Curious Capitalist

Moody’s Downgrades — Should We Care?

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Mike Segar / Files / Reuters

You’d be forgiven for asking who cares about Moody’s downgrading yesterday of 15 of the world’s biggest banks, including giants like Credit Suisse, Morgan Stanley, Barclays, BNP Paribas, Citigroup, Goldman Sachs, JPMorgan Chase and Bank of America. After all, Moody’s is one of the credit-ratings agencies that ranked subprime-mortgage bonds AAA before they exploded into the financial crisis.

What’s more, though the S&P fell 2.44% before yesterday’s closing bell, the downgrades had largely been priced in already. That’s because Moody’s had been warning about the action since February, and since then, there’s been plenty of bad economic news — the worsening of the euro-zone crisis, slowing growth in the U.S. and emerging markets and fears of a global double dip — that has affected many banks’ balance sheets. Recall that JPMorgan’s recent high-profile $3 billion loss was the result of a trade designed to hedge the risk that a lot of plain-vanilla loans were going south as the global economy worsened.

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The credit downgrade means two important things for banks. One is that many institutions they do business with face rules about the credit ratings of their counterparts — and those financial players might be inclined to shorten contracts or demand more collateral to do business with the downgraded banks. As a result, the downgraded banks may see their costs of doing business rise by a few billion dollars (which, it’s worth noting, is still chump change for most of these institutions).

We’ll know more about the immediate impact of the downgrades as the market starts to move on Friday, but longer-term, there’s no doubt where things are headed. Banks’ profit margins are being squeezed as they are under pressure to hold more capital, take less risk and basically act a lot more conservatively than they have in the past. In short, banks are slowly but surely moving from being casinos to being utilities. For more on the hows and whys of that, check out some of the seminal articles on “The New Normal” written by the very smart folks at PIMCO right after the financial crisis.

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