If Moody's Downgrades Banks, Will Anybody Care?


Moody's (NYS: MCO) definitely succeeded on one front yesterday -- it spurred some awfully concerning headlines.

The ratings agency put a whole gob of global banks on review for potential downgrade. UBS (NYS: UBS) , Credit Suisse, and Morgan Stanley (NYS: MS) were at the front of the firing line, supposedly at risk for a three-level rating cut. But they're hardly alone: Goldman Sachs and Citigroup (NYS: C) are among the banks that may be cut two levels, while Bank of America (NYS: BAC) and a few others may be dropped one level.

At a time when financial markets are still only starting to get their sea legs back and investors are ripping their hair out about Greece and the rest of the eurozone, this seems like a troubling potentiality. According to Bloomberg, if the maximum downgrades hit, it would force U.S. banks to raise $19 billion in new "collateral and termination payments."

Considering the significance of the potential cuts, one might wonder what drove Moody's action. As The Wall Street Journal describes it, the rating giant's concerns were focused on capital markets activities, and were "about everything from funding to pay structures, not necessarily new concerns." It continues:

For instance, Moody's points out that capital markets activities create "complex, highly leveraged" balance sheets that are "typically laden with opaque risk exposures that can change rapidly."

Attempts to manage risk can't be measured, Moody's argues, so it's hard to know how a bank is doing. And given risk management "can be tedious and expensive to perform, especially during bull markets" what's to keep cheeky banks from pushing that aside.

Is it just me, or do you get the sense that Moody's is, oh, let's say, five or 10 years too late?

If anything, banks have gotten safer since the financial crisis. Don't misconstrue that as me saying they're safe, but when you consider the lunacy that was taking place prior to the systemic supernova, there's considerably less to be worried about today.

Not that flexing keen 20/20 hindsight is anything particularly new for the major ratings agencies. In exploring the MF Global bankruptcy, my fellow Fool Alex Dumortier noted that Moody's was way behind the curve: "As far as Moody's goes, we could find no evidence of any warning or even mention of MF Global's European sovereign debt positions at any time prior to the first downgrade on Oct. 24."

By that time, MF Global had been disclosing its sovereign debt positions in SEC filings for months. Thanks in large part to that bloated eurozone debt, the company declared bankruptcy seven days after the downgrade Alex highlighted.

And don't even get me started on the rating agencies and their performance when it came to products like collateralized debt obligations and mortgage-backed securities.

This isn't news to any of the folks actually buying and selling the bonds that Moody's, Standard & Poor's, and Fitch are rating. At this point, it seems like the bond market puts as much stock in rating-agencies' views as they do in astrology, ancient alchemy, or the colorful views of Gary Busey. When S&P downgraded U.S. Treasuries last year, the move was met with a worldwide shrug and snicker. Since then, Treasury yields have only fallen further as investors continue to flock to the perceived safety of U.S. debt.

The same seems to be the case for this threat of banking downgrades from Moody's. The banks highlighted broadly finished up on the day. Bank of America tacked on 4%, UBS added more than 3%, and even Morgan Stanley was in the black more than 1%.

It's a tough position I find myself in here. It's like watching the guy in the park that's boogying to the beat of the music in his own crazy head. While I want to avoid joining the laughing-and-pointing crowd, I still can't help giggling at the spectacle.

In the end, Moody's is probably right to be bearing down on the banks and highlighting the risks of opaque and risk-hungry institutions. But it -- and the other two major ratings agencies -- just seems so out of step and out of tune with what's been happening over the past decade that the whole thing just ends up seeming comical.

And if that flood of downgrades actually does come? One thing that seems almost sure is that the market will meet it with a big yawn.

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At the time thisarticle was published The Motley Fool owns shares of Citigroup and Bank of America. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group and Moody's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Matt Koppenheffer owns shares of Bank of America and Morgan Stanley, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

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