Breakout

Bank Stocks Rally in the Face of Moody’s Downgrades

Breakout

Once upon a time, a two-notch credit rating cut by Moody's (MCO) or Standard & Poor's was disastrous; an unambiguous sign that your proverbial ship was headed for the rocks.

But those days may be gone for good. Late yesterday Moody's finally dropped a fresh batch of downgrades on 15 global banks. The move is being called ''backward looking," ''absurd," and "belated." But the best review of all is today's market action which is trading off the news as a contrarian indicator.

Could investors express their contempt any more clearly than bidding up the price of all 15 banks today that Moody's downgraded last night?

As my co-host Jeff Macke and I discuss in the attached video, the rally in banks is not only a blatant spite trade but is the equivalent of Wall Street flipping off Moody's and the entire rigged and antiquated rating system that they despise.

Moody's characterizes its move as part of a sweeping overhaul of its ratings on global lenders, citing "significant exposure to the volatility and risk of outsized losses" as the reason for the uptick in caution. The statement was clearly a thinly veiled reference to JPMorgan's (JPM) recent ''whale'' problem, in which a London-based trader's enormous hedging strategy had to be shut down at an estimated loss of $2 billion, not to mention immeasurable damage to the bank's reputation and its CEO.

As much as the market is having a moment of revenge, and commentators like Macke and me can blast the system and call for change, the truth of the matter is these ratings agencies still have some bite. That's not because they move markets, but rather because of what is known as counter-party collateral, a system between trading banks that requires them to post more collateral to back trades when their credit ratings decline.

In this case, the estimates range from $1 billion to $6 billion of additional coin each bank would need to pony up, which is no small sum, and why I refer to these relics as "annoyingly influential."

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