It wasn't a surprise, but the downgrade of Greek sovereign debt by Fitch to triple B-plus still came as a shock. World stock markets fell, the dollar rose, as did German bunds – all the usual haven plays that rallied following last week's debt standstill by Dubai. Greek government bonds meanwhile slumped – yields on 2-year bonds have risen by a whole percentage point in two weeks – and the stock market closed down 6 per cent, with banks particularly badly affected.
Big moves, but they all made sense, especially as the European Central Bank is preparing to wind down its emergency liquidity operations. Simply put, investors wondered for how long Greek banks would be able to finance their assets – which includes the purchase of Greek government bonds. That is because the ECB requires that assets used as collateral in its lending operations are rated higher than triple B-minus. But, as Capital Economics notes, before the financial crisis, collateral had to be rated A-minus at least, and the ECB is supposedly set to return to those rules by the end of next year.
If other rating agencies followed Fitch's lead – and on Monday, Standard & Poor's put Greek debt on watch for a possible downgrade – then Greek government debt could no longer be used as collateral. Greek banks would be left high and dry. In extremis, Athens would also have lost an important source of funding given that government bonds account for about 10 per cent of Greek bank assets.