In the wake of the approval of the European Union-International Monetary Fund rescue package for Ireland on Thursday, Moody’s on Friday slashed Ireland’s credit rating—not by an expected position or two but by five levels, from Aa2 to Baa1. It then warned that further downgrades might follow.
Coming in the midst of an EU summit meeting on the debt crisis, it was not reassuring news. The gathering of EU leaders was focused on restoring confidence despite the ongoing debt crisis, but leaders thus far have done little, apart from the approval of a change to the treaty demanded by Germany.
The European Central Bank (ECB) took its own action on Thursday, announcing that it would nearly double the amount of its subscribed capital. Jean-Claude Trichet, the ECB’s president, said that the bank’s governing council felt it appropriate to make “additional provisioning.”
Nonetheless, the spread on bonds for Greece, Ireland, Portugal and Spain all rose, as did the cost of insuring the debt. The inaction of the 27 leaders was a sore point for economists and analysts, and earlier mentions of possible downgrades for Greece, Spain and Belgium have added to the market turmoil.
Reuters reported that Carsten Brzeski, senior economist at ING Belgium, said, “European leaders failed to address the issue of debt sustainability and possible insolvency problems prior to 2013.” He added, “Debt restructuring, a common euro zone bond or an increase of the EFSF? None of these issues have been addressed. But they have to be.”
The euro seemed oblivious to the problems of the EU, rising against the dollar on news of optimistic German business morale. Because of a strong domestic sector, Germany’s businesses are at their most positive since 1981, according to a survey of German business sentiment.
While the EU meeting has thus far abstained from decisive measures, on Friday a draft statement reported by Reuters reflected that leaders have agreed to longer maturities for bond issues. They are also putting in place within the proposed permanent rescue facility a provision to require some bondholders to absorb losses in case of a default. All new bonds from 2013 and onwards that are issued in the euro zone, it said, must carry collective action clauses (CACs) that allow a specified majority of bondholders to overrule minority bondholders in the event of a restructuring negotiation.
The draft said, “This would enable the creditors to pass a qualified majority decision agreeing a legally binding change to the terms of payment (standstill, extension of maturity, interest rate cut and/or haircut) in the event the debtor is unable to pay.”