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European Bailout Fund Downgraded

As expected, Standard and Poor’s followed up their downgrade of various Eurozone countries last week with a downgrade of the European bailout fund, the EFSF, which has been funded by many of those downgraded countries, in particular France and Austria. This is important because EU leaders at one point wanted to leverage up the EFSF by essentially selling shares of it, in a way, to investors:

The EFSF relies on the triple-A ratings of its guarantors to raise cash in debt markets, which it then lends to stricken eurozone governments at a small mark-up. France and Austria account for some €180bn of the credit guarantees underlining the fund, created after the first Greek bailout in May 2010 and supposed to serve as a firewall sealing the eurozone’s core economies from the crisis.

Shorn of its top-tier credit rating, the EFSF is likely to be forced to pay higher premiums or operate with less cash at its disposal.

In a statement, S&P held out the possibility that Eurozone governments could shore up the fund, something that officials have said they were exploring.

But that possibility appeared remote after Wolfgang Schäuble, the German finance minister, argued that the EFSF already had ample resources, and that no further support from Berlin, its biggest sponsor, would be forthcoming.

I’m going to say this is a good thing, actually. Levering up the EFSF was a massively stupid idea, something I saw described as akin to setting dynamite to the can before kicking it down the road. The EFSF can probably still sell AAA-rated assets for now, as long as Fitch and Moody’s keep the rating stable. But it’s less likely they will be able to generate investors for the fund, which avoids that threat of a metastasizing collapse.

European officials reacted to the news by criticizing Standard and Poor’s for not understanding their cunning plan to create a fiscal compact to keep debt low. I’d say that European officials don’t understand Standard and Poor’s reasoning that austerity is absolutely killing their economies, raising the prospects of a host of not only defaults but mass incidents of suffering.

As Yves Smith says, better for the unworkable program to be unable to find financing now, than to have it put into use. I think the world dodged a bullet on this one. Of course, that doesn’t mean Europe has anything approaching a solution on the horizon.

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David Dayen

David Dayen