S&P downgrades anticipated, but still stir turmoil

FRANKFURT (MarketWatch) � The decision by ratings firm Standard & Poor�s to downgrade several euro-zone nations came as no surprise, but still leaves major unresolved issues for policy makers as they struggle to contain the region�s long-running debt crisis.

In the end, nine euro-zone countries saw their ratings cut on Friday, with France and Austria both losing their triple-A ratings. Germany, Europe�s biggest economy, saw its triple-A remain intact.

If that weren�t enough, fears of a messy default by Greece were also on the rise after talks between private creditors and the government over proposed voluntary writedowns on Greek government bonds appeared near collapse.

Click to Play Greece edges closer to a default

Greece appears to be close to default on its sovereign debt once again, eclipsing last Friday's news that France and other euro-zone members lost their triple-A credit ratings.

�At the start of this year, [we] took the view that things in the euro zone had to get worse before they got better. With the S&P downgrade of nine euro-zone countries and worries about the progress of Greek debt restructuring talks, things just did get worse,� wrote economists at HSBC.

European equity markets swung between small gains and losses Monday, while the euro mounted a modest rebound after posting 16-month lows Friday as news of the imminent downgrades leaked.

Politicians sought to control the damage, but the moves by S&P don�t mark the last word. Here�s a look at some of the outstanding issues.

EFSF

The European Financial Stability Facility, or EFSF, is the euro zone�s temporary rescue fund. It�s triple-A rating rests on guarantees from euro-zone countries. And with France, the region�s second-largest economy no longer rated triple-A, the EFSF is seen as likely to lose its triple-A as well unless euro-zone governments boost their contributions.

With the European Central Bank unwilling to go whole hog in snapping up troubled European government bonds, the EFSF is still seen as an important-but-undersized safety net for banks and troubled sovereigns.

This comes as efforts to boost the firepower of the fund have failed to gain traction, with Berlin and the ECB resisting calls to provide leverage through the central bank and China and other foreign investors balking at making large-scale investments in the fund.

Euro-zone countries have provided guarantees of 780 billion euros ($986 billion) to the EFSF, which gave it triple-A lending power of �440 billion.

With France and Austria losing their triple-A ratings, the fund�s triple-A funding power drops to �271 billion, said fixed-income strategists at Commerzbank.

While finance ministers from the 17 euro nations issued a statement saying they would explore the options for maintaining the EFSF�s triple-A rating, comments from German officials indicate Europe�s biggest financial power would prefer to settle for a double-A-plus rating.

�I was never of the opinion that the EFSF necessarily has to be triple-A,� Merkel said in a radio interview, according to Bloomberg. �Double-A-plus is also not a bad rating.�

The EFSF is set to be replaced by a permanent rescue fund, the European Stability Mechanism in July.

But in the meantime, investors could be put off owning euro-zone assets �if the financial safety net looks like it is threatened at this critical stage in the debt saga,� said Kathleen Brooks, research director at Forex.com.