Europe is in trouble. This is nothing new, of course, as headlines have constantly reminded us of the threats facing the euro, of the profligacy of many European governments and of the forces trying to tear the eurozone apart, battling those trying to keep it together. Europe is in trouble because so many economic and political factors seem to be on an unavoidable collision course, like a ship bearing down on a giant iceberg. No one is quite sure how bad it could get.

While pundits and politicians fret over the future, one group cannot afford to sit idly by: ratings agencies. The outlooks that they provide investors with help shape the amounts that sovereign countries have to pay for debt - in short, their creditworthiness. Just as a corporation's debt may receive a rating ranging from AAA to junk, nations also receive marks.

Investors typically focus their attention on two ratings agencies: Standard & Poor's and Moody's. While both have come under fire in recent years for their ratings of corporate debt and some of the more infamous financial instruments (remember all of those well-rated mortgages found in CDS?), there seems to be less concern when it comes to their approach to the health of eurozone economies.

According to Standard & Poor's, 13 of 17 eurozone countries have negative outlooks, including three of four countries currently given AAA ratings. Five countries - Cyprus, Ireland, Italy, Portugal and Spain - have adequate funding in the near term (BB or BBB+ ratings), but face greater threats to their financial stability in the long term. Greece, considered be to the precipitating cause of the current crisis, has the lowest rating, CCC. Germany, the country considered the last bastion of stability, was given a stable outlook and an AAA rating.

Moody's Starts the Frenzy
On Sept. 4, Moody's issued its own set of ratings, and its results have caused significant global consternation. Nine of the 16 countries it rated were downgraded since last year, with Cyprus, Italy, Slovenia and Spain falling the furthest. Moody's has five eurozone countries with AAA ratings listed: Austria, Finland, France, Germany and the Netherlands. This is a higher count than Standard and Poor's four top-rated economies (Moody's did not cover Luxembourg), and the two differed on France and Austria.

One of the debt instruments Moody's looked at was the one-year credit default swap (CDS)-implied EDF (Expected Default Frequency). The higher this rate, the more likely a country is to default on its debt, a bad sign for countries looking for funding in the credit market. The rate has improved for several countries over the course of the year, with Cyprus, Ireland and Portugal falling the furthest. But Europe is not out of the woods yet. From Aug. 17 to Aug. 31, Italy's CDS-implied EDF (one-year) has increased from 0.48% to 0.57% and Spain's from 0.62% to 0.70%.

And Then Things Get Complicated
Since the beginning of the crisis, the healthier eurozone countries have insisted that the countries with the biggest debt problems adhere to austerity measures and cut public sector spending; but it is not that simple. What makes assessing the risk of eurozone countries difficult is how many interlocking gears there are in the entire euro machine. While public sector spending has been a problem, so have other factors:

  • The labor competitiveness gap between eurozone countries has widened. Because of labor mobility laws, production has shifted to more competitive countries and helped keep unemployment rates high in countries with high debt.

  • Trade between eurozone members has become increasingly unbalanced, with countries such as Germany, the Netherlands and Luxembourg sporting current account surpluses approaching the 6% threshold set by the European Commission. Countries facing the worst debt problems have the worst current account problems. Remember, having a common currency means governments cannot toy with exchange rates.

Part of the Moody's report also hinted at more unexpected exposures; specifically, that some of the more stable countries are supporting the European Financial Stability Facility (EFSF). The EFSF is designed to prop up faltering eurozone economies, some of which may continue to need support in the coming years. By acting as guarantors to a large amount of EFSF funding, Germany, Luxembourg and the Netherlands were all put on notice by Moody's. Germany provides nearly 30% of the funding.

Fixit Before Grexit
Finland has managed to come out of the Moody's report relatively unscathed, despite also being an EFSF guarantor. In recent weeks there has been talk of a "Fixit" within Finland's government, meaning that the country is considering dropping the euro altogether. Unlike Germany and Luxembourg, Finnish banks have less exposure to the debts of countries such as Italy, Spain, Portugal and Greece. Finland also exports more of its goods and services to countries outside of the eurozone, while Germany's exports are heavily focused on eurozone members.

The Bottom Line
Much of the euro debacle has been a crisis of expectations that has morphed into a battle of words between northern and southern European countries. Southern Europe has been plagued by government debt, high unemployment and low competitiveness. Northern European debts have trended lower, and several governments there are looking to hold referendums about exiting the euro. After all, why would you want to pay for someone else's bad behavior? The problem is that while the execution of the euro was sloppy, many economies are simply too intertwined for a clean break. The ratings agencies know this, as do politicians. Prepare for a cold winter, with frosty glares between politicians rivaling temperatures outside.

Related Articles
  1. Economics

    Understanding Free Trade

    Free trade exists when nations can swap goods and services without the constraints of tariffs, duties or quotas.
  2. Mutual Funds & ETFs

    ETF Analysis: ProShares Ultra Nasdaq Biotechnology

    Find out information about the ProShares Ultra Nasdaq Biotechnology exchange-traded fund, and learn detailed analysis of its characteristics and suitability.
  3. Mutual Funds & ETFs

    ETF Analysis: First Trust Dow Jones Global Sel Div

    Find out about the First Trust Dow Jones Global Select Dividend Index Fund, and learn detailed information about characteristics and suitability of the fund.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Short S&P500

    Find out information about the ProShares UltraPro Short S&P 500 exchange-traded fund, and learn detailed analysis of its characteristics and suitability.
  5. Markets

    The 5 Biggest Chinese Natural Gas Companies

    Read about the top five Chinese natural gas companies as measured by gas production volume and learn a little more about their business operations.
  6. Markets

    The 5 Biggest Chinese Insurance Companies

    Read about the top Chinese insurance companies by market capitalization, and learn a little about their positions in the marketplace.
  7. Forex Strategies

    These Are The Best Hours To Trade the Euro

    Six popular currency pairs and numerous secondary crosses offer euro traders a wide variety of short- and long-term opportunities.
  8. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  9. Mutual Funds & ETFs

    ETF Analysis: SPDR Dow Jones International RelEst

    Learn how the SPDR Dow Jones International Real Estate exchange-traded fund (ETF) is managed and for whom the ETF is most appropriate.
  10. Investing Basics

    Explaining Trade Liberalization

    Trade liberalization is the process of removing or reducing obstacles that impede the exchange of goods and services between nations.
  1. Plain Vanilla

    The most basic or standard version of a financial instrument, ...
  2. Trade Credit

    An agreement where a customer can purchase goods on account (without ...
  3. Derivative

    A security with a price that is dependent upon or derived from ...
  4. Brazil, Russia, India And China ...

    An acronym for the economies of Brazil, Russia, India and China ...
  5. Credit Rating

    An assessment of the credit worthiness of a borrower in general ...
  6. Optimal Currency Area

    The geographic area in which a single currency would create the ...
  1. How can I use the funds from operations to total debt ratio to assess risk?

    The funds from operations (FFO) to total debt ratio is used in fundamental analysis to determine a company's financial risk. ... Read Full Answer >>
  2. How stable are municipal bonds?

    Stability is relative in the municipal bond market. Municipal bonds tend to be safer than many other types of investments, ... Read Full Answer >>
  3. What are the main risks associated with trading derivatives?

    The primary risks associated with trading derivatives are market, counterparty, liquidity and interconnection risks. Derivatives ... Read Full Answer >>
  4. Where can I find information about corporate bond issues?

    Information about new and existing corporate bond issues is published regularly in financial newspapers, such as The Wall ... Read Full Answer >>
  5. Why are high yield bonds typically lower rated bonds?

    The term "high-yield bond" is a bit of a misnomer. It is not the case that high-yield bonds tend to be lower-rated; instead, ... Read Full Answer >>
  6. What kinds of costs are included in Free on Board (FOB) shipping?

    Free on board (FOB) shipping is a trade term published by the International Chamber of Commerce or ICC, that indicates which ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!