Down in the ratings

Credit ratings agency Standard & Poor's fired a warning shot across the eurozone's bows on Monday, by threatening to downgrade the entire bloc, including Europe's economic engine Germany, if no significant moves were made to shore up the ongoing debt crisis.

The move threatens to undermine a plan to rewrite the European Union treaty to set uniform tough budget standards across the eurozone. That idea - drawn up by French President Nicolas Sarkozy and German Chancellor Angela Merkel - had briefly given the markets some confidence, but S&P's announcement had a negative impact on share values throughout Tuesday.

The announcement is effectively being seen as an ultimatum for the eurozone summit in Brussels on Thursday and Friday, with the Wall-Street-based firm warning that a bad summit would force them to downgrade the ratings of 15 eurozone economies.

Range of reactions

The reaction from the European Union was vehement. The head of the eurozone finance ministers, Jean-Claude Juncker, hit out at the S&P warning on Tuesday, saying it was "completely over the top."

"It is very surprising to me that this falls out of the sky on the eve of the European summit. It can't be a coincidence," Juncker told Deutschlandfunk radio. "We should not give the ratings agencies more credit than they deserve."

Daniel Bendel, financial market economist at the Cologne Institute for Economic Research, was less taken aback. "I think it wasn't very surprising that the agencies announced this, and we shouldn't be surprised by the reaction of the markets," he told Deutsche Welle.

Even though all 30 blue-chip stocks on the DAX index were in the red as trading got underway, Bendel remained unruffled. "A downgrade from triple-A to double-A is not very worrying, as it's still a very high rating," he said. "There is a lot of panic-mongering going on, but I don't think this will change much. I don't think this was the only reason the markets are down."

Image-conscious agency

S&P based its warning on five factors, which it identified as dragging the eurozone down: tightening credit conditions, higher government debts, higher risk premiums on eurozone sovereigns, continuing disagreements among European politicians, and the rising risk of economic recession.

But the ratings agencies also have their weaknesses according to European politicians. Their reputations were damaged by their passivity during the financial and economic crisis that erupted a few years ago.

Governor of the Bank of France Christian Noyer was particularly scathing. "The agencies were one of the motors of the crisis in 2008," he told reporters in Paris on Tuesday. "Are they becoming a motor in the current crisis? That's a real question we all need to think about."

Noyer also accused the agencies of having their own agenda. "When you look at the way S&P formulated its argument, you can see that they have changed their methods," he said. "The methodology has become much more political and less linked to economic fundamentals."

Bendel agrees. "During the subprime debt crisis, the agencies were criticized for not downgrading enough," he said. "I think they want to show that they're ready for this crisis, that they learned from the mistakes."

Stop kicking the can

Michael Hewson, analyst at London-based financial services provider CMC Markets, had little sympathy with such arguments.

"I think it's very hypocritical," he told Deutsche Welle. "These European politicians were the first to criticize the agencies for not downgrading during the subprime crisis."

"Basically they're telling Merkel, 'Are you going to stand behind Europe? If you are, then this is the cost.' " he added. "She and Sarkozy have been kicking the can down the road for too long, and the ratings agencies have said it has to stop."

Bendel also thinks it's a problem that ratings agencies seem to hold such a stranglehold on the markets. "There are only these three big names, so obviously that's always a problem, especially if investors concentrate on them too much."

But other analysts think this is precisely the reason why Europe should be taking the threat very seriously.

"I think the ratings agencies are still behind the curve," said Hewson. "If anything, they’re being too sensitive to criticism from politicians. I think they should be downgrading even more."

Shooting the messenger

"As citizens, we should be glad that the ratings agencies exist at the moment," Wolfgang Gerke, president of the Bavarian Finance Center (BFZ), told Deutsche Welle. "The politicians would love to gag them at the moment, but that wouldn't solve the problem. This warning means, 'You can't keep getting yourself in this much debt; otherwise, your interest rates will rise, and the financing of individual countries will become so expensive that you'll realize that's the wrong path.' "

But Germany, for one, refuses to be fazed by the dire prophecies coming from across the Atlantic. "What the ratings agencies do is the responsibility of the rating agencies, Merkel told reporters in Bonn on Tuesday. "We are meeting on Thursday, where we will make the decisions."

German Finance Minister Wolfgang Schäuble, while echoing Merkel's remarks, admitted the warning was "another confirmation that we must do everything we can ensure a good result" at the EU summit on Thursday and Friday.

"Every country," he said, "has to do its own homework."

Author: Ben Knight
Editor: John Blau