Moody's Downgrades the Big Banks While Europe Burns

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(Reuters)

In the land of the incompetent, the semi-competent is king.

On Thursday, the credit rating agency Moody's downgraded pretty much every big bank. Credit Suisse was hardest hit, with a three-notch downgrade. Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup, Deutsche Bank, Barclays, UBS, Crédit Agricole, BNP Paribas, and the Royal Bank of Canada all got a double-notch downgrade. Bank of America, HSBC, Société Générale, and the Royal Bank of Scotland received single-notch downgrades.

Whew.

It's tempting to say this is irrelevant. Really tempting. Bank stocks are up on Friday, so markets don't seem overly concerned. Whether it's giving their AAA stamp of approval to toxic waste during the bubble or downgrading the U.S. only to see U.S. borrowing costs fall to historic lows, the credit rating agencies (CRAs) aren't exactly known for their prescience.

But the bank downgrades aren't completely irrelevant. As Felix Salmon points out, these systemic downgrades highlight that the banking system still has, well, systemic problems. Namely, that the interbank lending market still isn't completely back to normal. Banks are clearly in much better shape than they were in 2008 -- at least in the U.S., if not Europe -- but there's still a ways to go. 

Then there's the collateral issue. The downgrades mean banks will have to post more collateral --- i.e., cash -- on their trades. Banks will be under even more pressure to deleverage. In other words, sell off assets to raise more cash and/or buy ultra-safe bonds. European banks have already been doing this for months to get ready for the new Basel III banking regulations that require higher capital ratios. This will not help.

Bank deleveraging is all well and good -- just not now. To borrow the old line from Saint Augustine: Grant me chastity and continence, but not yet. If banks are shrinking their balance sheets, they're not making as many loans. And if they're not making as many loans, growth will slow. 

Europe doesn't need that right now. If you haven't heard, things aren't going so well over there. Italian prime minister Mario Monti recently said they have about a week to save the euro. That might make him an optimist nowadays. Shadow banks -- unregulated lenders who are banks in all but name -- have stopped accepting anything but the best collateral. Lots of banks, particularly ones in Spain, don't have anything but the worst collateral. The European Central Bank (ECB) has tried to alleviate this incipient credit crunch by loosening its collateral standards. In plain English, Eurobanks can now get loans from the ECB in exchange for even junkier junk. That's the best -- and most frightening -- sign of how bad things still are. Say hello to the precipice.

We don't need Moody's to tell us this. But it's good to know that the real possibility of financial Armageddon hasn't eluded them. These guys are good.
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Matthew O'Brien

Matthew O'Brien is a former senior associate editor at The Atlantic.

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