Moody's May Downgrade Spain, The European Picture Darkens

Moody’s may take away Spain’s Aa1 sovereign debt rating.

The agency gave its reasons:

(1) Spain’s vulnerability to funding stress given its high refinancing needs in 2011. This vulnerability has recently been amplified by fragile market confidence.

(2) A potential further increase in the public debt ratio should the cost of bank recapitalisation prove to be higher than expected so far, whether to meet higher-than-expected asset impairments or simply to retain the confidence of the wholesale markets.

(3) Increased concerns over the ability of the Spanish government to achieve the required sustainable and structural improvement in general government finances given the limits of central government control over the regional governments’ finances.

The news comes at an inconvenient time for investors. EU governments  are also trying to convince the world they are economically viable.  There are still riots in the streets of Italy as Premier Silvio Berlusconi tries to hang on to the small majority in Parliament which has kept him in power. Greek unions have just shut down most public transportation to protest 10% pay cuts. The unions have been quiet recently. That did not last long.

The only recent problems in Europe are not just in the streets and halls of parliaments. Germany has said it will not support wider bailouts for its troubled peers. The European Central Bank has strongly suggested that the EU add to its bailout facility. So far, the suggestion has not been greeted with a rush of new financing.

The Spain ratings mess shows how quickly the feelings about Europe’s future swings from despair to optimism. It was only a week ago that Ireland approved an austerity budget to get its deficit under control. Plans were also put together for its faltering banks. Portugal narrowly escaped contagion which would have moved it to the bailout bread line. The early part of December looked good for Europe’s financial future, or so it seems.

The last part of December may bring more caution about the future of the euro and the need to increase the bailout fund put together by the IMF and EU in the spring. The trouble in Europe will not get settled this year or probably in 2011. As some problems are resolved, others arise very quickly.

Douglas A. McIntyre