The Moody’s Blues

08/07/2011 at 4:37 pm 3 comments

It is fair to say that markets were blindsided on Tuesday by the decision of Moody’s, the credit rating company, to junk Portugal. Confidence was creeping back in after Athens took its austerity medicine, securing the release of emergency funds – and then, wham! – a cent off the euro, a down day for equities and a two point jump in Portugal’s 10 year yield.

From Moody’s full statement it is clear that their main concern is the possibility that private sector creditors may be expected to incur losses in a hypothetical future renegotiation of Portugal’s bailout. This concern arises from the possibility that such private sector losses will form part of the renegotiation of the bailout of Greece.

Given that no details on Greece’s second bailout are available yet this looks a little precipitate. The Portuguese certainly think so, pointing out that the new government has only been in office for a month and is fully committed to implementing the austerity measures which form part of the country’s existing bailout package – a package which was itself only agreed in May. Furthermore, since the EU’s finance ministers are meeting on Monday and Tuesday of next week and discussions on the Greek bailout are ongoing, some have accused Moody’s of trying to influence the outcome.

Whatever the truth of this, the relevance of these rating company decisions is being challenged. The ECB have suspended the ratings requirements on Portuguese debt, meaning it can still be used as collateral for lending – exactly as they did for Greek paper last year. And although Moody’s and its peers may consider a rollover of private lending an event of default, ISDA – the International Swaps and Derivatives Association, key arbiters in the world of over-the-counter derivatives  – have said that they will not, and that such a rollover will not, therefore, trigger the settlement of credit default swaps.

If central banks and derivative market participants are beginning to ignore credit ratings, perhaps their days are numbered. That would certainly suit a number of European polticians who are taking Moody’s decision personally.

Before we get carried away, however, let’s remember that two percent leap in Portuguese bond yields. In the bond markets – whether for better, or as in the case of the subprime fiasco, for worse – credit ratings still count.

At some point in the future, those countries in receipt of emergency lending will need to go back to the bond markets to raise funds. When they do, it looks as though an adequately strong credit rating will still be required.

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