(NEW YORK) MintPress – Both Wall Street and Main Street have been bracing for a sweeping downgrade of major banks since February, when credit ratings agency Moody’s said it would review the status of more than 100 financial institutions around the world.
Still, it is the first time that Moody’s has imposed a widespread ratings cut on banks since 2007, a move that prompted investors to flee and severely hit the banks’ bottom lines.
Credit ratings are especially important to banks because they borrow a great deal of cash, which means a downgrade raises the cost of their loans. They also have to put up huge amounts of collateral in their capital markets operations, and a lower rating means they have to put up more of it to back up their financial activities.
That cuts into profitability because it ties up cash that could be earning money elsewhere.
Moody’s described its latest action as part of a sweeping overhaul of its ratings on global lenders. “All of the banks affected…. have significant exposure to the volatility and risk of outsized losses,” said Greg Bauer, a managing director of global banking at Moody’s, in a statement.
It targeted institutions with big trading operations, some of which, like Bank of America and JP Morgan Chase, also deal directly with consumers.
Biggest US banks pay the price
Just last month, JP Morgan disclosed that a London-based trader’s huge bet on financial instruments tied to corporate bonds had to be shut down at an estimated loss of $2 billion.
Moody’s cut JP Morgan’s long-term rating by two notches and also reduced long-term ratings by two levels at Goldman Sachs, Morgan Stanley, Bank of America and Citigroup.
It downgraded the ratings of giant European banks as well, including Deutsche Bank, Barclays, HSBC, Credit Suisse, Royal Bank of Scotland, BNP Paribas, Credit Agricole, Societe Generale and UBS. The cuts also hit Royal Bank of Canada.
“The risks of this industry became apparent in the financial crisis,” said Robert Young, a managing director at Moody’s. “These new ratings capture those risks.”
Game of catch up?
But critics say that the ratings agency’s latest actions are too backward-looking and do not take into account the measures that banks have taken to strengthen themselves, including raising capital and getting out of certain risky businesses like proprietary trading.
During the financial crisis, Moody’s and its competitors came under fire for placing high ratings on mortgage bonds that later blew up.
“While Moody’s revised ratings are better than its initial guidance of up to three notches, we believe the ratings still do not fully reflect the key strategic actions we have taken,” Morgan Stanley said in a statement.
Citigroup also issued a response, saying that Moody’s “fails to recognize Citi’s transformation over the past several years.” It added, “Citi strongly disagrees with Moody’s analysis of the banking industry and firmly believes its downgrade of Citi is arbitrary and completely unwarranted.”
Bank of America agreed, stating, “In addition to strengthening our governance and risk management, Bank of America ended the first quarter of 2012 with record capital ratios.”
Investors, for their part, seemed to echo those sentiments, bidding up the price of all 15 banks the morning after the announcement.
Financial impact
Still, the lower ratings are likely to increase the companies’ borrowing costs and affect their ability to raise capital.
The affected companies have already estimated some of the direct costs of a downgrade, measured in terms of additional collateral they would have to post or termination payments they would have to make.
Morgan Stanley said in its first-quarter report to regulators that a downgrade by major ratings firms to the new level imposed by Moody’s could cost $6.7 billion, while Goldman Sachs said its costs could hit $2.2 billion for a two-notch reduction.
Bank of America said a one-notch downgrade could mean a hit of $2.7 billion.
Legacy of government bailouts
At the same time, it’s not likely that the government will repeat the past and offer to rescue the banks.
In 2008-2009, Congress, at the urgent request of President George W. Bush, passed the Troubled Asset Relief Program or “TARP”, which resulted in a $700 billion loan to the leading banks. Although they have largely repaid the money and the net cost of TARP may eventually be in the range of $30 billion, the move remains hugely controversial.
After President Obama took office, Paul Volcker, the chairman of his White House Economic Recovery Advisory Board, said that bailouts create moral hazard. “They signal to the firms that they can take reckless risks, and if the risks are realized, taxpayers pay the losses, also in the future.”
In July 2010, Obama signed into law the Dodd-Frank Act, whose stated aim is “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”
Still, the government’s rescue of the banks remained a major issue in the 2010 mid-term election, with the tea party movement focusing its attack on bailouts.
The public outcry also triggered the Occupy Wall Street movement — established in September, 2011 — of the so-called 99% that will no longer tolerate the greed and corruption of the 1 percent.
As the latest downgrades make potently clear, four years after the onset of the financial crisis, the problems are far from over.