A Quick note on Bank Downgrades.

Just a very quick note.

Moodys just downgraded 26 Italian banks. I don’t think these will be the last. In fact I wonder if the extent of the downgrades that will flow from any Greek default and certainly from any further defiance in Spain has really been priced in by the banks. I tend to think they have not priced it in and might be taken by surprise at how many banks, which banks and in what countries the downgrades happen.

Here’s why.

Just as the ratings agencies factor in to bank ratings what they call ‘Sovereign Uplift’ (For those who want to know what Sovereign Uplift is and what the Rating Agencies actually do, I have written Lair’s Lexicon  primer on Sovereign Uplift ) – which means the amount of support they feel a bank can expect form its sovereign by way of bailing out – so I think that behind Sovereign uplift there is also what we might call Systemic Uplift.

That is, whether the ratings agencies make it explicit or not – I think there must be a line somewhere in their calculations which looks at the amount of support that Sovereigns can expect from the Central bank of whatever monetary system they  are part of. For US banks Sovereign and systemic are obviously the same. They both come from the Fed. But for European banks they are not identical. Each Sovereign has its own Central bank but above and behind them, supporting them albeit indirectly, is the ECB.

All European banks benefit from some degree of Sovereign Uplift on their ratings.  UK banks have, over recent years, benefited from as much as 5 grades. That is, their rating grade was up to 5 levels higher when BoE support fore the banks was factored in, than it would have been if the rating agency had looked at the strengths of the UK banks in isolation. But the ratings agencies looked at how much support they thought the BoE would give to the banks in time of need and this consideration boosted the rating and perceived ‘robustness’ of the UK’s banks by up to 5 grades. It is less now.

I think it is one of the unspoken or at least little talked about consequences of any country leaving the Euro, that this dents the credibility of the ECN’s implicit promise to stand behind any of its member nations. If the ECB runs up the white flag on this ‘absolute’ guarantee, then the guarantee is no longer AAA rated for any of the other nations that are struggling under and even threatening to throw off, their yoke of austerity and debt.

I wonder if this formed part of the reasoning for the downgrades in Italy. If the Central bank of Italy is thought to have the 100% unquestioning support of the ECB behind it, that is a far more solid proposition than the Central bank of Italy without ECB support.  All it takes is for the world to perceive that the ECB might not stand behind a sovereign’s central bank – may not be able to – and the calculation of support that that central bank can in its turn offer its nations banks, changes. Basically I’m wondering if the ECB’s credibility as the ultimate guarantor of solvency and systemic invulnerability has  finally wearing thin.  Perhaps the Eurocrats don’t realize that their reserves of authority  and credibility have been exhausted.

What this means is the ratings agencies must re-evaluate how robust many banks are now or at least soon, and before any actual event occurs in a nation. Thus nations and their banks, in nations that are not yet perceived to be in the firing line directly, may find their banks being fingered for downgrades without any apparent cause. If so then the ripples from Greece and perhaps Spain also will spread faster, sooner and wider than I think the banks and authorities might be expecting.

I would expects banks in Portugal, Spain, Belgium, Ireland, France and some even in Germany and Holland to be quietly put on the list for review. UK’s banks might be looked at for their exposire to Spain.

OR I could be quite wrong.  This is pure speculation. I would be interested to know what others think.

20 thoughts on “A Quick note on Bank Downgrades.”

  1. “that is a far more solid proposition than the Central bank of Italy without ECB support.”

    Are you sure that the power works in that direction? The ECB is a joint venture of the National Central Banks. It is not like the Federal Reserve, even though it tries to pretend that it is.

    My understanding of the ECB incorporation rules is that each NCB has an unlimited and untimed, non-collateral overdraft facility at the ECB. So the NCB just writes the cheque, and the ECB TARGET2 system just clears it. There is nothing the ECB can do about it.

    Who is the man that says no? And what legal basis does he have for doing that? If not, then an NCB that has been ordered by its government to do as it is told can always resolve the local banks. The ECB is relegated to a back seat driver.

    1. Neil,

      Good points. But I can’t help think that with the ECb having the right to issue the currency and print up bonds/debt that banks and whole country’s depend on this gives them a certain power.

      This of course doen’t alter your question over the locus of policy decisions. But there too I wonder if there isn’t a real push for more centralized euro level power. That desire is certainly there in the IMF blueprint for what Europe must do, which they all seem to be slavishly following.

      Your point about TARGET2 is important. TARGET2 is the lie that is going to horrify the German people when the finally understand the poistion the Bundesbank has got itself into behind their backs.

      Thanks for your comment.

    2. I’m not sure the ECB will be able to rely on “support” , as a “Criminal” case has already been brought against the German Bundesbank by the Association of German Bayern Tax Payers – due to Target2

      OK, this may not bear any fruits, but is an indication of sentiment in South Germany at least.

      Target 2: Federal lawsuit against Bundesbank
      05 May 2012

      TARGET2: The Association of Taxpayers in Bavaria joins a lawsuit against the federal bench. Suspicion: embezzlement, computer fraud, fraud triangle, suspicion of bogus transactions. The focus of prosecution for criminal business in Frankfurt to investigate parts of the federal bank’s board.

      http://translate.google.com/translate?sl=de&tl=en&js=n&prev=_t&hl=de&ie=UTF-8&layout=2&eotf=1&u=http://www.mmnews.de/index.php/wirtschaft/10028-target-2-strafanzeige-gegen-bundesbank#13370146210822&if_height=13675

      Original in German :
      Target 2: Strafanzeige gegen Bundesbank

      http://www.mmnews.de/index.php/wirtschaft/10028-target-2-strafanzeige-gegen-bundesbank#13370146210822&if_height=13675

      BTW … great Blog / I appreciate your insights, and have passed your Blog around to many.

      1. Phil,

        I am glad you find useful things in the blog and thank you for letting others know.

        But espeically thanks for the links to the lawsuit. That is great news. Even if it doesn’t go anywhere what they uncover as evidence should be incendiary.

  2. Maria das Santos

    Just how the banks here in the UK are looked at as if gold is beyond me.The BoE and the accounting cartels of this country are allowing assets to be held off-book and not counted as assets yet stinking like rotting fish and not a squeak from the rating agencies.I just cannot believe the strength of the pound against the Euro,we should be in the toilet with it particularly against the Dollar.Any way,back to cleaning floors for a living.

    1. The Happy Hobbit

      Please excuse my ignorance, but how is it possible for companies to hold assets ‘off book’?

    2. “just cannot believe the strength of the pound against the Euro”

      The GBP is a currency with it’s own Central Bank
      The EUR is an “project” , with many CBs and divided political interests !

      I have been long GBP since 1.10 EUR/GBP, but am expecting a (manipulated) change in trend soon ( UK would now have an excuse to “force” a weaker GBP… to “help” the economy / i.e. downward Fiat spiral to remain competitive ).
      IMO, the current GBP’s strength is more than likely due to the fact that the City is the biggest FX market in the world, and the second biggest Bond market. IIRC , London is some 10x bigger than FF+Paris together in terms of Bonds.
      .. Oh, and of course, the Anglo/American axis do not want talk of the EUR becoming a possible WW-Reserve-Currency candidate ( DSK’s big mistake , by talking / boasting about it )

      As to where the EUR is going (soon) and why, this article from the SchweizerZeit is IMO pretty close to reality :

      “We are trapped “

      http://www.schweizerzeit.ch/cms/index.php?page=/News/Wir_sitzen_in_der_Falle-602&SID=9a293f3a6741d75f71aea02629453c63436dfbcb

      ENGLISH :
      http://translate.google.com/translate?sl=de&tl=en&js=n&prev=_t&hl=de&ie=UTF-8&layout=2&eotf=1&u=http%3A%2F%2Fwww.schweizerzeit.ch%2Fcms%2Findex.php%3Fpage%3D%2FNews%2FWir_sitzen_in_der_Falle-602%26SID%3D9a293f3a6741d75f71aea02629453c63436dfbcb

      Explains how the EUro came ( and where it’s going ) ; who and why is was created ; what the price was ; the names of the politicians that enabled this tragedy … etc. etc.

      e.g.
      ***
      The success of the Bundesbank and its international prestige became it’s achilles heel . If the D-Mark currency had been weak, it would still be here today.

      What is was all about became during the course of a Franco-German meeting in Bonn in early 1988 very apparent. At that time, Jacques Attali, Mitterrand’s foreign policy adviser , said : “To achieve a balance, we want to talk about the German atomic bomb.” The Germans replied, “You know, we have no bomb ”
      Attali replied ….. ” I mean the German mark. ”
      ***

      BTW, the SchweizerZeit has had many insightful articles, especially one on the Bundesbank Gold Reserves.

    3. “I just cannot believe the strength of the pound against the Euro,we should be in the toilet(?)”

      That is the big question. The UK is the biggest debtor nation in the G20. This situation is now on a knife edge and the status quo is heading for upheaval. The UK is frantically printing money and buying its own bonds, and the ratings agencies apparently like this. But QE is destroying capital and savings in the process. The only question is , how much capital do they have left to destroy before the patient dies ? Wile E. Coyote may already be off the edge of the cliff , he just hasn’t looked down yet.

      Bill Gross, the manager of the largest bond fund in the world thinks the large debtor nations time is almost up :

      “Now, with dollar reserves widely dispersed in China, Japan, Brazil and other surplus nations, it is fair to assume that there will come a point where 2 per cent negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds…

      There is the potential for both public and private market creditors to effect a change in how credit is funded and dispersed – our global monetary system. What that will look like is a conjecture, but it is likely to be more hard money as opposed to fiat-based, or if still fiat centric, less oriented to a dollar-based reserve currency….

      The developing credit cancer may be metastasised, and the global monetary system fatally flawed by increasingly risky and unacceptably low yields, produced by the debt crisis and policy responses to it. The great white whale lies on the horizon. Investors should sail carefully.”

      http://tinyurl.com/ch3of78

      Gross echos this article posted in the last blog :

      http://fofoa.blogspot.com/2012/05/inflation-or-hyperinflation.html

  3. Italian bankers are none too happy – from Reuters :

    Moody’s decision is an assault against Italy, its companies, its families,” said Italian banking lobby ABI. “Once more rating agencies turn out to be a destabilising factor for financial markets with their partial and contradictory statements.

    I wasn’t aware bankers were concerned about Italian families, perhaps they mean the mafia & Camorra.

    “The rating agencies are a bit fickle, sometimes they attack countries and companies because there is not enough austerity,” said BNL Chairman Luigi Abete. “We should take these assessments with a huge pinch of salt, our banking system is solid.

    Must be the only one that is. Personally I cannot see anything positive happening in Europe, the previous Troika self congratulations & back slapping were just illusory & very temporary applications of sticking plaster. Common sense seems to point to the fact that those in charge are in denial, possibly because to them the consequences of failing to keep the leaking boat afloat, are unthinkable. I am certainly no expert but to me unless they can come up with a miracle, this is another sign that the Eurozone is stuck in a slow moving whirlpool, with only one way to go.

    Spanish banks next ? Very heavy stuff from Edward Hugh:

    The top line – Financial times:

    “Every leg of the eurozone crisis has been marked by denial of the full scale of the problems. Whether Spain’s authorities have been deceitful or wilfully blind makes little difference at this point. The banks will need more capital; the government will need external help, with all the market uncertainty and strings attached that this implies. And the pain in Spain will only get worse”.

    There are currently about 2 trillion loans issued by the Spanish banking sector, and about 1.2 trillion deposits. That’s about 165% leveraging.

    http://www.economonitor.com/edwardhugh/2012/05/13/its-time-to-stop-using-chewing-gum-and-chicken-wire-in-spain/

    You might not agree with his conclusions, but the article is extremely informative about the pain in Spain.

    If all money now produced, printed or whatever is debt, how can throwing new money to clean up old debt work ? I could well be missing something, but to me it just doesn’t make common sense.

  4. The Schweizerzeit website that Phil recommends above appears to be close to the SVP, the far-right, xenophobic party that is, thankfully, steadily losing credibility since its sponsor, Christoph Blocher, was voted out of the Swiss government by his fellow ministers.
    People are realising that they’re a bunch of hypocrites and charlatans, and I would suggest that you take any of their articles with a large pinch of salt, since there is usually some (nasty) ulterior motive behind their every utterance.
    Please don’t infect this excellent blog with links to such odious organisations.

  5. With the US national debt at almost $16 trillion and rising (equivalent to $138,000 per US taxpayer), we have to ask why aren’t the rating agencies focusing on the US economy?

    Is this not a de facto declaration of war on the Euro as the US is terrified of losing its reserve currency status and thus needs to trash any potential competing currency?

    It’s argued in many quarters that both Iraq and Libya were taken out specifically for having the temerity to consider switching from petro-dollars to either euros or a newly proposed gold dinar.

    Surely its time to recognise this reality and take whatever measures are deemed necessary to prevent the Eurozone being reduced to perpetual US debt peonage?

    PS. Outstanding blog Gollum – keeep up the sterling work.

    1. I think you are in to something, Anthony. The rating agencies are mostly British and American. The British are allied to the Americans and are both involved in petro dollar recycling. looks like we have a full blown effort to destroy the euro here. Wasn’t Iraq invaded because they switched to selling oil for euros ?

      1. See also Russia, Iran, Indonesia, India, China and Venezuela.

        Interestingly “in February 2011 Dominique Strauss-Kahn, managing director of the International Monetary Fund (IMF), called for a new world currency to challenge the dominance of the US dollar. Three months later a maid at the Sofitel New York Hotel alleged that Strauss-Kahn sexually assaulted her. Strauss-Kahn was forced out of his role at the IMF within weeks; he has since been cleared of any wrongdoing.”

        http://www.silverbearcafe.com/private/01.12/petrodollar.html

  6. @IvorTiklikov / Schweizerzeit article.

    I am no authority on whether or not the SZ a right-wing rag is or not.

    A description of the author of that article can be found here : http://de.wikipedia.org/wiki/Bruno_Bandulet

    # 1973 – “Chef vom Dienst” for DIE WELT Newspaper ( a main German newspaper )
    # 1975 – Chief Editor of the German QUICK Magazine
    # worked for one of THE most well know German Politicians “Franz Josef Strass” ( CSU Party , Bayern )
    # traveled the world as a “Special Correspondent” ).
    etc. etc. etc.

    So his credentials are pretty respectable if you ask me !

    Also, Dr. Udo Ulfkotte , who has occasionally written articles for the Schweizerzeit ( e.g. Bundesbank Gold ) can be examined here : http://en.wikipedia.org/wiki/Udo_Ulfkotte

    # a German journalist renowned as a security and intelligence services expert
    # an editor for one of Germany’s main dailies, Frankfurter Allgemeine Zeitung (FAZ).
    # Dr. Ulfkotte studied jurisprudence and politics at Freiburg and London.
    # He was an advisor to the Kohl government
    etc. etc.

    So , as I said , I cannot vouch for the Schweizerzeit, but the two people I mentioned look pretty “established” to me !

    In fact in 2003 , Dr. Ulfkotte was awarded the “State Citizen’s Prize”

    http://www.annette-barthelt-stiftung.de/staatspreis.htm

    A picture of him and Dr. Günther Beckstein ( well known CSU Politician ) can be seen at the bottom of the page

  7. I am not sure what these downgrades are all about. Sounds to me like a few guys sitting around having a few beers, a few laughs… then maybe later they roll a spliff after a few more beers then make a decision.

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