S&P was right to warn the Eurozone

Allister Heath
THERE was anger at Standard and Poor’s, the rating agency, last night, focusing on the timing of its decision to put fifteen Eurozone countries on negative watch. I disagree: for once, the agency demonstrated bravery uncharacteristic of the times we live in. I’m no defender of the rating agencies, who performed appallingly during the bubble (and have a long history of being overly optimistic, including in the run up to the Asian crisis of 1997 and the Russian default of 1998). Their opinions – for that is all they are – are given far too much weight by the authorities, who have built their ratings into numerous regulations (and until very recently artificially restricted the number of agencies with official recognition).

The agencies are being asked to provide near-omniscient accuracy, of the sort the world’s best investors could only dream of, which is ridiculous. That said, much of the anti-S&P talk last night was merely a case of shooting the messenger. The only thing that is ridiculous is that so many Eurozone countries still retain their AAA statuses. They should have been stripped of them many months ago; given that the very concept of a risk-free asset is questionable, over-leveraged, mismanaged economies saddled with a currency they do not control clearly have a non-zero and rising risk of default. S&P’s announcement merely means that there is a 50 per cent chance that these countries will be downgraded. It is not even certain.

The highly spun deal announced by Nicolas Sarkozy and Angela Merkel yesterday, which briefly sent the markets into a paroxysm of over-exuberance, is weaker than it looks – and it is merely a proposal which still needs the approval of 17 nations to be enshrined into law. Far from being a proper mechanism to ensure fiscal probity across the Eurozone, it is only an admittedly stronger version of the deeply flawed stability and growth pact adopted as part of economic and monetary union. I’m not convinced.

Take the agreement that there will be automatic sanctions for Eurozone countries running deficit above 3 per cent of GDP: a qualified majority vote will still be able to block the sanctions – in other words, in a crisis of the kind we are in now, with most nations borrowing too much, the rules would be ignored. The European Court of Justice will only have the power to judge whether countries have suitably changed their constitutions to enshrine fiscal rules – but not whether they are actually meeting or breaching the rules. The permanent bailout fund will be brought forward to 2012, with decisions made by qualified majority. The problem, of course, is if the guarantors of the fund are downgraded from AAA- as is likely – it will find it much harder and more expensive to borrow, making it almost useless to contain a crisis.

Last but not least, the provision that there will no longer be private sector involvement clauses placed into bailout agreements rightly doesn’t mean all Eurozone debt is guaranteed by everybody else. Sarkozy conceded that “under no circumstances” can Eurobonds be considered a solution to the crisis. It simply means that future defaults will look like Greece’s: private sector creditors will do ad hoc, “voluntary” deals about haircuts. There will (regrettably) be no automatic write-off of debt whenever a country is bailed out. All in all, far less radical stuff than the headlines would suggest. The Eurozone remains in deep crisis.

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