Moody's ratings cut for giant banks: a new weight on US economy
Moody's downgrade of the US banking system, following turmoil in Europe's banking sector, is a blow to reputation of banks but is not expected to tip the economy into recession.
That‚Äôs because the cost of doing business for these giant financial institutions such as Citigroup, Bank of America, and J.P. Morgan Chase, will go up as result of having their rating lowered. The banks will then either pass along their higher costs ‚ÄĒ such as the higher interest rates they will have to pay to borrow money ‚ÄĒ or will have lower profits which will again inhibit their ability to lend.
‚ÄúThe Moody‚Äôs downgrade is not a positive for anyone,‚ÄĚ says Sung Won Sohn, a professor of finance at California State University, Channel Islands, and a former banker. ‚ÄúThe lower ratings means their ability to lend will diminish.‚ÄĚ
However, some analysts doubt that the Moody‚Äôs action by itself will tilt the economy into a recession.
‚ÄúThe downgrade itself is not a waterfall event nor will it trigger a sudden decline in economic activity,‚ÄĚ says Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. ‚ÄúA few marginal borrowers may be turned down for loans at best.‚ÄĚ
Mr. Dickson worries that the downgrade is yet another psychological hurdle for consumers. After watching some of the largest banks in the nation have their debt downgraded, consumers may decide to hunker down. ‚ÄúI think there is more psychological damage than real damage,‚ÄĚ he says.
Moody‚Äôs downgraded the long-term senior debt ratings of four banks by one notch, while the ratings of 10 financial companies were downgraded by two notches, and one firm had its ratings lowered by three notches. A notch is simply a credit level.
A bank's credit rating is an important indication of what outside organizations think of it.
‚ÄúIn the wake of the Moody‚Äôs downgrades, the banks reputational risks has suffered,‚ÄĚ says Mr. Sohn. ‚ÄúFor financial institutions reputation is very important.‚ÄĚ
Many analysts had been worried that Moody‚Äôs would lower the debt of Morgan Stanley by three levels. Morgan Stanley‚Äôs executives had argued that the firm had strengthened its finances and should not get that steep a cut. Moody‚Äôs, in lowering Morgan Stanley‚Äôs debt by two notches, noted that the financial firm was helped by the deep pockets of one of its investors, the Mitsubishi UFJ Financial Group, and the belief that Morgan Stanley would be deemed too big to fail and thus get the support of the US government, if it were in danger of defaulting on its debt.
All of the banks that were downgraded by Moody‚Äôs are deeply involved in the global capital markets. ‚ÄúThese activities can provide important ‚Äėshock absorbers‚Äô that mitigate the potential volatility of capital market operations, but they also present unique risks and challenges,‚ÄĚ wrote Moody‚Äôs Global Banking Managing Director Greg Bauer in Moody‚Äôs review.
Those risks and challenges have been illustrated by the travails of J.P. Morgan Chase, which has already said it lost at least $2 billion in a series of complex trades that turned bad. J.P. Morgan‚Äôs CEO, Jamie Dimon, has had to apologize to the firms‚Äô shareholders and been questioned ‚ÄĒ and sometimes tongue-lashed ‚ÄĒ by members of Congress in two recent committee hearings.
Sohn points out that the only major bank that was not downgraded by Moody‚Äôs was Wells Fargo which is mainly in the consumer banking business.
The rating downgrades had been expected, since Moody‚Äôs had indicated three months ago it was looking more closely at the banks and financial institutions and would issue a report by the end of June. Nevertheless, the stocks of the banks dropped sharply on Thursday as rumors began to swirl that Moody‚Äôs was about to issue its report after the markets closed. Many of the banks‚Äô stock prices fell between 2 to 3 percent.
This drop has prompted David Kotok, the Chief Investment Officer of Cumberland Advisors¬† of Sarasota, Fla. to decide to buy bank stocks. ‚ÄúThe banking system is for sale below book value,‚ÄĚ he says. ‚ÄúThat‚Äôs cheap.‚ÄĚ
On Friday morning, it appeared that other investors also agreed that the market looked like a bargain. After falling 250 points on Thursday, the Dow Jones Industrial Average was up 76 points at 10 a.m. on Friday, and bank stocks rebounded as well.¬†
However, the downgrade of the banking system comes at a time when investors are still nervously watching European authorities attempt to cope the need to provide more capital to many of the continent‚Äôs banks. On Thursday, for example, Spain said its banks would need another $78.75 billion in new funding.
On Wednesday, Federal Reserve chairman Ben Bernanke said the Fed was watching the European banking situation closely. The turmoil in Europe was one of the reasons why the Fed lowered its estimate of economic growth in the US for 2012 by 0.5 percentage points and for 2013 by 0.3 percentage points. The Fed also said it would continue a program of selling some of its short term investments and buying longer term bonds in an effort to lower interest rates over a longer period of time.
However, Wall Street was generally disappointed by the Fed‚Äôs move. ‚ÄúIt was tepid,‚ÄĚ says Mr. Kotok. ‚ÄúWe‚Äôre not out of the woods yet."¬†¬†