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Eurozone slammed by credit downgrades, collapse of Greek bond talks

(AP photo)

Greek Finance Minister Evangelos Venizelos talks to reporters after talks broke off with private bondholders on a plan to head off default.

Friday the 13th was not a good day for Europe.

In the midst of the European trading day, news began circulating that credit agency Standard and Poor's would downgrade many eurozone countries, including France, Italy and Spain. Given Europe's deepening financial problems, that move had been widely expected.

What traders and investors did not expect was for talks to break down between Greek officials and bondholders over how to avoid a looming default.

"While we're all focusing the S&P cuts, we could come back next week and find out that Greece is about to go right over the edge," said Art Cashin, head of trading for UBS at the New York Stock Exchange.

After talks with creditor banks broke down, Greeks officials warned of "catastrophic" results if a deal to swap bonds is not reached soon. After more than three months of negotiations, the parties remain badly divided over how much Greece will end up paying and how big a hit the banks will take. 

S&P, which took away the cherished AAA rating from U.S. government securities in August, took the same step with France Friday, cutting the rating one notch to AA+.

“This is not a catastrophe. It’s an excellent rating. But it’s not good news,” Finance Minister Francois Baroin told France 2 television, saying the government would not respond with further austerity measures.

S&P also downgraded eight other countries, including Austria and Slovakia by one notch and Italy, Spain and Portugal by two notches. Cyprus, Malta and Slovenia were also downgraded. S&P gave a negative outlook to 14 eurozone countries, meaning there is a one-in-three chance they could be downgrded again in 2012 or 2013. Only Germany and Slovakia were given "stable" outlooks.

"Today's rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone," S&P said in a statement. The agency cited, among other factors, tightening credit, weakening growth prospects, and "an open and prolonged dispute among European policymakers over the proper approach to address challenges."

S&P said a summit meeting last month "has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems."

Meanwhile the International Monetary Fund tried to calm markets after the collapse of the Greek debt talks, issuing a terse statement.

“We look forward to the resumption of talks between Greece and its creditors," said a spokesman. "It is important that this lead to a (private sector) agreement that, together with the efforts of the official sector, ensures debt sustainability.”

Time is running out for Athens. The Greek economy is sinking under the weight of deep budget cuts and rising borrowing costs. Investors are fleeing Greek bonds. After months of failed debt talks, Greece needs a deal with bankers to avoid default before some 14.5 billion euros ($18.4 billion) worth of debt comes due March 20. Even if bankers agree to a deal, it could take as long as six weeks to process the debt swap.  

When the idea first was floated in October, banks were told they should expect to lose half the value of their Greek debt holdings. But because Greece's finances have deteriorated since then, bankers reportedly are being asked to swallow losses of 70 percent.

The debt deal is also critical to efforts to provide Greece a financial lifeline. Officials from the European Union, International Monetary Fund and European Central Bank arrive in Athens Tuesday for talks on a new, 130-billion-euro rescue plan. They are reportedly insisting on a final debt agreement with bondholders as a condition of the bailout.

Some investors think a default is inevitable, with dire consequences for other debt-burdened European countries.

"Investors are going to say, 'Where else could this happen?'" said an investment manager at Shelter Harbor Capital. "'Why would I ever buy a French or Spanish or Italian bond if after you buy it you can change the rules on me?' That's why Greece is important even though it's a small country and not a lot of money in the grand scheme of things."

News of the imminent downgrades and the Greek talks knocked European stocks lower, although U.S. markets took the news in stride. The Dow Jones Industrial average was down only 54 points in late trading. The euro fell to a 16-month low.

"It's a reminder to investors that we are not seeing a comprehensive road map for the eurozone economies to get out of this fiscal mess. We're not seeing a move toward fiscal union," said Richard Batty, strategist at Standard Life Investments.

Investors and bankers aren't the only ones concerned about the risk that Europe's debt crisis goes off the rails. As the U.S. economy struggles to regain its footing, Europe appears to be sliding into recession.

That slowdown is already being felt on U.S. shores. Fresh trade data Friday showed U.S. exports slowed last month.

"The widening in the trade deficit in November to a 10-month high is perhaps the first real sign that the crisis in Europe and the more general global slowdown is starting to take its toll on the U.S.," said Paul Dales, senior U.S. economist at Capital Insight.

U.S. exports have been a driving force in the economy's improvement in 2011, but growth remains weak. After expanding by 1.3 percent in the second quarter, the pace picked up to 1.8 percent in the third quarter. Based on other economic data, that momentum is believed to have carried over into the fourth quarter. The government will release its first estimate of fourth-quarter GDP Jan. 27.

Part of that improvement was the result of increased consumer spending. With wages stalled, consumers have begun tapping their savings and credit cards to keep spending, a trend economists warn is not sustainable. That's why many of them have trimmed their growth forecasts.

Dales and his colleagues at Capital Insight estimate U.S. GDP hit a 2.2 percent annual growth rate in the fourth quarter and then began weakening. They expect the pace to slow to 1.5 percent for 2012 as a whole.

That would leave the U.S. economy little cushion from the potential financial shock of a disorderly debt default by one or more European countries.

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Full statement from S&P

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Marc Faber, editor and publisher of the Gloom, Boom & Doom Report, discusses the S&P downgrade of France and other European countries. He believes they should be downgraded even further.