Europe has lived in an almost perpetual state of collapse lately, with promising deals followed by despair. Today was one of the despair days.

First, Standard and Poor’s cut the credit rating for nine Eurozone nations, including France, which previously had AAA-rated debt.

S&P lowered its long-term rating on Cyprus, Italy, Portugal and Spain by two notches, and cut its rating on Austria, France, Malta, Slovakia and Slovenia by one notch.

“Today’s rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone,” S&P said in a press release announcing the downgrade.

I’ve documented S&P’s political advocacy and use of leaks toward that advocacy. But I can’t see much wrong with their analysis. Europe has catastrophically bungled their response to the financial crisis, and with the weakness of their political structures, I fail to understand how they can fix it. The currency union and reticence of the ECB to act like a central bank really does threaten default events and total collapse.

As the debt downgrade was an expected event, it may not have much of an impact. The big problem is that it will probably lead to a downgrade of the European bailout fund, the EFSF, because of France’s involvement in that. But the far bigger problem is what happened in Greece today.

Greece’s creditor banks broke off talks after failing to agree with the government about how much money investors will lose by swapping their bonds, increasing the risk of the euro-area’s first sovereign default.

Proposals by a committee representing financial firms haven’t produced a “constructive consolidated response by all parties,” the Washington-based Institute of International Finance said in a statement today. Talks with Greece and the official sector are “paused for reflection on the benefits of a voluntary approach,” the group said.

Greek officials and the nation’s creditors agreed in October to implement a 50 percent cut in the face value of Greek debt, with a goal of reducing Greece’s borrowings to 120 percent of gross domestic product by 2020. More than two months after the accord was announced, the two sides still need to agree on the coupon and maturity of the new bonds to determine losses for investors. The IIF has aimed to implement the swap this month.

Germany and France have said that without a deal, Greece will not receive the next tranche of bailout funds. That almost certainly means a default. So the creditors really don’t have a strong hand here, as they have a choice between a haircut and nothing. But they probably think that the contagion would be so great that the big European powers will not let it happen, and as a result they can get paid off at par if they make a credible threat. So everyone’s trying to game everyone.

The one fly in the ointment is that hedge funds hold a lot of Greek debt, and they may find a default even more lucrative, because they would stand to reap payouts from credit default swaps. So in the insanity of global finance, there are some entities practically rooting for default, regardless of the implications on the people of Europe.

Hold on to your hats, everyone.

David Dayen

David Dayen