Due Diligence
Moody’s Says Too Big To Fail May Be Dead; Threatens To Cut Bank Ratings

Moody’s Says Too Big To Fail May Be Dead; Threatens To Cut Bank Ratings

TOo Big To FailNot that anyone has much faith in the ratings agencies anymore, but Moody’s announced Thursday that it may downgrade the debt ratings of Bank of America, Citigroup and Wells Fargo due to a reduced appetite in Washington to bail out the banks under Dodd-Frank. Moody’s said that debt ratings for J.P. Morgan, Goldman Sachs, Morgan Stanley and State Street Corporation could come under review for the same reason.

Following the market meltdown of 2008-2009, the government poured many hundreds of billions of taxpayer money into bailouts of U.S. financial institutions—the most notorious being the bailout of AIG. To prevent such a thing from happening again Dodd-Frank provided for the creation of a “resolution authority” that would create a system for the orderly unwinding of the country’s largest banks in the event of their failure.

But the Moody’s downgrade talk is a little funny—and late. For one thing, we are approaching the one-year anniversary of passage of Dodd-Frank, so its contents have been known for some time. Of course, many of the details have still to be ironed out. But why did Moody’s wait until now to make this assessment? Further, few think Too Big To Fail has gone away. While one of the aims of Dodd-Frank was certainly to remove that moral hazard—the market perception that some banks enjoy implicit government support—few people think that it actually succeeded at doing that, including Yale economist Robert Shiller. In fact, some think Dodd-Frank made the problem worse, including David Skeel, who we interviewed here.

Could it be that, in the wake of a recent SEC proposal to overhaul the rating agencies’ business, Moody’s just wants to show it can indeed be tough on the banks? SEC commissioner Mary Schapiro announced in mid May a set of proposals to reform the ratings agencies’ business, including better internal controls and more transparency concerning how they determine their ratings. What do you think?

From Moody’s note:

“Today's rating actions reflect Moody's view that, in light of developments on the Dodd-Frank Act that have occurred to date, the unusual levels of uplift incorporated into the ratings of Bank of America, Citigroup, Wells Fargo may no longer be appropriate,” Moody’s wrote in a note about its plan to review the bank ratings.

“The US government's intent under Dodd-Frank is very clear,” says Moody’s Senior Vice President Sean Jones, according to the note. "Going forward, it does not want to bail out even large, systemically important banking groups." Mr. Jones notes however that Moody's continues to believe that such a group could not be resolved without risking a disorderly disruption of the marketplace and the broader economy. "Even so, the support assumptions built into these three banks' ratings are unusually high, which may no longer be appropriate in the evolving post-crisis environment," added Jones.

“Moody's also continues to evaluate whether it should reduce to below even pre-crisis levels its support assumptions for the eight US banks that currently benefit from ratings uplift. In this context, the rating outlook on the deposit, senior debt, and senior subordinated debt ratings of Bank of New York Mellon has been changed to negative from stable. This brings its outlook into line with that of the other US banking groups whose debt and deposit ratings benefit from government support assumptions: JPMorgan Chase & Co, The Goldman Sachs Group, Inc., Morgan Stanley, and State Street Corporation.

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