans for penalties against governments which run deficits are too weak.

Despite ECB dogma, stricter balanced-budget rules would not help. Spain and Ireland, for example, were not running large deficits before 2007, and have been brought down by the collapse of property bubbles rather than any sort of excess in government spending.

However, the rumoured hope of euro-leaders was that the treaty, even if in itself worthless or counterproductive, might induce the ECB to stem the crisis by buying or guaranteeing the debt of stricken countries. That looks even less likely now.

The credit-rating agencies which have downgraded the ratings of the EFSF, France, Austria, and others are as unreliable as economic guides as the ECB is. As Aditya Chakrabortty notes in the Guardian (17 January), they “failed to warn investors about the Asian financial crisis, Enron, the subprime crisis, Lehman Brothers – and Greece....

“Of the corporate debt rated by [one of the two dominant agencies] as AAA, 32% has been downgraded within just three years, 57% within seven years...”

As with the ECB, the credit-rating agencies are important not because they are astute but because they have power. Pension funds and insurance companies often have rules obliging them to keep their wealth, or a large chunk of it, in top-credit-rated assets.

The EFSF downgrade means that its lending power is reduced, and the downgrades of other states mean that financiers are likely to demand even higher interest payments in return for buying their bonds (IOUs).

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