Eurozone crisis for dummies
Posted: Friday 20 January 2012
Downgrading of Eurozone countries and the EU bailout fund
The credit ratings agency Standard & Poor's (S&P) has downgraded the EU bailout fund to AA+ from AAA. The European Financial Stability Facility's (EFSF) rating is based on the ratings of the countries that guarantee it. S&P's downgrade of the credit ratings of France and Austria on Friday 13 January meant there were not enough AAA rated guarantors for the fund to maintain its top rating. The downgrade could increase the cost of funds raised by the EFSF. S&P indicated that the EFSF could regain its AAA rating if it obtained additional AAA rated guarantees (although where these will come from is anyone’s guess).
The EFSF was established to allow countries with top credit ratings to borrow money at better rates, which they could then lend on to countries that were struggling. The S&P downgrade took away two of the fund’s six AAA rated guarantors. In effect that reduces the fund's AAA rated guarantees from 440bn euros ($557bn; £364bn) to approximately 260bn Euros. About 40bn Euros of that is already earmarked for the bailouts of the Irish Republic and Portugal, with another 100bn Euros likely to be needed for the second bailout of Greece. The downgrade in the EFSF rating does not, in itself, affect the fund’s lending capacity.
If the other credit ratings agencies, principally Moody’s and Fitch, were to follow suit and downgrade the EFSF rating, then it may prove very difficult for the fund to retain its effective capacity.
What does all of this mean?
All of the countries within the Eurozone are in trouble, though some more than others. The problem is that all EU member states rely heavily on each other for trade, and if some EU member states are not in a position to trade, then all will be affected.
The best outcome
This is the scenario that Germany and France are hoping for: that all Eurozone governments agree and stick to the strict new borrowing rules and, possibly, Italy and Spain get bailouts financed by the European Central Bank. More importantly, confidence returns, financial markets are willing to lend to Eurozone governments and banks again. In turn, the banks start lending more, consumers (especially German consumers) start spending again. Businesses start investing again. Europe suffers only a light recession, but then recovers, and slowly but painfully grows its way out of its debt problems. If only it were that easy!
To discuss this further please contact John Lunn in our Banking Team.
