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Friday, December 20, 2013

EU hit with downgrade

While the spate of EU downgrades has slowed to a relative drip feed this year, it turns out there was at least one left in the locker – the EU, which Standard and Poor’s (S&P) this morning cut from AAA to AA+.

Many may ask, does the EU even have its own credit rating? And if so why? The answer is, of course it does, although why is a bit more ambiguous. It relates mostly to the rating of the EU budget and any bodies which borrow with EU guarantees. This includes the European Financial Stability Mechanism, the smaller €60bn bailout fund which is backed by the EU budget.

The move is largely symbolic but the reasoning behind it is interesting if a bit strange in places:
  • The first couple of points are obvious: the on-going financial and political instability in some states has led to the downgrade. This is par for the course in terms of ratings.
  • It’s also obvious that the EU rating would be reflective of the ratings of its largest members, some of which have seen downgrades over the past year.
  • However, it then gets a bit odd. S&P cites the EU budget negotiations, which were admittedly tricky and divisive, as an example of declining support for the EU. Firstly, the budget negotiations are always difficult but were eventually concluded and were pretty much wrapped up early this year. It’s also a bit strange given that the budget cannot run a deficit and countries are obliged to contribute – it’s not clear exactly how this relates to a credit rating issue.
  • The final point S&P raised was the issue of ‘Brexit’ and how the UK referendum could create uncertainty. Again this is some time away so the timing of the decision seems strange. Nevertheless, it does drive home an interesting point, in that S&P believe the EU would be less creditworthy without the UK. Something for members to ponder as the push for reform begins to get underway properly.
In any case, the main impact is likely to be symbolic. S&P have choice timing delivering the news on the same day when there was much backslapping and congratulations over reaching a deal on the banking union.


Anonymous said...

One wonders why an organisation that has not been able to audit its own accounts for c.22 years even has a credit rating at all.

How would credit rating agencies rate a company that was not able to audit their accounts for a similar period of time?

I call for fairness and the level application of credit rating rules for all companies, governments and supranational bodies.

Ignoring issues such as this is a major risk in any financial system and will likely be the cause of the next credit crisis.


Anonymous said...

"However, it then gets a bit odd. S&P cites the EU budget negotiations, which were admittedly tricky and divisive, as an example of declining support for the EU. Firstly, the budget negotiations are always difficult but were eventually concluded and were pretty much wrapped up early this year. It’s also a bit strange given that the budget cannot run a deficit and countries are obliged to contribute – it’s not clear exactly how this relates to a credit rating issue"

OE - This is exactly how the credit crisis started with the mis-selling of CDOs. It comes down the credit worthiness of the underlying parts - the individual EU sovereign nations, many of whom are struggling to meet their own financial commitments and pay their own debts without an open-ended EU budget contribution to worry about.

The point is that the EU does not fundamentally understand finance at all - even its own finances. The EU has mixed politics and finance and politics come first for them. What a dangerous cocktail

I agree with the downgrade completely.


David Hart said...

Two things about this blog strike me.

There is a boost for Cameron’s negotiating position, in that S & P cite the uncertainty about Britain’s position as being a significant factor in their decision making process.

Secondly, it is that even the big economic powerhouse of Germany has been disregarded in favour of the political instability.

Cameron has been dealt two good cards, not aces exactly, but certainly a knave and a king. Let’s hope that something bad doesn’t happen to spoil Cameron’s hand. Something for instance, like being caught spying on EU allies…


Cameron draws a two, a four and a five. Folds.

Rik said...

Next to SCs point.
The EU budget is done on a CF basis. Therefor in the real world it can, and already did, run deficits. I did not check the exact rules but this is how it goes everywhere else so the EU being different would be surprising.
Just one example.
EU civil servant pensions. Real world debt as these are unfunded , but because of the accounting rules a zero item (until they hit in).

Another issue is that at the end of the day the EU is a completely legal construct. Not a real entitity (with legal rights), like a country or a person.
If say next to the UK a few other contributors would pull the plug it likely is a complete goner (also as a creditor).
No EU left no one to get your money from left (including from guarantees). Hard to see that there are proper rules inplace to deal with this and things like unfunded pensions when there is an exit or breaking apart.
With a Brexit or a Grexit/Itxit Spaxit, Gerxit all realistic possibilities simply a real danger.
These are huge gaps especially with the nett contributors. And the PIGGS learn that 2% annual adjustments are basically the max that is without huge political problems manageable. Brexit is much larger than that.
Probably talking 5-10% depending on from which angle you look at it.

Another issue that legal rules state deficit running is not allowed doesnopt mean that it won't happen. The EU is hardly great in following rules or the normal legal explanation thereof when they find it inconvenient. Basically the EZ is now held together by 'breaking the law' (the not Judas Priest version).

Seen from that angle, like with France, AA+ Still seems way too high. If you would ask anybody with a brain if they would rather have Austria, Holland, or the US as a debtor or the EU (or France) the answer is clear. It is simply in no way even AA+. It is basically probably junk (or close to that) imho without the German backstop.
The PIIGS are bust without ECB backstop. The ECB backstop itself is bust without the German backstop.
France is in huge problems if the thing would fall apart (it is imho effectively also hanging on the German backstop).
Other creditworthy nations are simply way too small to carry the load.
Why mainly look at the EZ? You donot need to be a brain surgeon to see that if problems arise it will likley be there. And if underlying creditors/guarantors are rubbish it also likely will be there.
And looking outside the EZ the UK is by far the biggy (even more than Germany is in the EZ). Rest is small Skandinavians and Eastern European stuff that has basically low ratings and did already an all in on the EU. If something goes wrong with the EU they are in serious deep manure and so will be their budgets and ratings.

Rik said...

The problem as I see it is that the set up of the EU looks simply more and more unstable. Political/electoral platforms in the nett payers are eroding rapidly. And political alternatives are rising rapidly as well.
Combined with the fact that the EU leadership on several important issues simply seem to miss that (at least completely ignore it). Immigration probably the most clear example at this point.
Yes the rules are that way.
But the rules are in no way carried by proper platforms especially in the nett contributors.
So basically the rules are crap, not fit for purpose.
Nothing is done realistically however from the EU side to adress that.
Simply meaning if there will be a huge immigration stream up North West and it would for a big part consist of the wrong people. 2 Likelies. You will have a increased platform problem.
And with parties like Wilders, AfD, UKIP now on the map or close you have a existential issue that is not far from being an existensial problem.
The UK is just on of the things. Eurosceptics are now close to 50% of the seats in Holland. Italy with Mr Bunga pushed in the Eurosceptic camp (and the 'desertors' less popular than Monti, with Grillo and idiotic electionrules there could easily be a 50% majority there as well. And the current government, even more than every other Italian one, simply doesnot look stable.

This is one of the issues the UK should stress to make its nego position stronger. And it is a longer term issue. That markets are now ok with it in a Prozac peak simply doesnot mean we will not see a down turn before the UK referendum. The latter looks simply more or less certain. Extrapolate the trend and in 2017 you would have stockmarkets at twice the historical highs and in a rubbish economy. Will not happen.
Huge risk of market problems as well as political contagion to other countries (with subsequently market problems).
On the latter everytime Cameron makes the continental press on an EU issue, Wilders is twitting or whatever it is called and the AfD professor is interviewed by a major newspaper.

Freedom Lover said...

As far as I am concerned, Standard and Poor’s (S&P) are free to rate the EU however they like. But if Freedom Lover was a rating agency, it would have downgraded the EU to worse than JUNK years ago!

Rik said...

@David Hart

Being caught with your pants down re spying on allies is a bad one of course.
The uncertainty plays anyway and so does the political and financial risk attached with it, whether or not there is a spying issue.
Look at the freetrade negotiations with the US (a much larger culprit) and there are basically no delays worth mentioning. If the stakes are high enough it will be seen as a completely seperate issue. And an UK exit is probably of the same magnitude as the US-EU deal. And as an exit would play over time (several years, by the nature of things) risk is very difficult to estimate. Look back and it probably would have killed the Euro in the early Greek bust stages. Look a few months back and it likely would have been no problem with all markets on prozac. Impossible to judge unless the EZ crisis would be over but it won't be also not in 2017 (not even close). Huge potential that it will start to play somewhere, when nobody knows.
But it is a very realistic risk and when it happens at the wrong time it is likely game over for the Euro. Imho they simply cannot run the risk.

Of course Cameron would be better off shutting up himself and donot bring the thing up. Arresting boyfriends and MI-number chiefs defending stuff in public and so on. The stuff will get in the open swallow the turd asap the shorter you have the foul taste in your mouth and certainly donot give it extra media coverage.

Basically let Obozo take as much flak as possible. Should be possible imho, but not all of it. Would be to o good to be true. The US is be biggy (by far)and get media coverage. And people like to shoot at a fallen hero more than on anybody else. In that respect Dave is lucky the Obozo is an incompetent twit and has just been found out. Natural taget for flak. After 5 years which says a lot about the quality of the media and the inyelligence of the average voter btw.

Another point is that it is realistically possible to have the spying issue from the table before the negotiations actually start. Of course Dave should work on that and not continue with spying on allies as people will be watching and if he get caught a second time it really will get risky.

So basically I donot see real problems and the potential ones look easily avoidable. Of course however thing donot happen by themselves.

Anyway the spying thing had completely gotten out of control. They know what my old mother has had for lunch but cannot come up with any proper evidence of say the Syria chemical attacks. Or show in a recent Americamn courtcase one case in which this all would have been helpful.
And a lot of people might not like him, but Barrosso hardly looks like a terrorist. It clearly are the EU lunches and it is not a bombbelt.

Anyway there was so much happening there and so many people had access to the info that a leak at some time was more or less guaranteed. And the scandal that would come from that was always very likely outweighting the positives. Not even to mention the costs and the invasion of privacy issue.
In that respect for this issue (the reneg) probably good that it happens now. 2 Months before an actual reneg with the wrong info (what probably would have happened) would be much worse.

Anonymous said...

Spying on your allies is not wrong, but getting caught is, this has been the basis for centuries, nothing to see move along. The eussr should be rated as junk at best it can't manage to get its accounts signed off because so much money goes missing, and yet no one is fired for incompetence.

Unknown said...

High ratings influence negatively on countries’ economy. Banking sphere downgrade causes many financial and social problems. So people stop trusting banks, take away deposits, and stop returning loans… But the question how to get cash quickly stays. And it is on the top of attention.