It’s no go my honey love, it’s no go my poppet;
Work your hands from day to day, the winds will blow the profit.
The glass is falling hour by hour, the glass will fall for ever,
But if you break the bloody glass you won’t hold up the weather.
— Louis MacNeice, from “Bagpipe Music”
The patient is in intensive care. He has a high fever. Emergency palliative measures have thus far been ineffective. His temperature continues to rise.
Solution: The attending physician orders the nursing staff to stop using thermometers.
A severe drought has been underway for many months. The level of the local reservoir is alarmingly low. A water shortage affecting businesses and residences is inevitable.
Solution: The town council orders the removal of the depth gauge from the reservoir.
The above fantasies are parables for the European Union’s strategy for dealing with the ongoing recession and sovereign debt crisis. As I reported last year, when the bond ratings agencies displease Brussels with their assessments of the riskiness of European debt, the EU’s preferred coping mechanism may be summed up as: “Break the bloody glass!”
The suppression of Moody’s, S&P, and Fitch has now been enshrined in official EU regulations. The current meltdown in Italy — with the yield on Italian bonds rising past 7.5% — has added urgency to Brussels’ demand that the Italian government implement the new rules.
According to ANSAmed:
Italy to Apply Measures Soon — Rating-Agency Gag
(ANSAmed) — Brussels, November 11 — “It is necessary that the Italian Parliament approve and give immediate enactment to the crucial measures”. These words from the President of the EU Council, Herman Van Rompuy, came during a speech given in Florence today. In the meantime, a new EU regulation affecting rating agencies places a ban on the issuing of ratings for countries facing financial crises, especially those that “are negotiating an international financial assistance programme” with the objective of “stabilising their economy”.
The new measures would empower ESMA, the European market watchdog, to ban the publication of “sovereign ratings in existing situations of risk for the orderly functioning of the financial markets or for the financial stability of the whole or part of the EU’s financial system”. In plain words, those affecting countries in crisis which “could cause negative knock-on effects” for other countries. The power to limit the issuing of ratings may only be exercised in “exceptional circumstances,” that are to be spelled out by a delegated commission.
The new regulation also contains sanctions: whenever a rating agency “is accountable for infringing, whether intentionally or though gross negligence” the EU regulation, thereby “causing damage to investors,” it will be subject to civil sanctions.
In even plainer words: for purely political reasons, the European Union is muzzling the bond rating agencies and suppressing their reports.
The ratings agencies are de-facto captives of the political establishment — their putative independence vanished more than a decade ago, after the internet began providing investors with alternative means of gathering the same crucial information. The agencies are already reluctant to issue evaluations that displease the institutions and governments that pay for their services, so why would they rock the boat? Why should a government crackdown on them be necessary? What’s going on here?
The current “exceptional circumstances” in Italy revolve around the “spread”, the difference between the yield on Italian bonds and that of their German counterparts. Last week the spread on Italy’s 10-year bonds reached 488 basis points, the highest it had been in decades, and then kept rising. It peaked at 574 basis points before dropping a little after the EU successfully pressured Prime Minister Berlusconi to resign in favor of a hand-picked Brussels apparatchik.
Contrary to the EU’s expectations, the ouster of Mr. Berlusconi did not settle the markets. This is no surprise to a sane and sober outside observer, since the current debt crisis is obviously systemic. It is not dependent on particular personalities or political parties, and the market for European debt cannot be fooled by cosmetic changes and political sleights of hand.
The cost of Italian borrowing remains high because investors quite rationally doubt the ability of the Italian government to service its debt over the long term. They are capable of making this assessment with or without information from the ratings agencies. When Moody’s or S&P reluctantly downgrades a country’s sovereign debt, it is only ratifying what the markets already know. Not doing so would make it a laughingstock, and reduce its evaluations to complete irrelevance.
The EU is like a shaman brandishing a fetish to ward off a fatal disease. Muzzling the rating agencies is a futile gesture, a sign of cluelessness and desperation. It may have the unintended consequence of driving bond prices even higher — in the absence of the additional information provided by ratings agencies, investors may assume that the situation is even worse than it seems, and decide to further divest themselves of European sovereign debt.
A fiscal cyclone is threatening the eurozone. Ominous storm clouds are gathering on the horizon.
Solution: Break the bloody glass, hunker down in the root cellar, close your eyes, and pretend it’s sunny.
Hat tip: Insubria.