S&P’s Downgrade Analyses: Politically Motivated or Overcompensation?

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(eToro Blog) The fallout from Friday’s downgrade of nine Eurozone members continues during a trading day expected to be subdued with Wall Street’s closure for a federal holiday. But the affect on the equity markets in Europe is expected to be rather short-lived, as analysts point out that the markets had generally already priced in the downgrades, especially since S&P telegraphed its intent a month ago.

Nonetheless, there is a great deal of criticism for the mass downgrades, coming not only from the Eurozone’s directly-affected leadership but from those on the sidelines. Many analysts argue that the downgrades feel more and more subjective, and not a little politically motivated. But is that the case, or is it something else?

Consider the fiscal crisis of 2007-2008, and the roles that the credit ratings agencies then played, or perhaps didn’t play, would be more apropos. Many believe that the reverence which investors once held for the “Big Three” credit ratings agencies – Standard & Poor’s, Fitch and Moody’s – was diminished after they failed to be the reliable brokers of financial information that they were entrusted to be. Remember Lehman Brothers and AIG? They were “gifted” with investment grade ratings almost until the moment they filed for Chapter 11 bankruptcy protection.

It is quite interesting to learn that the representatives from S&P and Moody’s who testified before a U.S. Congressional Committee defended their analysts’ decisions in those cases. In essence, they said that the federal government’s rescue of Bear Stearns suggested to them that they would also provide support for Lehman and AIG if it proved necessary. How that plays a part in the analysis process was called into question, but remains unanswered.

It appears that the credit ratings agencies, all of which are U.S.-based, could now be over-compensating for previous malpractice, hitting the Eurozone hard – harder, perhaps than need be. The Eurozone’s various leaders have publicly accused the credit ratings agencies for giving the U.S. preferential treatment. The U.S. credit rating was eventually downgraded in August, but many analysts believed that that downgrade was long overdue, given the federal government’s growing public debt and what is deemed to be an unsustainable deficit. The president of the European Commission (E.C.), Jose Manuel Barroso, expressly said that he believes “there may be some bias in the markets when it comes to the evaluation of the specific issues of Europe.”

The president of Cyprus was unequivocally angered by Friday’s decision, decrying it as “completely unfair and loaded with ulterior motives.” According to him, the Cypriot economy was now showing signs that it was emerging from the debt crisis and had a handle on its financing needs, and then S&P comes along with a downgrade.

The most recent downgrades have drawn fresh criticisms from officials of the E.C. and the Eurogroup, who point out that the various Euro area governments, singularly and collectively, have been working vigorously and taken decisive action to push through reforms, strengthen banks’ balance sheets and “whatever it takes” in order to recover from the crisis and restore growth to the Eurozone. But S&P said that all of those measures “may be insufficient.” The German Vice Chancellor said, “It is apparent time and again that U.S. rating agencies pursue very much their own goals.”

Certainly, the earlier calls for the creation of an independent, Euro-based ratings agency are likely to resume, in earnest, as will earlier consideration of muzzling the Big Three. German Chancellor Angela Merkel has already said she supports such a move.

While some analysts point out that the downgrades are merely subjective opinions, and that investors should take them with “a grain of salt,” the real concern is how much worse those subjective opinions have made the situation. Pimco CEO Mohamed El-Erian said that the downgrades will have a multi-layered effect on the Eurozone which will result in a drop in future investment flows and more persistent albeit incremental market pressure. Simply put, that means an increase in borrowing costs for many of the downgraded members, making it that much harder to reduce their already elevated levels of debt, even as they simultaneously attempt to encourage economic growth.

 

Copyright 2012 eToro Blog



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Economy , Forex and Currencies

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