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Latest bank downgrade actually good

By Claes Bell · Bankrate.com
Friday, December 11, 2015
Posted: 11 am ET

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Eight of America's largest banks saw their credit rating cut this month by Standard & Poor's, which is … actually good news for Americans? Let me explain.

S&P cut ratings on these banks (one of which you probably do business with in some way):

  • Bank of America Corp.
  • Bank of New York Mellon Corp.
  • Citigroup Inc.
  • JPMorgan Chase & Co.
  • Morgan Stanley
  • State Street Corp.
  • The Goldman Sachs Group.
  • Wells Fargo & Co.

Ever since the financial crisis, credit ratings for major banks have understandably been a hot-button issue. Depending on a person's view, any drop in ratings tends to bring up either:

  1. Bad memories of the late 2008 freefall in the financial markets after Lehman Brothers folded, mixed with anger that more hasn't been done to rein in the banks.
  2. Frustration at seeing yet more evidence that the monstrous overreach of the Dodd-Frank financial reform law has been needlessly burdensome and ineffective.

But neither of these reactions apply very well in this case. Here's S&P's explanation for the rating:

"Based on our review of progress made toward putting in place a viable U.S. resolution plan, we now consider the likelihood that the U.S. government would provide extraordinary support to its banking system to be 'uncertain' and are removing the uplift based on government support from our ratings."

In other words, nothing changed at the banks themselves -- it's just that they're slightly less likely to get a bailout from Uncle Sam.

Progress made on preventing future bailouts

What caused the change?

Since the recession-era bailouts, banks have been getting a big boost to their credit ratings by being implicitly backed by the U.S. government. (It's kind of like how a person with not-so-good credit can benefit from being added as an authorized user on the credit card account of a person with good credit.)

Banks were getting this boost because no one believed the U.S. government would actually let a major bank fail. That would mean an economic catastrophe, layoffs, the whole works.

But now, under the Dodd-Frank financial reform law, regulators have been consistently working to remove that threat by establishing procedures for a failing bank to be "resolved" in an orderly fashion.

"The banks have been benefiting from having this uplift, this assumption in the ratings that they'd get rescued, basically, by the government or back-door support from the Fed," says Mayra Rodriguez Valladares, managing principal of MRV Associates, a New York-based financial consulting firm specializing in risk management.

"This is a signal from the ratings agencies that they really do believe that these resolution frameworks are in better position than they have been, and that it's not just talk -- that these bailouts wouldn't happen," Valladares says.

S&P's new ratings are closer to what the banks would earn on their own, and that's basically a good thing, Valladares says. She expects that other ratings agencies will soon follow suit.

"I would be surprised if they took much longer," she says.

Follow me on Twitter: @claesbell.

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