Sunday, January 15, 2012

The Reasons Behind Standard and Poors Downgrade of Eurozone Sovereign Debt





A link to the rationale given can be found here...

http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245327305715

In short, they don't believe in the J-Curve effect created by structural reforms and austerity and are looking for a more comprehensive and integrated policy response to the pressures on the downgraded countries.

My cynical take is that S & P is really just watching what the market does with bond yields and now adjusting its view accordingly. The rating agencies came under heavy and sustained criticism after their role in rating MBS and CDO securities in the credit crunch and are now doing all they can to avoid similar criticism.

IMHO, they are being too sensitive. The Euro Zone have been making significant reforms and, in some cases, succeeded in reducing deficits. Noticeably, France has done better job than the UK in this regard, but hey, S & P are just looking at what the market tells them.

This really is all about sentiment and, if Italy's yields fall to sub 6% in the next month, they will start to look very silly indeed. For the record, I have no idea if they will or not!



Standard and Poors Downgrade Detail

That said, I found the following quote from the report very interesting...

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.
...all of which is fine but it does express how out of date Standard and Poors are in looking at these issues. Spain and Ireland both had huge housing booms, so yet again, this kind of commentary only highlights the misguided consensus on the optimal role of central banks.

In another post linked here I have previously pointed out that you can have the dangers of inflation without the inflation!  It is simply not enough just to target a headline inflation rate and hope that this approach is a universal panacea.

It's time for central bankers to target asset price bubbles or at least do what they can to stop creating them!