Greece's bond rating has plummeted to the cellar, as key European policy makers openly squabble about a plan to keep the entire house from collapsing.
Standard & Poor's Corp. slashed its rating on sovereign Greek long-term debt on Monday by three notches to the equivalent of triple-C, below even the lowest speculative grade and its worst rating for any country.
Rival debt monitor Moody's rates Greek bonds slightly higher but also in the C category, which puts the chances of default at 50 per cent or better.
"Risks for the implementation of Greece's EU/IMF borrowing program are rising, given Greece's increased financing needs and ongoing internal political disagreements surrounding the policy conditions required by Greece's partners," S&P said in a statement.
Greek bonds already trade at levels normally consigned to rising default risks, so the latest cut will have little impact in the bond market. Greece has not had an investment-grade rating in 14 months. The insolvent government was already cut off from access to the capital markets by crippling risk premiums. But the move underscores the fact the investing community has run out of patience with the Europeans and their bumbling efforts to avoid the euro zone's first sovereign default.
Credit-default swaps on Greece, as well as Ireland and Portugal, the other two euro-zone bailout recipients, climbed to record levels Monday. And the spread between the yields on 10-year German debt, regarded as the euro area's safest, and comparable Greek bonds was slightly more than 1,400 basis points.
The market fears are being fanned by the unusual public argument that has broken out between Berlin and the ECB over the latest Greek rescue plan.
Under pressure from within its own ruling coalition, parliament and an increasingly restive electorate, the German government changed course last week and called for a "soft rescheduling" that would require bondholders to agree to a seven-year extension of maturities. This, the central bank, the French government, the rating agencies and market participants have declared, would amount to a default by another name that would have severe repercussions for the financial system, the other fiscally damaged governments and the euro itself.
The feud features entrenched interests on both sides. Berlin knows any further bailouts for Greece without tough conditions and some pain for bondholders will further inflame a German public already angry about taxpayer-funded rescues of fiscally irresponsible governments in peripheral parts of the euro zone.
The ECB adamantly opposes any maturity extension, because the bank would immediately have to write down the value of billions of euros worth of Greek government bonds it holds as collateral in exchange for loans to the Greek banks. Bank officials have warned it will not accept this collateral if the bonds are declared to be in default. Stripped of operating capital, the Greek banking system would collapse like a cheap suitcase. Such a move would also damage German, French and other euro-zone banks holding Greek debt.
"The balance of forces in the euro zone is a little like it was in the Cold War: Both sides are brandishing deterrents that would be too horrendous to use," Philip Whyte, a senior research fellow at the Centre for European Reform in London, told Bloomberg News. "It's all going to turn on whether you can fiddle with debt maturities without calling it a credit event."
One proposal being floated is to ask bondholders to agree to the debt maturity extension, rather than have it forced on them. But such a "voluntary" rollover would still amount to a bond default, the rating agencies say.
"In our view, any such transactions would likely be on terms less favourable than the debt being refinanced, which we, in turn, would view as a de facto default," S&P said.
For now, "the markets seem to be pricing in the assumption that euro policy makers will muddle their way through this current malaise and that Greece will continue to receive financial life-support, and as such be of limited consequence to financial markets at least until 2013 when the current bailout program ends," Simon Ballard, senior credit strategist with RBC Capital Markets in London, said in a report. "But this does require a lot of faith."