After confirming the soundness of France for quite a long time, S&P radically changed its attitude towards the euro-zone’s second largest economy.
The credit rating agency announced that all euro-zone members (apart from Greece) are now on CreditWatch negative. This means that their rating could be downgraded in the next few days. Germany is no safe haven. S&P also made this worrying comment for France:
We expect to conclude our review of eurozone sovereign ratings as soon as possible following the EU summit scheduled for Dec. 8 and 9, 2011. Depending on the score changes, if any, that our rating committees agree are appropriate for each sovereign, we believe that ratings could be lowered by up to one notch for Austria, Belgium, Finland, Germany, Netherlands, and Luxembourg, and by up to two notches for the other governments.
(emphasis mine). So, the French Republic is not on the list of countries that can get a one notch downgrade, but rather on the “others” list. This is a significant blow to France.
S&P will later issue separate statements for all the 15 countries and the downgrade depends a lot on the summit towards the end of the week, but its safe to say that France got a big blow.
French Banks Highly Leverage
The highly leverage banking system in France is likely the cause of including France in the two notch downgrade list. French banks are highly exposed to sovereign, and especially Greek debt and have little cash in comparison to their debt.
Also the size of the French banking system is too big for its economy. The Franco-Belgian bank Dexia already collapsed. The big French banks remain at risk. If the French government takes over any of the big 4 banks, a credit rating downgrade is imminent.
France wants the ECB to heavily participate in calming the markets and buying peripheral bonds. Sarkozy wanted to shore up the country’s banks and wanted to preserve the perfect AAA rating. Now it is at risk, with a chance of heavy blow.
Further reading: Société Générale Highly Leveraged – Not too far from Lehman Brothers before the crash.Get the 5 most predictable currency pairs