German Chancellor Angela Merkel arrives at a session of the Bundestag, the lower house of parliament, that will vote on a Spanish bank aid package in Berlin, July 19, 2012. Merkel's authority within her centre-right coalition was at stake on Thursday when uneasy German lawmakers vote on Berlin's contribution to a euro zone aid package for Spain's ailing banks.Thomas Peter/Reuters
The debt crisis that has plagued the euro zone for more than two years now threatens its top-rated nations – including Germany – amid mounting concerns that Spain is teetering on the brink of collapse.
Moody's Investors Service struck at the core of the 17-member monetary union late Monday, revising to "negative" from "stable" its view of the triple-A ratings of Germany, the Netherlands and Luxembourg.
The influential U.S. ratings agency cited the escalating troubles in the euro zone, the possibility of Athens departing and the troubling possibility that vastly larger Spain and Italy will need to be rescued by their European partners.
Moody's move illustrates how the virus that began in Greece and quickly spread through the peripheral European countries is now infecting the core. That raises the possibility of higher debt costs for the more fiscally sound countries that have so far escaped a rash of downgrades and attacks by bond vigilantes.
The latest development came as Spain's crisis heightened, with benchmark 10-year bond yields surging at one point to a euro-era record of almost 7.6 per cent, while Italy's widened to a six-month high.
Fears are growing that Madrid itself is on the verge of seeking a massive bailout from its European partners, which would put the future of the euro in grave doubt.
"At this stage, a Spanish bailout to cover the exchequer financing needs for 2013-14 is virtually unavoidable," said Constantin Gurdgiev, a finance lecturer at Trinity College in Dublin.
The troubles in Spain sent tremors through nervous global markets. Bond, equity and commodity investors around the world headed for U.S. Treasuries, Canadian government debt and other harbours considered relatively safe from increasingly stormy European seas. The sharp decline in Spanish stocks amid rising volatility prompted the market regulator to prohibit short-selling for three months. Italy has imposed a one-week ban on shorting of certain bank and insurance stocks.
Investors are losing confidence in the ability of the Europeans to keep their single currency from failing. The euro plunged against other major currencies, reaching its weakest level against the U.S. dollar in two years, and a record low against the Canadian dollar.
Markets are at the limits of their patience, said Alex Jurshevski, managing partner with Recovery Partners in Toronto, which advises governments on how to manage debt crises. We've come along three, four years in a process that seemingly has had no clearly announced objective, no set of milestones. "What we saw was the markets saying, 'Enough is enough.'"
The latest developments and the harsh reacton in bond and equity markets have heightened fears that Spain is rapidly running out of fiscal manoeuvring room. Spain's deteriorating finances and the perilous fiscal state of key regional governments are not news to the markets.
But the warning flags posted by Moodys are bound to worsen the already sour market mood. "The rising uncertainty regarding the outcome of the euro area debt crisis given the current policy framework, and the increased susceptibility to event risk stemming from the increased likelihood of Greece's exit from the euro area, including the broader impact that such an event would have on euro area members, particularly Spain and Italy," the agency said.
"Even if such an event is avoided, there is an increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required. Given the greater ability to absorb the costs associated with this support, this burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form."
The ratings agency is not yet predicting a Greek exit, but warns that the risk has increased and that such an outcome "would pose a material threat to the €. Although Moody's would expect a strong policy response from the euro area in such an event, it would still set off a chain of financial-sector shocks and associated liquidity pressures for sovereigns and banks that policy makers could only contain at a very high cost."
Spain, in particular, is hobbled not just by the financial crisis, but a crippled economy and the unsustainable debt burdens of some of its largest regional governments. Its central bank reported Monday that the economy slid deeper into recession in the second quarter, shrinking by 0.4 per cent, after a 0.3-per-cent decline in the first three months of the year. Almost one in four people are out of work, and unemployment among young people is running at half the workforce.
Now, the country's troubled regional governments are lining up for billions of euros in aid from the cash-strapped central government. Valencia revealed on Friday that it would seek to tap Madrid's recently created €18-billion fund for the regions. Like many of the rest of Spain's 17 autonomous regions, Valencia faces huge debt payments for infrastructure borrowing during the bubble years, and heavy social spending since the collapse in 2008. Total maturing debt for the regional authorities this year totals nearly 36-billion euros. As many as eight regions may need bailouts to meet their bond commitments.
Among the remaining triple-A credits in the euro zone, only Finland is left with a stable outlook from Moody's.