The S&P and the EU: Timing Is Everything

In keeping with a tradition firmly established in the 20th century, Europe suffered a late-night bombing raid on Friday evening. This time the attacker was Standard & Poor’s, everybody’s favorite rating agency, which announced well after the markets closed in New York it was downgrading the debt of no fewer than nine European countries. France was dropped one notch and therefore lost its prized AAA rating, and Italy and Spain both dropped two notches. Portugal’s sovereign debt, like Greece’s, has now been relegated to “junk” status.

This was not a sneak attack. In December, S&P had given broad warnings that steps such as these might be taken. Furthermore, late last week rumors were circulating in markets around the world that S&P was getting ready to lower the boom, so to speak.

As you will no doubt recall, S&P downgraded United States debt late last summer, making the US for the first time in history a less than AAA borrower. As a result of that step, S&P was the subject of heavy criticism, not to mention a federal investigation. On the other hand, the downgrading of US credit had relatively little effect in the marketplace; after all, the United States is still the world’s largest economy (unless you amalgamate all the economies of the EU, which fewer and fewer people do these days,) and is still seen as a bedrock of cool in a world which is getting ever warmer, financially and politically as well as climatically.

The always decorous French were particularly stung by so déclassé a thing as a credit downgrade. In France, a AAA rating was something of a matter of national pride; a financial Maginot line. Worse, always stylish French president Nicolas Sarkozy is facing a stiff electoral challenge early this spring from the Socialist party, which will certainly characterize the downgrade as a slip-and-fall on the Sarkozy runway prance. Despite the lateness of the hour, everyone in Paris was ready with predictable statements, downplaying the significance of the S&P assessment.

They’re probably right. Many observers believe that the downgrade was already “baked into” market action on both sides of the Atlantic, and although there will certainly be a reaction when the markets reopen it may well be mild.

The principal reason that I expect market reaction to be muted is because of the timing of several events, all of which occurred late last week. For example, S&P did not release its new report (which was blandly entitled “Standard & Poor’s Takes Various Rating Actions on 16 Eurozone Sovereign Governments”) until after the markets closed New York. This is standard operating procedure in order to give traders time to think it over and therefore react more sensibly. From that standpoint, last Friday was a particularly propitious time, given the fact that it preceded a three-day weekend in the US. And since it was late-night in Europe, everyone there could sleep on it a couple of days before getting to their screens on Monday morning. There’s nothing unusual about all of that.

However, on Thursday Spain conducted a debt auction, which was, in the view of many observers, a remarkable success. It sold about 10 billion euros’ worth of bonds, twice the expected amount, at prices yielding a full percentage point less than those of previous auctions.

So, on Thursday morning Spain’s cost of borrowing was substantially reduced in the face of suddenly strong demand for its sovereign debt, but by Friday evening S&P saw fit to downgrade it a full two notches. The luck of the Spanish?

I wonder what the result of that auction would have been had it been held on Saturday morning instead of Thursday morning…

Even more curiously, Italy conducted an auction of its sovereign debt on Friday morning, within a few hours of the S&P announcement, which also went quite well — all things considered. It sold about 4.8 billion euros’ worth of bonds and found at least decent demand, with rates dropping about 15% as compared to the results of its last sale.

All of this occurred at the tail end of a week that had seen the euro climbing in value against the dollar. Clearly, the EU had had a pretty good week until the S&P catcall. But most strangely, the announcement of the results of the Italian auction were delayed inexplicably, a fact that was generally overlooked in most of the reporting of the auction results. Perhaps the delay was merely the result of an overlong espresso and biscotti break, perhaps not– curiouser and curiouser.

The European debt crisis is now two years old, and a double dip recession seems very likely since no real progress has been made in resolving that crisis, as S&P very correctly pointed out in the report that accompanied its new ratings. A default by one or more members of the EU, or even just another recession, could have a quite nasty ripple effect throughout the world — particularly in the US which is a major trading partner of the EU countries, and whose banking system is intertwined with all of the central banks and financial institutions that would be severely damaged by such events. Many observers believe that the EU, at least in the form that in which it has existed for some time now, would not survive a real meltdown. Given the fact that pretty much all markets in all countries seem to be more and more vulnerable to psychological factors, I suppose it is in the best interests of all governments around the world to manage information so as to minimize mayhem and fear, irrespective of what actually happens in the coming months. After all, what really goes on in Area 51 makes no difference to our daily lives, unless and until there is an actual alien invasion, right?

So the balanced seesaw of news that has characterized all of the financial events in Europe lately will probably continue until the crisis blows up or blows over. It really is all about timing; one does not need too much imagination to speculate that the Italian and Spanish debt auctions went well BECAUSE THEY HAD TO GO WELL, given the fact that everyone knew that S&P downgrade was likely imminent. If those auctions had produced a disastrous result, there would have been an awful lot of unsettling bad news in a very short time.

Aside from the fact that I love espresso and biscotti, I really wish I could have been present at whatever conversation caused the delay in the announcement of the Italian auction results. Whatever else is true, right now, Europeans are trying to buy a stairway to heaven by buying time–and it makes me wonder…

Image: Funky Tee