S&P Sees Profound Changes Coming to the Banking System

The series of events that have led to the shutting down of the credit markets and eroded confidence in the global financial system will lead to the most profound changes in the banking system since the Great Depression, according to Standard & Poor’s Ratings Services.

In a new report "How The Credit-Market Crisis Is Changing The World Of Banking", S&P says the outlook for the global economy is worsening, and the changes resulting from these recent events are leading to a reassessment of the creditworthiness of financial institutions. “Despite the unprecedented government actions to bring order to the banking sector and to help stabilize capital markets, in Standard & Poor’s view, there will still be an impact on the real economy from the contraction in financing and asset price declines, which will likely cause more delinquencies and defaults on loans.”

As a result, an increased call for regulation and a wave of bank consolidations, as seriously weakened institutions are acquired by stronger ones, along with this newfound coordination of global regulatory and central banking initiatives, appear likely to significantly alter the nature of the financial services industry.

S&P believes several factors will combine to change the face of the banking industry:

• Increased regulation;
• Consolidation of weaker entities;
• Fundamental reconsideration of the “originate to distribute” model;
• Adaptation to higher volatility; and
• Higher losses for this economic cycle.

“It appears the level of losses for banks will be much greater,” said Standard & Poor’s credit analyst Tanya Azarchs. “Although governments have demonstrated a willingness to provide extraordinary support to a degree we have not previously seen, we now believe credit markets may be prone to bouts of illiquidity in the future. We are therefore reassessing the vulnerability of the wholesale-funded banking model and will conduct a global review of major mature market-financial institutions, which will consider all factors, including government support and deteriorating financial performance.”

Comments

[kingaj12:]

I'm astonished that S&P is still in any capacity to comment. Didn't they rate all that AAA paper? Didn't they set the rules? Don't they have any idea of their role?

2008 Nov 26 11:26 PM

[User 283977:]

Good points Kingaj.... If those derivative based securities can't be valued now, what was the basis for S&P, Moody's and Finch's original valuations?

One of the underlying problems points at these rating agencies business model. Issuers pay the credit ratings agencies for evaluating securities. The more securities you rate, the greater your income. The more securities you rate positive, the greater the number of those types of securities the issuers will generate. That looks like an invitation for a conflict of interest to me.

At a hearing presided over by the House Oversight and Government Reform Committee in Washington, internal documents from the rating agencies revealed that the credit rating agencies KNEW that the ratings they were giving the derivative securities were overvalued. It wasn’t until this past year, when homeowners began defaulting on sub-prime mortgages, that the credit ratings agencies began downgrading thousands of those securities (see NY Times, October 22, 2008 "Credit Rating Agency Heads Grilled by Lawmakers").

The rating companies have some kind of Charter from the Securities and Exchange Commission that gives them an effective monopoly on security ratings. Interestingly, that same Securities and Exchange Commission is also responsible for the removal of Rule 10a-1, the uptick rule that regulates rules for short selling. The uptick rule prevented short sellers from adding to downward momentum when the price of an asset is experiencing sharp declines. The SEC eliminated the rule on July 6, 2007. The first major downward movement of the Dow occurred in July of 2007 … Coincidence?

We are looking at trillions of dollars of good faith investments being downgraded to TOXIC WASTE status because these government chartered rating companies rated securities who's valuation were impossible to establish as investment grade. When you are dealing with decisions that involve TRILLIONS of dollars, and you make the same mistake over and over again, excuses along the lines of "anyone can make a mistake" loose any logical basis. If its not outright criminal collusion, then at the minimum, its complete incompetence. In either situation, I think these companies have earned the loss of their government charters as presumably trusted rating agencies. How can you trust anything they have to say after this debacle?

As a final point, what about the role of the SEC in this mess? The SEC is the sponsor of these rating agencies. The SEC removed the uptick rule that led to "naked" short selling which was implicated in the failure of Lehman. It seems to me that if a government agency (SEC) grants an effective monopoly to a business that the same government agency, the SEC must undertake a regulatory role towards those sectioned rating agencies. This brings us to the second underlying problem, a failure in government with respect to the performance of its regulating responsibilities. The SEC's Chairman Christopher Cox role in all of this needs to be completely examined.

2008 Nov 27 12:18 PM