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The Ratings Risks of Getting a House in Order

Behind closed doors, euro-zone heads of state are in talks over a long-term solution to the fiscal crisis that engulfed Europe’s periphery over the last 12 months. This week they meet in Brussels for talks that will set to tone for a second meeting in late March at which the market is expecting an outcome.

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For weeks now, events in the Middle East have taken the spotlight off the euro zone and its fiscal problems. But on Monday, Moody’s weighed into the issue by downgrading Greek debt to B1, from Ba1, with outlook negative.

Added to a downgrade of the outlook on Spanish debt by Fitch late on Friday, the news intially hit the euro in early trading Monday and raised some interesting questions for Europe as it pushes on with fiscal consolidation.

The message is clear and raises questions about the path European Union policymakers are taking.

“The fiscal consolidation measures and structural reforms that are needed to stabilize the country's debt metrics remain very ambitious and are subject to significant implementation risks, despite the progress that has been made to date.” Moody’s of said in a statement.

“The country continues to face considerable difficulties with revenue collection,” it said.

“There is a risk that conditions attached to continuing support from official sources after 2013 will reflect solvency criteria that the country may not satisfy, and result in a restructuring of existing debt.”

Basically, Moody’s said Greece might not meet its own targets, is losing revenue and could be forced to restructure sooner rather than later, hardly a message EU leaders will want to hear as they prepare for a major month for the European project.

Despite taking very unpopular measures, the Greek government could fail anyway and is certainly not being thanked by the Greek electorate. A poll over the weekend showed that 71 percent of Greeks believe Prime Minister Papandreou is following the wrong policy to deal with the crisis.

The Greek government is not amused with Moody’s, to say the least.

“The rating downgrade announced by Moody’s today is completely unjustified as it does not reflect an objective and balanced assessment of the conditions Greece is presently facing. Furthermore, its timing and the multi-notch nature of the downgrade are incomprehensible and raise a number of questions,” the Greek finance ministry said in a statement.

“Moody’s focuses its analysis exclusively on the downside risks and while mentioning the significant progress Greece has made in the implementation of its fiscal consolidation and structural reforms program it does not actually incorporatee in its analysis and ratings decision their upside impact on the economy,” it said.

Spanish Fears

While some believe the euro project will work outgiven the political will in Germany and France to keep the integration project started after the Second World War on track, Spain remains the too-big-to-bail, too-big-to-fail event risk for many.

Late on Friday after the close of the European market, Fitch downgraded its outlook for Spain citing risks stemming from fiscal consolidation, bank restructuring and a weak economic recovery.

While praising the Spanish government on its structural reforms, Fitch remains worried about the country’s savings banks and warns their restructuring puts Spain’s AA+ rating at risk.

Spain is currently demanding that its banks raise more capital and estimates it could cost 20 billion euros to recapitalize them. Some in the market believe the cost could be four times that much.

Like Greece before it, Spain could move to clean house with its banks and be thanked by no-one. Not the rating agencies, the electorate nor the market.