Moody's mass downgrade of bank credit ratings was being parsed by the markets Friday as a destabilizing development that could trigger future collateral crunches at some of the world's top financial institutions, a new hit to the credibility of global banking and even a game-changing development that was tilting the field towards more conservative banking.
Lost in the post-downgrade murmurs, however, was a more insidious conclusion: Moody's action on Thursday was a shot across the bow of world governments -- a veiled threat that pointed at politicians in Germany, the United Kingdom, France and the United States and plainly stated, Stop talking about making the banks responsible for their own follies -- or else.
It's almost difficult to overstate how much Moody's Thursday action was about government. The word government appears 48 times in the Moody's statement, more times than words such as earnings (40), management (32), liquidity (31), funding (24), revenue (16) or a whole host of other concepts that, back before the era of corporate socialism, were considered to be the key factors on which the creditworthiness of a bank was gauged.
Not that a calculator is needed to understand the outsize role Moody's view of governments around the world is. Right in the beginning of the statement put out Thursday, under the section meant to explain the agency's rationale for downgrading senior debt and deposits, Moody's explains it is acting in response to the clear intent of governments around the world to reduce support for creditors and has now adopted a view that government support is likely to become less certain and predictable over time.
It gets even better (or worse, depending on where you're sitting on the issue).
Moody's explains in its downgrade of the senior debt of various U.S. and British banks that it is not hitting the rating assessment on these instruments too hard, because it believes there's a very high likelihood of support from the respective national governments should institutions like Bank of America, Goldman Sachs, Citigroup, Barclays and HSBC fail. At the same time, the ratings agency notes it is downgrading its long-term outlook on these banks, as it understands that support will decline in the future, perhaps sometime in 2022, after President Palin announces she's shifting federal moneys away from feeding homeless, veteran-orphaned AIDS babies so that Goldman Sachs' bondholders can be made whole for the fourth time.
Moody's view is more nuanced for its expectation of Swiss government action. It also sees the government as ready to bailout senior bondholders in Credit Suisse and UBS but heavily downgrades ratings on subordinate debt on the assumption that, should the banks in Zurich get in trouble again, Geneva might take the radical Marxist action of letting investors in highly speculative uninsured bonds actually experience some capitalism.
The real interesting stuff, however, is how Moody's says it now believes the French and German governments will act to protect their banking industries in times of stress.
Undoubtedly interpreting that a new Socialist government in France is likely to be more hostile to banking interests, Moody's does not display the same level of unbridled confidence on the belief the Palais de l'élysée will be there to save Société Générale, Crédit Agricole or BNP Paribas should any of those institutions stumble. Instead, it spells out that its senior ratings incorporate three notches of uplift from government support assumptions. But, the ratings agencies then slashes the bank's nonsenior ratings, explaining that in Moody's view, government support in many European countries, including France, is no longer sufficiently predictable or reliable to warrant incorporating government support-driven uplift into these debt ratings.
The message to newly minted French President François Hollande is clear: Keep talking about making the banks the masters of their own destinies, and we'll nuke their ratings.
Credit rating agencies' assessment of banks remain highly important in the financial world. Funds use them to determine which kind of assets they can invest in. Automated computer programs use them to arbitrage in terms of price for bonds stocks and bonds. And most importantly, bank counterparties incorporate them into lending and borrowing contracts, meaning the difference between several notches in ratings can translate into billions of dollars in interest rate or collateral payments.
Whether or not the ratings agencies should be so powerful is a topic of passionate debate. And it is likely to get even more passionate once people truly grasp the audacious nature of what the Moody's statement Thursday means for Germany.
Like it did for the U.S., the U.K. and Switzerland, Moody's stated it saw a very high likelihood of support from the German government to bondholders in Deutsche Bank should the financial crisis take down Continental Europe's largest bank. But unlike its caveats made for banks in those other countries, Moody's does not downgrade Deutsche's long-term outlook or its subordinate ratings with a view that the German taxpayers might eventually say Enough! with all the bailouts. Indeed, Moody's states the only reason they are even touching Deutsche Bank is because of overly risky ambitions in capital markets.
To recap that logic:
Dear Frau Merkel: We hope everything is well with the whole bailing out the Irish, Portuguese, Spanish, Greek and Italian banking systems. Just as a reminder, we're counting on you to be there with your magical bucket of trillions whenever the insane derivatives traders pulling in seven figures in Düsseldorf see their whole 'risk-less' money-making schemes collapse. Love, Moody's
On a related note, the Dow Jones Bank Titans 30 Index, a global benchmark of large financial institutions, is trading nearly flat from before the announcement by Moody's, down some .07 percent, perhaps on the assumption that the more things change, the more they stay the same