Moody's whip hand over Greece

Posted by Paul Murphy on Dec 18 08:30.

Here’s a small absurdity: a private credit rating agency can now determine whether the European Central Bank will accept the debt of a particular eurozone sovereign as collateral.

Following Fitch’s move on Greece last week, and then S&P’s downgrade on Wednesday — both agencies now rate the Hellenic Republic BBB+ – Moody’s is left with an outlier rating for the country of A1.

As Goldman Sachs economist Erik Nielsen pointed out in a note to clients on Thursday, under normal circumstances eurozone sovereign bonds are only eligible for ECB collateral as long as they have an A- rating or better from one of the three credit rating agencies.

This rule has been relaxed to allow collateral with a BBB- rating (or greater), but this concession expires at the end of 2010.

That means that if Moody’s were to cut Greece three notches (to Baa1+, Moody’s equivalent of BBB+) Greece would be cut off from Europe’s key financing facility on January 1, 2011.

Now, Nielson doesn’t know how Moody’s will act, one way or another, but he does think the ECB needs to change its rules – and quickly.

. . . the unthinkable – that the ECB would not accept sovereign securities from a member as collateral – has become a measurable risk, and one exclusively controlled by Moody’s. Clearly untenable!

What to do?

Well, the ECB could wing it — gambling that the Greek fiscal position will improve sufficiently so as to make action by Moody’s unlikely. A fully fledged bailout — from the EU or the IMF — would help. Or the ECB could simply announce an extension to its relaxed rules.

But Nielson would like some clarity:

First, the ECB should change its requirement that all three credit rating agencies rate a credit below A- to the more common system of “two out of three” providing a certain rating. This would remove the inappropriate veto right of any one of the three agencies.

Second, the ECB should add a “conventional warfare threat” to its present “nuclear war threat”. Just as nuclear threats may not always be credible because of their severity, the threat of total elimination from its repo system on the signal from a credit rating agency may not always be credible. A “conventional arms supplement” for the ECB could be a step-wise increase in the haircut.

Third, the ECB should make its existing rules as well as any future revisions explicit and public. Clarity and transparency serve all institutions well.

As for Greece, the outlook is not considered rosy. Here’s Sian Harvinder from RBS:

Moody’s has Greece on A1 (=A+ in S&P language) with a watch negative. So how far will they go? A one notch downgrade looks in the bag so let’s call it A flat already. Greece is then two notches away from a triple BBB handle rating…

In the final analysis, and as we first said when the new Greek debt numbers came to light, Greece is a BBB country, and ultimately we should expect Moody’s to see the light…

The hyper-activity of rating agencies combined with the current plan that the ECB collateral threshold will move from a crisis setting of BBB- to A- in 2011 will have investors very nervous. After all, investor could be one Trade Union demonstration/strike away from BBB handles on all three ratings agencies, even if Moody’s does not move to this level in 2010…

We see several years of rolling crises. The best that GGBs can do is to hope for EU/ECB support and firm global growth to cover up the problems for a few more years.

Related links:
Moody’s sees sovereign states a-suffering – FT Alphaville
Please have confidence in us! – FT Alphaville
How do you say vicious circle in Greek? – FT Alphaville