Why Moody's Took a Hatchet to the Banks

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Investors are licking their wounds following Moody's downgrade of 15 of the biggest banks in the world on Thursday afternoon, especially since the hit coincided with the Dow closing down 250 points, bringing the second-worst trading day of 2012. Already, top banks like Bank of America, JPMorgan Chase, and Goldman Sachs, all downgraded between two and three notches, are protesting the move as "backward-looking." Why did Moody's do it?

Moody's is trying to compensate for messing up in 2008. The severity of the downgrade, despite some signs that banks have recovered, has led some to believe Moody's is repenting for previous sins. The Moody's downgrades are “a mea culpa from 2007 and 2008,” James Leonard, a credit analyst at Morningstar, told Bloomberg's Dakin Campbell and Michael Moore.  “The banks have gotten so much better in the last few years in terms of capital, yet their ratings keep going down. What does that tell you? That the ratings were so wrong before.” Gerard Cassidy, a bank equity analyst at RBC Capital Markets, agrees. “American banks are stronger today than they were three years ago,” he said. “Yes, their ratings are lower, but is Citi tomorrow going to have to pay an extra 50 basis points for commercial paper? I don’t think so.” 

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U.S. Banks are just plain riskier. One of the main frustrations from U.S. banks responding to the downgrade is the comparatively more favorable treatment of Asian banks by Moody's. But analysts speaking with The Associated Press say it's deserved. “The trade-offs for Western banks, purely from a profitability perspective, may favor the prop desk and trading and hedging,” said Anand Pathmakanthan at Nomura Equity Research. “The banks here in Asia are much more fundamentally sound and much easier to understand than say, Citigroup or JPMorgan, which events have shown, nobody really knows what’s going on there.” The AP adds that "the lure of larger profits from riskier, highly leveraged trading may prove too tempting compared with traditional banking such as loans for housing or small businesses, which require high volume and a network of branches to boost returns." In the note from Moody's, global banking managing director Greg Bauer said all the banks “have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities."

JPMorgan Got the Ball Rolling. As Bloomberg's Dawn Kopecki reports, the $2 billion in trading losses at JP Morgan's chief investment office was an "important factor" in Moody's decision, according to the ratings service. "JPMorgan benefited from the assumption that there’s a 'very high likelihood' the U.S. government would back the bank’s bondholders and creditors if it defaulted on its debt, according to the statement," she wrote. "Without the implied federal backing, JPMorgan’s long-term deposit rating would have been three levels lower and its senior debt would have dropped two more steps, Moody’s said."

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