Armageddon, Revisited

We learned a number of interesting things during the End Times, that began with the collapse of Lehman Brothers in mid-September, 2008. For example, we learned how much the banking business had changed in the previous decade. We also learned how blatantly people could just lie. 

The Tea Party types, who really don't know what they're talking about on any subject, suggested that the banks should've been allowed to fail, seemingly entirely ignorant that the phrase "Too Big to Fail" actually does have some real-world implications. 

The worst part is that I'm philosophically inclined to agree with them. But to this very day, no one has been able to adequately explain to me how you maintain a modern civilization without a financial services (or, as it pertains to AIG, insurance) industry. 

You see, banks are required to hold a given amount of money in reserve capital each night to do business the following day. More often than you'd suspect, they do this by borrowing from one another. This is what the papers mean when they discuss the "overnight rate", which is the interest rate the banks (or the Federal Reserve) charge one another on those loans. 

The government rescue of Bear Sterns allowed the remaining banks to believe that everything would be okay. But when Lehman was allowed to go under, they panicked, mostly because they knew that they all had the same balance sheet problems, to one extent or another. Not knowing who the next to go down would be - although pretty much everyone suspected that it would be Merrill Lynch, followed by either Morgan Stanley or Bank of America - they all stopped lending to one another. 

The banks wouldn't have just failed and vanished, either. Because deregulation allowed investment banks to become bank holding companies, they had commercial banks in their portfolios, the deposits of which were insured by the Federal Deposit Insurance Corporation. The last time something like this happened - following Reagan's deregulation of the Savings and Loans in the 1980s - the federal government was on the hook for roughly $160 billion. 

After we just barely dodged the asteroid and the dust cleared, the Obama administration and Democratic Congress went about crafting the most tepid legislation they could without laughing out loud, like Harvey Korman used to on the old Carol Burnett Show. This became known as Dodd-Frank. The Tea Party went ballistic at the prospect of even this, not understanding that the underlying regulations of the act would be written by scumbag lobbyists, making them less than useless. 

I was watching a Canadian comedy show last weekend. An American comic got up and asked the audience, "Does Canada have banks? I only ask that because, in America, we don't any more."  That was the only thing I laughed at during that hour. 

As it turns out, the punchline might yet be stronger than I originally thought. 

Some of Wall Street’s biggest banks are bracing for fallout from a possible cut in their credit ratings.

Moody’s Investors Service, one of the two big ratings agencies, has said it will decide in mid-May whether to lower its ratings for 17 global financial companies.Morgan Stanley, which was hit hard in the financial crisis, appears to be the most vulnerable. Moody’s is threatening to cut the bank’s ratings by three notches, to a level that would be well below the rating of a rival like JPMorgan Chase.

Bank of America and Citigroup may also fall to the same level as Morgan Stanley, but those two are helped by having higher-rated subsidiaries.

Oh. That can't be good, can it? 

Why, no. No, it can’t.

Credit ratings are particularly important for financial companies, which greatly depend on the confidence of their creditors and the companies they trade with. A high credit rating enables banks to put up less money, which they can borrow cheaply, while a lower credit rating can mean they have to put up more money and perhaps pay more for their loans.

The three banks that stand to be the most affected by a ratings downgrade have already said that they would have to put up billions of dollars more in collateral to back trading contracts.

Having a substantially lower credit rating than rivals, however, could do much wider damage over time. It could affect billions of dollars in trading contracts that are an important business for Wall Street. Many of these contracts demand that the company on the other side of a trade have a high enough credit rating.

The country’s big mutual funds, asset managers and other institutions are reassessing their trading relationships in light of a possible ratings cut. In some cases, contracts are being rewritten. In others, big investors may walk away.

Weighing the creditworthiness and ratings of banks “is a major focus at Vanguard and at other buy-side companies who do business with Wall Street,” said William Thum, a lawyer with the mutual fund giant Vanguard, referring to institutional investors like his company.

Some of the funds that he deals with are prohibited from trading with banks that have a less-than-sterling credit rating.

The rest of the Times article goes on to minimize just how bad this can be, because it ignores what a credit rating downgrade can do to the stock price of the banks.

More than anything, what killed Lehman was the cratering of its stock. Past a certain point, it didn’t matter if someone took Lehman’s toxic assets of its books because the company was already worthless. The fact that the appropriately named Dick Fuld refused to sell Lehman at a discount only sped the collapse along.

Bank of America’s stock is already coming close to the point where it’ll be delisted as junk.  If it becomes too expensive or risky to trade with them, the same thing will happen to Morgan Stanley and Citigroup.

If multiple enormo-banks become worthless overnight, God knows what that will do to the stock market. The same issues that prevented normal bankruptcy proceedings of the banks in the fall of 2008 still exist today.

Unlike four years ago, the Tea Party effectively controls the House of Representatives, making a congressional bailout impossible. Nor can it be guaranteed that Obama would sign one in an election year. That means that the Fed would have to run to the rescue, yet again.

Or it might not. Ben Bernanke must be getting tired of being demonized by pretty much everyone, and could decide to give everyone what they want. Liberals could punish the banks out of existence, and the Tea Party could have the Mad Max 2: The Road Warrior economy that it’s fantasized about ever since Rick Santelli told them to.

On the other hand, if you think that vicious predators like Lloyd Blankfein are going to any more benevolent when they’re riding motorcycles and wearing goalie masks than they are now, you’re in for a helluva surprise.