When Bad News Is Good News Is Bad News

Greece's sovereign debt rating was downgraded by Moody's today, following similar downgrades by Fitch's and S&P's. Yet the Athens Composite Index actually rallied on the day. Why? Because the downgrade was less than expected. For now, at least:

Greece, facing a government budget deficit next year of more than 12 percent, has come under pressure from bondholders — and the European Union — to bring its finances under control.

The Socialist prime minister, George A. Papandreou, has promised to fix the problem even in the face of resistance from his own supporters. But he has not completely convinced investors that he can shrink the state sector, which employs one of every four working Greeks, especially in the midst of an economic crisis.

Moody’s cut its rating on Greece’s debt to the lowest level it has assigned to any euro zone member, at A2, five notches above “junk” status, but still two notches above the ratings assigned by rival agencies Fitch Ratings and Standard & Poor’s. Moody’s left open the possibility of another downgrade, saying the outlook on the debt was “negative.”

Greece has two problems: the government has pledged lavish public spending programs, but it is also an EU member, which brings certain obligations. Greece will not be able to keep both balls in the air for much longer; either some austerity measures will have to be implemented to curb budget deficits, or Greece risks being kicked out of the Eurozone (for more on why, see here and here). Public sector workers are planning a general strike next month to protest any austerity measures, so once again labor is sowing the seeds of its own destruction; when will we learn? The best case scenario is an IMF loan, which will certain come with some strings attached.

President Papendreu, a capital-S Socialist, has pledged to restore credibility without, you know, actually cutting spending. And he blasted the decision of the ratings agencies to downgrade. Edward Hugh says the agencies are right:

George Papaconstantinou, finance minister, responded in fighting spirit, and is quoted as saying “we don’t think this [the S&P rating downgrade] reflects the efforts the new government is making to stabilise public finances which had derailed” - a reference to a collapse in revenue collection and excessive spending under the previous government. “It didn’t take into consideration and didn’t assess correctly what is happening at this point.” But the whole point is that it was not only Greek finances which became derailed over the last decade, but the whole economic model on which Greek society has been based, and it is this derailment which needs to be fixed, and it is in this context that the measures which have been proposed fail to convince.

The future looks no better: demographic trends that will threaten state budgets in most industrialized countries are even more pronounced in Greece. If Greece can't adjust now, future adjustments may be even more painful. But it is not clear that the government has the will, or that the populace has the stomach, to take the necessary steps to fiscal rectitude. I expect things to get much worse in Greece before they get better.