Europe declares war on rating agencies

 Politicians have denounced Moody's drastic downgrade of Portuguese debt as an act of financial vandalism. Photo: BLOOMBERG

Wolfgang Schauble, German finance minister, said there was no justification for the four-notch downgrade or for warnings that Portugal might need a second bail-out. "We must break the oligopoly of the rating agencies," he said.

Heiner Flassbeck, director of the UN Office for World Trade and Development, said the agencies should be "dissolved" before they can do any more damage, or at least banned from rating countries.

Moody's downgrade late on Tuesday set off immediate contagion to Ireland, with dangerous ripple effects across southern Europe. Yields on Irish two-year bonds surged above 15pc of the first time. Italian borrowing costs reached levels not seen since the aftermath of the Lehman crisis in late 2008. Yields on Spain's 10-year bonds jumped 12 basis points to 5.59pc.

The renewed jitters chilled the torrid summer rally on global bourses. The FTSE 100 slipped 21 points to 6,002, while Milan fell 2.4pc. A quarter-point rate rise in China added to the mood of caution, capping commodity gains.

David Owen, of Jefferies Fixed Income, said concerns are growing the crisis could spread to bigger economies as growth falters across Europe's southern arc. "The risk of cross-over into Spain and Italy is very serious. The fear is what will happen if Spanish 10-year yields rise above 5.7pc and stay there for a few weeks. Spain also has €2.5 trillion of private sector debt, and a rise in rates risks pushing the country into recession."

Portugal's new premier, Pedro Passos Coelho, said Moody's downgrade was a "punch in the stomach" at a time when the new government has done everything demanded by the EU/IMF inspectors.

The rating said it had little choice once EU leaders began to insist on "burden sharing" for private holders of Greek debt, raising the spectre of default. It is almost certain any Greek formula will be extended to Portugal.

The European Central Bank has cautioned EU leaders from taking a hard line on private creditors, warning it would destroy confidence among the very investors needed to fund Europe's deficits. The net effect would be destructive. This is exactly what has occurred.

The Institute of International Finance (IIF) representing 400 global banks has floated the idea of a bond "buy-back" on a voluntary basis that would help Greece lower its debt burden, but this has not been enough to satisfy German demands for more creditor pain.

The IFF said yesterday it was studying a "menu of options to help Greece", including variants of a complex French plan for debt rollovers. The original plan was widely deemed too harsh on Greece.

Jose Manuel Barroso, the European Commission president, questioned Moody's motives and said it had fanned the flames of "speculation" with an unwarranted downgrade. "It seems strange there is not a single rating agency coming from Europe. It shows there may be some bias in the markets when it comes to the evaluation of the specific issues of Europe," he said, seemingly unaware that Fitch Ratings is French-owned.

The Commission is drawing up laws to clamp down on the agencies. These will now be tougher. "Developments since the sovereign debt crisis show we need to take a further look at reinforcing our rules," said Mr Barroso.

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Spain downgrade sparks storm over rating agencies

The central bank said on Thursday that 12 cajas (savings banks) and other banks must raise €15.2bn between them by September, led by Bankia (€5.8bn), Novacaixagalicia (€2.6bn), and Catalunyacaixa (€1.7bn).

Moody's praised Spain for its market reforms and said "debt sustainability is not under threat." But it also warned of fresh "episodes of funding stress". The government, regional juntas, and banks must together must raise or roll over €300bn of debt this year.

Fitch Ratings also issued a report concluding that the bail-out costs might spiral, putting the figure at €97bn in an Irish-style "stress scenario" where property losses reach 58pc. The Irish parallel has infuriated Madrid since delinquency rates on Spanish homes are low. Loan-to-value ratios on mortgages average just 62pc.

Spanish officials said it was astonishing that Moody's should drop its bombshell hours before the central bank was due to publish its own far more detailed analysis. "Moody's don't explain how they come up with these numbers," said one source.

European anger over the power of "Anglo-Saxon" rating agencies has been welling for months but has now reached fever pitch. Greece's finance minister George Papaconstantinou wrote on Thursday to the EU authorities calling for restraining action after Moody's cut Greek debt three notches three-notch. "Such unjustified and imbalanced decisions could become self-fulfilling prophecies. Rating agencies must be regulated effectively at a European and world level," he said.

Brussels is drawing up tougher rules, perhaps making Moody's, Fitch, and S&P liable for the damage of "incorrect ratings". An EU source said it was scandalous that one agency had rated Greece by sending a single person to the country twice a year for a half a day. "When the IMF goes in, they send a whole team for a week. We want to know how much serious time and effort goes into these ratings."

Spanish officials feel aggrieved that they are being punished after taking the lead in eurozone bank reform, going beyond Basel III rules with earlier compliance and requirements for core Tier I capital of 10pc for some banks with a reliance on wholesale funding. Indeed, the ECB even warned in its monthly bulletin that Spain is perhaps too "ambitious", creating the risk of a credit squeeze .

For all the fury over Moody's, Spain undoubtedly faces an ordeal by fire as the ECB prepares to raise rate rises as soon April. One-year Euribor rates used to set the cost of most Spanish mortgages and corporate loans have surged to 1.95pc since the ECB shift, part of an instant tightening effect rippling through Spain's economy. This is potentially threatening. Private debt is near 240pc of GDP.

Julian Callow from Barclays Capital said Spanish house prices are falling steeply after a lull late last year, with the Fotocasa index falling at 5.2pc rate. "Spain has suffered a series of negative shocks, with energy costs going up and no magic package yet in sight from the EU. The ECB should not be rushing into monetary tightening at this moment, The more property prices fall, the more strain this puts on banks," he said.

EU officials are playing down hopes of an EU deal on Friday. A draft "Pact for the Euro" – an enhanced Stability Pact – has been watered down to meet the furious objections of several states and may not be enough to satisfy German demands for Teutonic rigour.

However, it still includes plans for a "debt-break" along German lines that is constitutionally "binding" on all states, as well as intrusive rules on pensions, collective-bargaining, labour costs, and wage indexation.

It empowers the European Commission to vet rules "before" they have been approved by national parliaments. This treads on sensitive toes. The power to tax, borrow, and spend is the essence of national sovereignty. While the document states that the "prerogatives of national parliaments" should be respected, it is far from clear how these can be reconciled.

EU diplomats say the implicit quid pro quo is that Club Med must accept this straight-jacket to secure German backing for a more muscular bail-out fund (EFSF). Yet it is unclear whether Chancellor Angela Merkel can offer meaningful concessions, given a broad-based revolt by Germany's Bundestag, Lander, and academia.

Mrs Merkel is likely to block plans to let the bail-out fund buy eurozone bonds, since this would usher in fiscal union by the back door. Nor does she seem willing to cut the penal rate of interest on the Irish and Greek rescue by enough to make any difference. Capital flight from the eurozone is likely to gather pace if none of these changes are agreed this month. This risks raising the stakes for Spain, and perhaps Italy.

The yield on Italian 10-year bonds pushed above 5pc on Thursday, a level that could start to endanger debt sustainability given the catatonic state of the economy and the sheer size of Italy's public debt at 120pc of GDP. Italy's industrial output fell 1.5pc in January, and has barely recovered from the Great Recession.

Bundesbank chief Axel Weber said that Germany's rebound should not be exaggerated. The growth speed on the economy is just 1pc over time. "Europe will become more and more insignificant in the global economy," he said.

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