Why the European downgrades matter
Perhaps more importantly, and at the risk of repeating myself, the downgrades increase the dependence of the big banks on finance from the European Central Bank – and for the economic recovery of the eurozone, that’s a very bad thing.
The less that banks are able to raise funds in a normal commercial way, the more they’re dependent on a central bank, the more reluctant they are to lend to the wider economy – and given the massive dependence of the eurozone economy on finance provided by banks, that leads to a reduction of economic activity, a reinforcement of recessionary conditions…
..the downgraded Italian and French governments would be seen to be less financially capable of bailing out Italian and French banks in a crisis, so other creditors would be shouldering more risk…
So even if the downgrades don’t lead to default by a nation or a bank, they make it much harder for the banks – and in a way the whole eurozone – to get off life support.
…That creates a damaging negative feedback loop (less lending means asset price falls, more bankruptcies, bigger losses for banks, and even less lending by capital-constrained banks) which makes it all the harder for the eurozone to break free of its cycle of decline.
And, as I said in my earlier note, the downgrades also make it harder for the eurozone to establish a proper circuit breaker – in the form of a giant bailout fund – to protect other sovereign creditors in the event that today’s impasse in Greek debt talks lead to a Greek default.
Here is a useful and only slightly overstated summary of where things stand:
The entire eurozone banking system can be seen to have been nationalised – or at least the funding of banks has been nationalised, even if their ownership hasn’t been transferred to taxpayers.
Addendum: Here are some comments from RBS.