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How Important Is the European Downgrade?

There was a time when the mere threat of a ratings downgrade would strike terror in the hearts of those that offer bonds to the investor community -- That was when the ratings agencies had not damaged their reputations with some very bad assessments during the boom years and before the entire investment community did not already know what they were going to say before they said it.

The downgrades in Europe took nobody by surprise given all the financial and economic chaos that has gripped the region. It essentially was confirmation, as opposed to information. Not that the markets didn’t react -- they did. While the downgrade was not shocking, it reinforced the fact that there is still no plan to pull Europe out of this mess. Without a plan the financial chaos just stretches out and creates more panic.

Still, it is well-known the ratings agencies have always struggled with the assessment of national debt. The country has options that a company does not have, but there also are limitations that companies lack. A company in distress can slash costs to the bone if that is what is needed to turn the thing around, but an elected government can only go as fast as the electorate will allow.

The raters have also been known to try to use the system to cajole and persuade nations to do what the agencies' analysts think appropriate -- that generally means putting austerity at the top of the list of strategies, even if that means that a country risks social chaos and  government upheaval. It will be the rare set of leaders that will seek to please the ratings agencies instead of making the voter happy. As a matter of fact, the governments in Europe have been calling for restrictions on the ratings agencies long before Friday's mass downgrade. This latest set of assessments will add fuel to the fire.

Source: Chris Kuehl, PhD, NACM economist