Friday, May 7, 2010

Credit Rating Agencies Warn of “Contagion”.. Market moving to double deep?

The credit rating agency, Moody’s has warned of potential fallout from the Greek debt crisis to foreign banks within the European Union; even if they are not in the Eurozone. This is a sort of a pot calling the kettle black situation in that when ratings agencies downgrade the credit worthiness of a sovereign state, the cost of borrowing for that country is increased due to the higher perceived risk of a default. This very act makes a default all the more likely, since servicing the national debt becomes more expensive. It is good news for speculators as it means that the yield on government bonds in the countries tainted with the “scourge of contagion” will rise (reflecting higher risk, of course).

Fitch’s was reportedly “considering a downgrade” of Portuguese government debt. Students of economic history will remember that the credit rating agencies gave their blessing to the securitisation of mortgage debt (including the notorious alt-A or sub-prime debt) in the 80s which sowed the seeds for the current global economic crisis. They were hugely wrong about that call. It is little surprise, then, that the European Commission is publicly musing about regulation of the credit ratings agencies. "We have seen developments in the markets that raise some doubts about behaviours of some of the players," said a Commission spokesman. In December of this year, the European Commission will be granted the powers necessary to impose controls over the ratings agencies activities within EU territory. It could be that these powers come into force sooner rather than later.

Despite credit agencies bestowing “junk status” on Greek government bonds, the European Central Bank (ECB) has made it clear that Greek bonds would be accepted as collateral for ECB loans although this required a change in its rules. EU states need to act decisively to steady the ship and restore confidence to the markets.

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