It’s hard to imagine anyone will take tough-sounding stances by ratings agencies seriously, but Moody’s, in a chat with the Financial Times, says it has (finally) taken notice of how banks play games with regulatory capital requirements. Sheila Bair noted in an interview at the Atlantic economy summit in March that in retrospect, one comparison that flushed out banks that were likely to get in trouble was that the were in compliance with risk weighted capital rules but also had very high levels of leverage (simple equity to total assets measures).
The Moody’s step takes place by updating its risk models to adjust for bank phony baloney. I’d also be thrilled if they started adjusting ratings for lack of transparency, but we’ll take what we can get. And this adjustment isn’t mere lip service; a wave of downgrades is coming based on this change.
Notice that the Moody’s rating action and model change will pressure the other ratings agencies to follow suit. I’d really get a kick out of it if Moody’s were to start to issue industry commentary that discussed at length how banks were gaming capital requirements. Heretofore, that sort of discussion relegated to the nether regions of discourse, which these days is the blogosphere, academia, and foreign TV. Remember, when Bill Black said on the Bill Moyers show that the initial stress tests in 2009 were a sham, not a single reporter called him up, even though that charade continued for another month. Even if the revised ratings don’t adequately reflect the level of bank chicanery, this change will make it much more mainstream to talk about regulatory arbitrage, both in general and in detail.
Key sections of the Financial Times account:
The credit rating agency announced it was placing 17 banks on review for a downgrade earlier this year, citing “vulnerabilities” in the companies’ vast and volatile capital markets businesses….
But in an interview with the Financial Times, Moody’s banking analysts said the agency was updating its financial ratings to take into account the historical tendency of banks to leverage their balance sheets and arbitrage global financial rules, often to the detriment of the banks’ own health and the safety of the wider banking system…
Moody’s caution could see all 17 banks downgraded when the review is finally completed, expected to happen in mid-June. Three of the banks, Credit Suisse, Morgan Stanley, and UBS, face as much as a three-notch downgrade; 10 face a two-notch slide and four a one-notch drop.
We’ll see just how serious these model adjustments are when the ratings come out next month. And there may be another layer of kabuki here. We were sympathetic to the argument that Standard & Poor’s was manipulating the debt rating of the US to escape liability for its role in the crisis (recall the huge scare in late summer 2011 that the downgrade would be The End of the World As We Know It?). This move to recognize how capital rules are undermined by the banks is welcome but overdue. One has to wonder if at least some of the motivation is to put the official critics of the ratings agencies on the back foot.