The Agencies and the Olive Belt

Germany has, almost too late, reiterated that there will be a rescue for Greece, and that it will last for three years, totalling some €135 billion. But Mrs Merkel is still vague about the terms, and this will not please the markets.

However in the meantime there has been a downgrading of the debt of Portugal and Spain.

I have spoken of the ratings agencies before, but it is worthwhile recalling the power they have. The main ones, who effectively control the markets are Standard & Poor’s (S&P), Moody’s and Fitch. They rate each debt instrument as it comes out and their sovereign debt departments regularly re-rate countries’ debt; so if a bank is organising a loan, say, for Spain the agency will check that it is in the approved format (ie no surprises) and allot the rating for short term – up to two years – medium term 5-10 years etc. This is aimed as a guidance for the investors who hold the debt. Obviously the worse the rating the more a country has to pay; for debt already issued the price goes down, say from par to 95 pushing the yield up. Portuguese debt currently yields 3.3% more than German.

As said, one of the main problems is that the banks which pay for the ratings. If Fitch isn’t prepared to give the rating the bank wants, it can just use Standard & Poor’s or Moody’s.

One of the game changers in all this was Iceland, a default the agencies didn’t see coming. It may be that the olive belt countries in Europe are suffering for this now: the agencies don’t want to make the same mistake again and so are downgrading frantically. And it’s OK because nobody is organising loans for Greece right now (except Mrs Merkel) so there’s no money in keeping them high.

The ratings are slightly different with each agency but to take S&P, there are ten levels of investment grade debt. Britain is at the top (just) with AAA. Second is AA+. Spain has been downgraded to AA which is the third level. Greece has now achieved junk bond status at BB+ which is the eleventh level and means the bonds cannot be held by insurance companies, investment trusts etc.

Perhaps like the rest of the financial world, the agencies err on the side of risk taking, then err on the side of caution. But Portugal, Spain, Greece, Italy, Ireland, the Baltics and the former Soviet block are at their mercy right now