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Moody's Blues: Major U.S. Banks Prepare For Possible Downgrades

"The Moody's action is concerning because it's the beginning of what you might continue to see."

Several major U.S. banks, including J.P. Morgan Chase, Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc., and Morgan Stanley, are preparing for the possibility of a downgrade by Moody's Investment Service that could come by the end of this week, the Wall Street Journal reports.

The looming downgrades, which have been in the works since February, have leaders on Wall Street up in arms.

Citigroup chief financial officer John Gerspach said last month that the Moody's ratings method "is backward looking and does not provide adequate credit to the strength and diversity" of Citi's business or its main banking subsidiary, Citibank, according to a recent Dow Jones report.

"Every time Moody's downgrades, it's going to lower our universe of what we can buy," David Fishman, co-head of global liquidity management for Goldman Sachs Asset Management, told the Journal.

Image courtesy the Wall Street Journal

The downgrades come at a bad time when the markets are already on edge due to the ever-growing financial crisis in the eurozone, the likelihood of a Greek exit, and the economic slowdown in China.

Furthermore, the effects of the downgrades could be far-reaching as analysts predict they will affect how “municipalities raise money to provide services and build schools, how money-market funds invest cash from companies and savers, and how banks raise capital to support their lending and trading,” the Journal  reports.

The downgrades will only add to an already complex formula investors use to price debt. That is to say, investors don’t rely solely on ratings from Moody’s, S&P, and Fitch.

“In addition to bond ratings, investors look at capital ratios, loan-loss reserves, spreads of bonds and credit default swaps, earnings and business strategy, and macroeconomic factors and geography, according to the presentation,” the Dow Jones reports.

“One important market metric -- the price of insuring bank debt -- suggests investors indeed are looking beyond bond ratings when they gauge risk levels,” the report adds.

However, this isn’t to say that the downgrades, should they happen, wouldn’t adversely affect these businesses.

“The biggest impact could be to deprive some institutions of trading revenue,” the Journal reports. “A three-notch downgrade of Morgan Stanley could slash demand for derivatives, a crucial business on Wall Street, by around 30 [percent].”

Moody’s may downgrade Bank of America by one notch, Citi, Goldman, and J.P. Morgan by two, and  Morgan Stanley by three.

"The Moody's action is concerning because it's the beginning of what you might continue to see," said James McCarthy, co-head of global liquidity management at Goldman Sachs Asset Management.

Click here to read the full WSJ report.

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