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Moody's ratings cut for giant banks: a new weight on US economy

Moody's downgrade of the US banking system, following turmoil in Europe's banking sector, is a blow to reputation of banks but is not expected to tip the economy into recession.

By Ron SchererStaff writer / June 22, 2012

Tourists walk past a Bank of America banking center in Times Square in New York June 22. Downgrades by ratings agency Moody's will make funding more expensive for banks that rely the most on capital markets, while reinforcing the competitive advantage of "safe haven" banks that can fund themselves from stable customer deposits.

Brendan McDermid/Reuters

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New York

Moody's Investors Service's decision on Thursday to downgrade the debt of 15 global banks and securities firms is yet another weight on the flagging US economy.

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That’s because the cost of doing business for these giant financial institutions such as Citigroup, Bank of America, and J.P. Morgan Chase, will go up as result of having their rating lowered. The banks will then either pass along their higher costs — such as the higher interest rates they will have to pay to borrow money — or will have lower profits which will again inhibit their ability to lend.

“The Moody’s downgrade is not a positive for anyone,” says Sung Won Sohn, a professor of finance at California State University, Channel Islands, and a former banker. “The lower ratings means their ability to lend will diminish.”

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However, some analysts doubt that the Moody’s action by itself will tilt the economy into a recession.

“The downgrade itself is not a waterfall event nor will it trigger a sudden decline in economic activity,” says Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. “A few marginal borrowers may be turned down for loans at best.”

Mr. Dickson worries that the downgrade is yet another psychological hurdle for consumers. After watching some of the largest banks in the nation have their debt downgraded, consumers may decide to hunker down. “I think there is more psychological damage than real damage,” he says.

Moody’s downgraded the long-term senior debt ratings of four banks by one notch, while the ratings of 10 financial companies were downgraded by two notches, and one firm had its ratings lowered by three notches. A notch is simply a credit level.

A bank's credit rating is an important indication of what outside organizations think of it.

“In the wake of the Moody’s downgrades, the banks reputational risks has suffered,” says Mr. Sohn. “For financial institutions reputation is very important.”

Many analysts had been worried that Moody’s would lower the debt of Morgan Stanley by three levels. Morgan Stanley’s executives had argued that the firm had strengthened its finances and should not get that steep a cut. Moody’s, in lowering Morgan Stanley’s debt by two notches, noted that the financial firm was helped by the deep pockets of one of its investors, the Mitsubishi UFJ Financial Group, and the belief that Morgan Stanley would be deemed too big to fail and thus get the support of the US government, if it were in danger of defaulting on its debt.

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