The US downgrade has benefited Treasuries but sent France and French banks reeling

US Treasuries’ unexpected reaction to the US downgrade

When Standard & Poor’s stripped the US of its ‘AAA’ credit rating on 5 August, it didn’t have quite the apocalyptic consequences some had feared, with as investors continuing to regard US Treasuries as safe. But it has still shown that, despite being widely discredited over their handling of CDOs in 2005–7, the credit rating agencies still hold tremendous sway over the markets.

The yield on America’s benchmark 10-year Treasuries actually fell from 2.44% on 4 August to 2.17% on 10 August This was partly due to supportive action from the Federal Open Market Committee which pledged to keep US interest rates exceptionally low until at least 2013 (and, as Barry Ritholtz explained, there were other reasons too).

However, the not wholly unexpected downgrading of America did spark predictable attempts to shoot the messenger (not least from Tim Geithner’s US Treasury). It also caused extraordinary convulsions elsewhere in markets already nervous about whether the EU has lost the will to salvage the euro.

As global stock markets gyrated on the news, America’s ignominy prompted investors to wonder whether other nations that still enjoy AAA ratings — particularly the weaker AAA sovereigns like Austria, Finland, France, and the UK — might also face downgrades. As John C. Ogg put it on MSN, “Wall St. decided to reassess the entire global triple-A landscape.” In turn, this paradoxically drove it to put more money into Treasuries!

There’s a great deal at stake here. If France were to be downgraded, it might well cripple the eurozone as a whole, at least according to some commentators. The Italian financial journalist Fabrizio Goria ominously tweeted what might happen on 9 August. “Remember: if France loses triple A, goodbye EFSF, goodbye Eurozone as we know it.”

Fears for France turned to wild panic and a rout on 10 August. Investors were perhaps not being wholly irrational here. France has a large public deficit, a population that is more reluctant than most to make sacrifices, and its banks have among the highest levels of exposure to toxic Greek debt of any banks (see my blog post of June 2).

The panic about France only abated — albeit marginally — when an S&P analyst intervened to say that, under President Nicholas Sarkozy, France is more serious about tackling its fiscal overhang than the US and that its AAA rating is not at risk (there’s the CRAs’ influence for you again!). For heaven’s sake they even prompted Sarkozy to give his ministers a week to formulate new deficit-reduction measures. 

Christian Jimenez, president of Paris-based fund managers Diamant Bleu Gestion, remarked: “The rumours on the French triple-A rating are having a catastrophic impact, despite the denial from credit agencies. Shorts are on a rampage; it’s a calamity. This has nothing to do with fundamentals.”

After Moody’s and Fitch also denied they had any intention of downgrading French debt, the short-sellers turned their attention to French banks. There was a whiff of October 2008 as Société Générale became the number one target, with rumours swirling that it was experiencing a run on deposits and would have to be bailed-out by the French government due to its exposure to Greek debt.

The sense of financial doom intensified on fears that, as a consequence of the running sore of the eurozone sovereign debt crisis, French banks were struggling to fund themselves.

A Bloomberg report suggested that Société Générale had been singled out because of its perceived dependence on short-term funding. RBS analyst Stefan Stalmann said in note to clients: “The mix of euro doubts and rating fears in recent days and weeks may have dented the confidence of funding counterparties, which has then fed back into equity markets.”

Société Générale’s share price plummeted by as much as 23% on August 10, before closing 17% down on a day. Presumably, guts were wrenching inside the triple towers of the bank’s swanky La Défense head office.

As the yield on US Treasuries fell, the bank’s CEO Frédéric Oudéa later appeared on CNBC to try and pour oil on troubled waters. He claimed that all the rumors about SocGen were “absolute rubbish” and that they had been brought on by a market that had “lost its rationale.”

He told the channel’s Bill Griffith and Maria Bartiromo that: “We have seen rumours and the impacts on all French banks. Two days ago it was on UK banks or Italian banks. Today it was clearly related to France and there were some particular rumors. All that is absolutely unfounded. I can definitely deny all these rumors.”

Amid the panic, Citigroup chief economist Willem Buiter was contemplating broader issues.

In a note to investors re-published by FT Alphaville the Dutch economist wondered whether we might be entering a world in which no G7 country had an AAA rating. Buiter wrote: “Only a few small countries with a surviving culture of tax compliance and political institutions that effectively impose the government’s intertemporal budget constraint may have AAA ratings in the not too distant future.”

He meant countries such as Norway, Sweden, and perhaps also Switzerland. But even they probably shouldn’t feel too smug, wrote FT Alphaville editor Neil Hume.

In keeping with many other commentators, Buiter doesn’t see the US downgrade as particularly dramatic. As he pointed out in his note, the downgrade was both “inevitable” (given the US government’s inability to come up with a credible deficit reduction programme and the farce of the recent debt ceiling talks) and “long overdue”.

But Buiter added that the move is still: “A symbolic event in the life cycle of the former economic and financial hegemony. It also represents another step on the road to the complete disestablishment of the G7 as guardians of fiscal responsibility and sustainability.”

Even though they’re clearly deeply flawed, it seems inevitable that the three main Western rating agencies, together with China’s Dagong Global Credit Rating Co. will both be acting as the ‘score-keepers’ on the strength of Treasuries and sniping from the sidelines as this humiliating process unwinds. Indeed as they seek to rebuild their tainted reputations in the wake of the CDO-rating scandal, they might even begin to prize accuracy and timeliness a little bit more than they have done in the past.

This article was first published on Qfinance on 11 August 2011