Monday, May 7, 2012


The French people have chosen, and as expected, Francois Hollande is the winner.  The immediate fallout of this choice will probably be limited.  Hollande is likely to soften some of his campaign promises, and he is sure to try to cooperate with Angela Merkel.  Certainly, Hollande would love to see the dawn of a new era of Merkellande to replace the heady Merkosy days, but TRG see's another possibility.

The election in France did not open a new fault line, but the likelihood of a quake has nonetheless increased.  S&P has already downgraded France; Fitch and Moody's both have France on negative watch.  Since all the ratings agencies have pointed to a lack of political will to control the budget as a key risk for France, they cannot be feeling too comfortable with the election that just took place.  The battle for French votes often seemed like a contest for who could be the most fiscally irresponsible.  As noted previously, TRG does not think that austerity is the answer, but at the moment, nothing workable appears to be on any European table.

Normally TRG pays little attention to the ratings agencies.  At best, they are just incompetent, and at worst, they are a willing participant in a corrupt financial system.  Nonetheless, a France downgrade by Moody's or Fitch is worth paying attention to because it will position a very dark cloud over the core of Europe.  The S&P downgrade had a minimal effect, but another downgrade will mean big trouble, and here's why:

The EFSF, and ESM both rely heavily on financing that is guaranteed by European governments.  The amount of financing this guarantee provides is directly related to the credit ratings on the guaranteeing governments.  Currently France is calculated as a triple A credit for the EFSF and ESM because when the three main credit rating agencies disagree, then two out of three count.  So if France looses it's rating from one more agency, the safety net for all of Europe is going to suffer.  Already the EFSF and ESM would struggle to provide a meaningful bailout for Italy or Spain, but without France's triple A rating things will start looking very grim indeed.

The EFSF and ESM would suffer an indirect consequence of a credit downgrade on France, and that would be on top of any direct consequences (higher interest rates on French debt).  It's hard to estimate what the direct consequences of a downgrade would be on French debt, but if the yield were to get much above 4% on the French 10 year note, then suddenly, we might have to find room for an 'F' in the 'PIGS' acronym.

Even a remote possibility of France becoming a USER of the EFSF and ESM rather then a guarantor/contributor would be catastrophic.  Additional financing would have to be arranged, but unlike the last shotgun negotiations between Sarkosy and Merkel, this time, Angela Merkel will have no partner.  Rather then Merkellande, we will have Merkeland, and the problem with that should be obvious.

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