If Moody's Downgrades Banks, Will Anybody Care?

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Moody's (NYSE: 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 (NYSE: UBS  ) , Credit Suisse, and Morgan Stanley (NYSE: 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 (NYSE: C  ) are among the banks that may be cut two levels, while Bank of America (NYSE: 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.

There are bank stocks that some of the smartest investors are buying, but they're not not the big investment banks. To find out which banks make the cut, grab a free copy of The Motley Fool's free special report, "The Stocks Only the Smartest Investors Are Buying."

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.

Read/Post Comments (8) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 17, 2012, at 1:00 PM, steveat wrote:

    As much as I WANT to invest in these financial institutions, I feel that we are not out of the waters yet. I'm actually not quite sure if Moody's has downgraded anyone yet? Isn't that stuff supposed to be released in a few weeks?

    I don't think Greece is out of trouble yet either. There is no way they will be able to continue running the country with the restrictions they have agree to, however, the Greek economy is relatively small and even if it did go belly up, it won't affect us that much.

    The problem is Italy! After Greece, there will be talks with Italy and the problem there is that Italy represents about 17% of the EU economy whereas Greece I believe hovers around 2%. yeah, BIG difference. If italy is even half as problematic as Greece, we are screwed. Everyone is and so is the Euro. Basically Italy is bigger than Ireland, Spain, Portugal and Greece combined.

    There is at least one major dip left to go and that is what I am waiting for, but that may not come till the end of the year and by that time, who cares. We all know the world will end. The Mayans, Italians, Chinese, Indians and tribes in Africa have all fortold the prophecy 8-)

  • Report this Comment On February 17, 2012, at 1:21 PM, TMFKopp wrote:

    @ steveat

    "I'm actually not quite sure if Moody's has downgraded anyone yet?"

    No, not yet, they are reviewing the banks and considering downgrades.

    "There is at least one major dip left to go and that is what I am waiting for"

    I've always found that a tough approach to take. There will *always* be another dip at some point. But when? And when it comes will I consider it enough of a dip? Or might I get tired and worn down from waiting and end up missing out on much of the gains before the dip, but still jump in before the dip?

    Trying to guess those kinds of moves has always seemed a little to crystal ball-y for me. I just stick to looking at company values and when they're attractive, I buy. When they're not, I don't (or I sell). But that's just me...


  • Report this Comment On February 17, 2012, at 2:29 PM, Teacherman1 wrote:

    If you are into foreign banks like STD and BBVA, you might want to take note that the short sell ban

    was lifted on them.

    They are kind of "see sawing" right now, but if you are a long term investor, they are both still at reasonable prices, and if we have another "Euro Crisis Alert", they might get shorted down to an even more attractive level.

    For the record, I am long both at under $8, but still looking for an opportunity to add some more for a longer term hold.

    If you don't like the "big banks", HBAN is a good solid, conservative, well run bank that has been "hovering" just under $6, but is up some today.

    I am long HBAN too, but may sell and buy back in on the next "gloom and doom" secnario for the banking industry.

    JMO and worth exactly what I am charging for it.

  • Report this Comment On February 17, 2012, at 3:02 PM, DJDynamicNC wrote:

    Nailed it here. I'm not sure why anybody would take the ratings agencies seriously anymore, and apparently the markets agree. Their value is predicated on predicting what makes a good investment risk and they've proven singularly inept at making that prediction.

  • Report this Comment On February 17, 2012, at 9:02 PM, Frisia wrote:

    The influence of the rating agencies is disproportionate to their value; where were their advices when we really needed them?

    They totally missed the financial sector problems in 2008. They even kept triple A recommendations for the institutions causing the meltdown!

    The same again for MF Global, they did not see it coming.

    Now the advices of these agencies are merely disruptive for institutions and companies that are taking measures to improve themselves. These negative ratings, based on questionable data, really don't help to improve the situation.

    Maybe they have a hidden agenda?

  • Report this Comment On February 18, 2012, at 1:46 AM, LatifK wrote:

    If only these same "rating agencies" had this same kind of vigilance and voraciousness to be the bell weather they are supposed to be, these rating cuts might actually have some meaning.

    Their behavior right now, is much like the worker after having been busted sleeping on the job... they are trying their best to show they still provide value and are relevant, but in reality everyone around them has already realized that they really serve no function at all, and that perhaps one less cog in the wheel is just what is needed.

  • Report this Comment On February 18, 2012, at 3:18 PM, Realexpectations wrote:

    I personally think these rating agencies are scam. Wall Street is rigged in one way or another. Just like everyone knows politicians are employees of wall street. I say the same thing about the agencies.

    Like you said 5-10 years too late?

    You have to actually ask, will the market care?

    Huh, wonder why that is?

    I think the market is it's own rating agency, stocks typically go the direction of their worth.

  • Report this Comment On February 19, 2012, at 3:37 PM, JacksonInVA wrote:

    This article highlights some of the reasons I have no positions in the financial industry. I have no faith that the risks can be known. In addition, I am still just down right angry, particularly at Goldman Sachs. GS should be broken up into very small little pieces and cast to the wind.

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