More Financial Pitfalls Ahead - S&P

A day after S&P lowered its outlook on General Electric (GE) debt, the ratings agency is at it again with downgrades for 11 major U.S. and European banks. The GE debt guidance stated that there is a one-third chance that GE’s coveted AAA rating will drop to AA+ on concerns of deteriorating earnings from GE Capital. In the statement, S&P claimed that GE Capital as a stand-alone entity would be rated A+ (four levels lower). GE, the largest issuer of U.S. corporate bonds, saw its shares slip more than eight percent on the announcement. GE’s CEO Jeffrey Immelt made it clear that he would do all in his power to maintain the conglomerate’s AAA rating, starting with shrinking the company’s leverage ratio to 6 to 1. If this deleveraging is not enough, the obvious next step would be to lower the dividend payout. As of now, the company has reaffirmed its annual dividend of $1.24. per share, but 2009 will be the first year that the company has not increased the dividend since 1977.

This morning brought more bad news for financial stocks, as S&P lowered its debt ratings on 11 banks and issued a warning for one more. Among the firms affected were; Bank of America Corp. (BAC), Barclays PLC (BCS), Citigroup (C), Credit Suisse Group (CS), Deutsche Bank AG (DB), J.P. Morgan Chase & Co. (JPM), Morgan Stanley (MS), Royal Bank of Scotland Group PLC (RBS), UBS AG (UBS), Wells Fargo & Co. (WFC) and Goldman Sachs Group Inc. (GS). S&P’s downgrade places an exclamation mark on a horrific year for financials, with the sector having already reported some$745 billion in write-downs and losses attributable to the credit crisis.

Keeping the news in perspective, none of these companies are a rated below A – which is well above the investment grade level. These downgrades should come as no surprise to anyone. There has been evident weakness in financials for many months as storied brokerages like Bear Stearns and Lehman Brothers have become insolvent and slipped away. The timing of S&P’s action seems a little odd though as the ratings agency seems to be developing a harsher assessment of the financial health of many battered firms just as a sense of calm is returning to the equity markets.

Ratings agencies have come under the microscope recently as they failed to see the devastating risk posed to the system by the mortgage-backed or collateralized debt securities that they were charged with rating. In hindsight, since the ratings agencies are paid to provide ratings opinions by the issuers of the debt, there is natural conflict of interest which might preclude a thoroughly objective and dispassionate opinion. This situation was made even worse by the fact that many analysts within the ratings agencies did not fully understand the risks presented by many of these complex financial instruments. This excellent piece from Money Morningdetails what has gone wrong in the ratings system and suggests some ways to fix what has become just another “ratings game”.

As for today’s downgrades, they should not substantially change investor’s outlook going forward. There was no new information offered today in what S&P released. There are serious risks in investing in financials right now, as any seasoned investor is well aware. However, that risk may be acceptable to certain investors for the prospect of a substantial long-term reward for enduring what could be a very rocky near-term ride.

Comments

[investor88:]

Ah substantial long term rewards investing in financials for short term risky, rocky ride. Sounds good and familiar but maybe not for the average Joe who has to keep some money for survival under current financial turmoil.

2008 Dec 19 06:54 PM

[James Wilson:]

Bush cowed all the Regulators and even got Spitzer moved away from Wall Street so this crash of the economy could happen.

Look at all the plans that are right in your face. Subprime Loans even NINJA Loans that are in direct violation of the RICO ACT !

Analyist and Regulator who turn their heads and the Bush Adminstration taking states to court to stop them from using Consumer Protection Laws to stop Predatory Lenders !

How else can the North American Union come to be ?

You have to lower the Standard of Living in the USA and lower the Wages.

They have to crash the market before leaving office too !

2008 Dec 20 01:39 AM

[hmcclung:]

My turtle died yesterday....damn George Bush!!!!

2008 Dec 20 09:17 AM

[Emerald:]

A day late and a dollar short! S&P ratings have been a joke for a long time. This is meaningless. Just a confirmation of news that was obvious back in February of 2008. Tell me its bad after the stocks are down 50% and the government bailed them out? Really.

2008 Dec 20 10:53 AM

[tipalia:]

HMCCLUNG who was the president for the last 8 years? that crisis I agree with you might have started before Bush but what did he do to stop that greed that was going on for the last 8 years? But again I partially agree with you again because I would blame Greeny (Greenspan) first and secondly Bush. What a fiasco, do we need another revolution? What happened to those fat Cats ( CEOs, board of directors, CFOs,...) ?
I bet you they walk freely and they ll have a better Xmas than the rest of us
and wondering what can we do with the taxpayers money. A good example of this behaviour AIG, isn t it?

2008 Dec 20 11:21 AM

[M. Burke:]

America is the land of false choices and people who only know how to talk their book. The truth is Secretary Paulsen inadvertently said it right during a Congressional hearing: "We are all to blame" The truth is that the crisis originated back in 1977 during the Carter Administration. A series of actions - some well intentioned, some not, inept and corrupt - by Democratic and Republican members of Congress, central bankers, inept regulators with diminishing enforcement budgets, rating agencies, Fannie/Freddie management, mortgage brokers, greedy Wall Street participants who played with fire one time too many, toxic securities levered 8:1 relative to the face amount of the bonds and then levered 30:1 again via the balance sheets. It goes on and on including people taking mortgages they knew they couldn't afford. Congress continuing to pile on pork during a national crisis. A bail out that is ineffective and inept and generally characterized as behind the curve the entire time and still is A bailout that pulls Grand Theft Auto in public view to the tune of $1 trillion to favored players, Tax law changes for the banks of $150 billion (section 382 giveaway, SILO etc, one of which appears to be illegal). The Fed paying 1.5% on reserves (should they still do so with rates now at zero?). All these cash flows just given away - using our money - with no conditions attached. Don't you love Wall St saying that $ are fungible so they won't track whether taxpayer money was used to pay bonuses. Is anyone anywhere tracking what is happening to deferred comp plans where tax benefits were obtained in return for taking the firm's credit risk. You bet taxpayer money is being used for all of these purposes and maintaining dividend payments. Moral hazard is in full view and it's far worse than we ever imagined.

This is one sorry pathetic debacle that, despite disingenuous assertions to the contrary, was not a once in a century storm which implies random violence, not a Black Swan, but a White Swan as Taleb said. It was not rocket science. It was a known hype that depended on housing prices going up forever - which they never have - and the continuation of the low cost leverage party that started in 1982. Then we applaud as geniuses firms selling $2 billion in toxic securities in one room while they were betting $4 billion in the next room the thing would implode. Betting 2:1 against your own clients. And I should live so long as to witness a Congressional hearing in which members of Congress hold not only the other party responsible but also members of their own party when the blame is obvious. The hypocrisy has reached all time highs. And we the voters are responsible for the people we elect and don't hold accountable so I guess we deserve the country we have. There are very few statesmen left who think of their country first before the accumulation of political power and money.

And then the auto bailout. Just when maybe we might get something right, we turn victory into defeat. Instead of turning an industry around and preserving our manufacturing base, everybody goes back to feeding at the public trough, making sure that there will be either a public funds annuity for as far as the eye can see or an implosion that will turn a deep recession into something worse. And let's not forget the moral hazard associated with institutions too big to fail. By public policy we have now created institutions far larger - so hold on to your hats and your wallets for the next time or later this time. The party is over. The American consumer would have experienced a lower standard of living for the next decade just from the deleveraging effect. In a credit crisis and a financial crisis, this will be far worse. With the banks and credit card companies jacking up interest rates and cutting off home equity lines of credit even for responsible people, we will have a whole decade of people deemed unworthy of reasonable rates or any credit at all, Given that insurance companies now use credit scores for premium calculations, guess who else is licking their chops, By the time the banks and the insurance companies are finished with the American consumer who will be able to buy a car. Even now that market is going to be a 10-14 million unit market for the next 5 years. The demand destruction already going on is severe and picking up steam. There are even signs that we have scared enough people to not only cut back but also start saving. God help us. Deleveraging, a credit crisis, a financial crisis, a screwed up bailout and savers!!!! All at the same time. We are doomed! ( Do you think Wall St earnings projections will ever catch up?) Did I forget China, the financier to the U.S., is at risk with its growth rate falling below the 8% level the Government feels is necessary to keep the "through train" going moving the peasants from rural areas to urban locations that must have enough housing, jobs, infrastructure and growth to absorb them. The appearance of reverse migration back to the countryside and the pockets of social unrest starting to unfold has China scared to death.

Moreover, we have the spectacle of America, the land of free markets and capitalism and mucho advice to the rest of the world on how to responsibly resolve a financial crisis, resolving to get the benefits of restructuring America without actually restructuring America. This predictably will only make matters worse and more durable. Alice in Wonderland and Kafka sitting next to each other at the tea party beaming. Is this a great country or what! The inmates, bright as they may be and they are, were running the asylum.

LOTS of influential people predicted the danger (Gramlich, Buffett, Templeton, Roubeni etc.). According to the NY Times, even AIG - yes, that AIG - in 2005 yelled out loud "No, we are not going to write any more CDS on Merrill Lynch mortgage securities because of loosening underwriting standards". Maybe we should have a formal mechanism for this kind and quality of input to be vetted more thoroughly and a formal report issued to a broad spectrum of institutions. Instead all the warnings were just brushed aside and, in some cases, the people issuing the warnings terminated. The party was just too delicious.

It takes a long time to build a great country but a not so long to destroy it. As secretary Paulsen said "We are all to blame." Kudos to us all. If we continue to mismanage this crisis........

2008 Dec 21 07:27 PM

[M. Burke:]

PART 2

I forgot one amazing moment at an amazing time approaching September 15.

I actually tried to introduce a way to save Lehman Brothers that the people who saw it thought had merit. It finally made its way to Dick Fuld but not until the last Sunday. Frustrated, I tried to reach major commercial banks and investment banks. The common message I got back was stunning. We do not want to save Lehman.

For the investment banks, it seemed like shooting yourself in the foot. After all, who was going to be in your syndicates now other than commercial banks with bigger balance sheets who are trying to kill you. Good call!

As for the commercial banks, at least you could fathom the response.

However, by the time it was over 2 days later, one had to ask "Don't the Fed, the Treasury, the commercial banks and the investment banks know that Lehman's downfall would have drastic repercussions?" These are the best & brightest who are the pros, the ones who know. It is their business to know. Lehman Structured Notes in money market funds here and around the world. You guys know those notes are only as good as Lehman's credit. The only lesson you possibly can take from it is "The DNA id the DNA is the DNA" You've competed so ferociously for so long that you don't know any other way to respond. Watch your livelihood go down the drain. Now all we have are commercial banks. Some of the new ones don't even seem to know what that means as they make public statement after public statement that not much will change in their business models. May I introduce you to the Fed, your new master. Of course, the Fed and the Treasurer have shoveled so much money into the banks outside of TARP through the side door with little public notice to the tune of hundreds of billions of dollars that go right out the door in bonuses, deferred comp, dividends.

We want Lehman to fail! From the guys with no new business model.

Three major items will be looked back on. How the crisis built and burst, how some many people could have prevented the trough from being so severe but did nothing, and how inept and ineffective the response to the crisis has been. We may never get to the first because most of the people responsible refuse to take any responsibility. We already have the second. The third is off to a really bad start.

Restructuring America without actually restructuring America.

Right behind those three will be the expose on who got taken care and the staggering sums involved. Either its grand Theft Auto in full public view or the problem is so massive that all of the banks are insolvent and you have to get every dollar to them before too many people realize it. That the same people keep benefiting from each action tips my view one way.

It may be that both are true - in which case we're $8 trillion heading toward $11 trillion.

Lastly, this debacle will have two additional debilitating effects that are significant but not talked about very much. First, America's soft power has reached new lows, compromising our national security. Second, numbers like $8 trillion will make $100 billion seem like not that much money, disabling a governor on the spending of additional massive amounts of money and compromising our children's future well being.

Superimposing all of this on a retirement problem that was already coming to a theatre near you, we have a perfect storm and we created it. A White Swan that everybody is desperately trying to convince the public is a Black Swan.

Here's hoping for the Hollywood ending. The American people are traditionally at their best in a crisis and not so good the rest of the time. We had better be at out best because anybody who tells you this will be behind us in the next 12 months is either in denial or delusional.

2008 Dec 21 09:10 PM

[sumosama:]

I stubbed my toe this AM...part of the vast right wing conspiracy!! LOL!

Happy Holidays!


On Dec 20 09:17 AM hmcclung wrote:

> My turtle died yesterday....damn George Bush!!!!

2008 Dec 22 12:59 PM