REVIEW & OUTLOOK
JANUARY 14, 2012
Downgrading Europe
S&P discovers the euro-zone's debt problem.
France joined the United States in the club of former triple-A credit risks yesterday, when Standard & Poor's stripped the country of its top rating. Spain, Italy and six other euro-zone countries were also handed downgrades at the same time.
Like the U.S. downgrade last summer, the rating changes themselves don't tell the world or the markets anything they didn't already know. S&P, as so often with ratings agencies, is following the market rather than moving it, and France's looming downgrade was perhaps the worst-kept secret in finance. The biggest impact may be political, especially for the re-election chances of French President Nicolas Sarkozy. Perhaps he can call President Obama for advice on how to blame his legislature.
These pages have long argued for reducing the importance of the credit-ratings agencies, especially where their ratings are given an explicit role in law and regulation. But S&P's sweeping downgrade does reflect the truth that Europe's actions in trying to save the euro haven't stemmed contagion. They've spread it. The EU has reacted to the debt crisis by having the stronger countries in the euro zone guarantee loans to the weaker ones. But these loans haven't solved the crisis, and thanks to the guarantees, they've left relatively strong countries exposed to the weakest.
As a practical matter, the downgrade reduces the ability of the euro-zone's bailout fund to issue triple-A rated debt. Given that the EU's other crisis-response strategies all remain very much on the drawing board, the inescapable conclusion is that the EU's room for maneuver has been reduced. The downgrade might do some good if it motivates Europe's leaders to rethink this strategy, but we wouldn't bet the MF Global portfolio on it.
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