April 1, 2015
S&P Downgrades and Banks: Threats to Global Stability
Posted on Jan 19, 2012
By Nomi Prins
Standard & Poor’s likes moving on Friday nights after the markets are closed. It was on a Friday night that it downgraded U.S. debt to AA+ from AAA. And on Friday night, Jan. 13, it downgraded France and Austria from AAA to AA+ and seven other European countries too—Cyprus, Italy, Portugal and Spain by two notches, Malta, Slovakia and Slovenia by one. Portugal, Cyprus, Ireland and Greece remain at junk status. Germany’s AAA rating stayed the same.
The markets weren’t shocked by last week’s wave of pre-broadcast S&P sovereign debt downgrades. For months, the question wasn’t “if” but “when.” And true to form, just as with the U.S. downgrade, S&P’s reasoning skated the surface of prevailing wisdom: Governments have too much debt and not enough income. That’s only part of the story.
Nowadays, when any sovereign gets downgraded by a rating agency, it’s not just because its debt repayment ability is questionable (the publicized logic of rating agencies), but because it incurred more expensive debt to float its banking system. These are institutional problems that in turn cause recurring national economic ones.
Nowhere in S&P’s statement about “global economic and financial crisis” did it clarify that governments (including the U.S.) were hit due to having backed big national banks (and international, American ones) that engaged in half a decade of leveraged speculation.
The United States
Square, Site wide
On Aug. 5, 2011, S&P downgraded U.S. government debt to AA+. This was four days after Congress voted to raise the national debt cap—to prevent a downgrade—preceded by political squabbling and the U.S. Treasury and Fed begging Congress to raise the debt cap. S&P, that beacon of accountability, claimed, “American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.” In other words, too much debt, too little income.
According to the U.S. Treasury, the main reason for the debt increase was a stalling economy—lack of enough incoming tax receipts to pay expenses (which include interest payments on growing debt). That’s not true. Tax receipts dropped $400 billion to $2.1 trillion in 2009 from a year earlier. Expenditures jumped to $3.5 trillion in 2009 from $3 trillion in 2008. Treasury debt ballooned by nearly $4 trillion from 2008 to 2009.
So where’s the money? About $1.6 trillion lies on the Fed’s books as excess reserves that banks—dealers for sovereign debt—put there. Nearly a trillion dollars went to backing Fannie Mae and Freddie Mac, which enabled banks to artificially overvalue related securities, and to extra interest payments. There was $700 billion in the Troubled Asset Relief Program, which though mostly repaid, never manifested into debt reduction, and hundreds of billions of dollars of asset guarantees underlying big bank mergers. So, 75 percent of the extra debt went to saving banks. S&P didn’t mention this. The policy repeated across the Atlantic.
The Irish government’s pain started when it guaranteed the bonds of Anglo Irish Bank in September 2008. In May 2010, Ireland Central Bank head Patrick Honohan assured the world that he’d have “two big banks fixed by the end of the year.” On that endorsement, the government backed bondholders on the banks’ behalf. The economy deteriorated.
Six months later, nobody would lend to Irish banks. Irish austerity promises didn’t change the fact that Irish banks weren’t big enough to contain their waste. By November 2010, banks paid for 60 billion euros of maturing bonds with emergency European Central Bank (ECB) loans, part of a bigger bailout, and the ECB became the backbone for the Irish bank guarantee scheme, whose participants included Ireland’s big financial firms: Irish Life & Permanent, Bank of Ireland, Allied Irish Bank, Anglo Irish Bank Corp. Ltd. and Irish Nationwide Building Society.
The ECB deemed the bailout a success. Yet by the summer of 2011, Ireland was downgraded to a notch above junk and households (and foreigners) accelerated their extraction of money from Irish banks, weakening the banks’ funding base further. The Irish government now owes 110 billion euros to the banks, the National Asset Management Agency (NAMA, aka “bad bank”), the EU, ECB and IMF, with no way to repay it.
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