Moody's Frowns On Iceland--Sovereign Debt Problems Still Menace

Moody’s and S&P have had a habit of downgrading sovereign paper in nations such as Greece, Spain, and Portugal long after it was clear to the capital markets that their prospects to pay their obligations were distressed. That does not mean that the EU sovereign debt crisis is over. The countries with the most severe problems still have to prove that austerity measures will be accepted by populations that are not meek. There is also a fear that new taxes will drive down GDP in nations that are clawing for more treasury receipts.

Moody’s put Iceland on negative credit watch, another rating action that would seem to be terribly late. However, the new attitude toward Iceland follows earlier downgrades and may represent a new round of concerns about whether financially weak nations to service their debt obligations. Moody’s said in its report that “The magnitude of the banking system losses that will result from the recent court ruling is not known at this time but it is clear that Iceland still faces significant risks to its economic and financial recovery.” The concern was triggered  by the recent Supreme Court ruling on the illegality of foreign-exchange-linked loans and the  government’s continuing difficulties in achieving a resolution to its “Icesave” dispute with the UK and Dutch governments.

The ratings concern raise two critical points. The first is that administrations and legislatures in nations in Europe may agree on the best path toward balanced budgets and lower national debt, but powerful courts may thwart those plans. The other is that banking losses, which could still be in the future of Europe’s financial institutions, may wreck economic recovery plans

Many financial analysts believe that the stress tests of EU-based banks were far too lenient. The largest financial institutions in Europe may be at risk of large losses in a sharp economic downturn or sovereign debt crisis. Iceland, a nation which had financial problems early in the cycle of concerns about sovereign paper, may be the canary in the coal mine again.

Douglas A. McIntyre