Moody's Investors Service has downgraded the ratings of three of the nation's top lending institutions, Bank of America, Wells Fargo and Citigroup, sending the stock market into a tailspin, as all three indexes closed down more than three percent and down more than 450 points. Moody's wasn't the only culprit in today's tailspin, as fear of the Eurpoean economic crisis, combined with comments made Wednesday by Federal Reserve Chairman Ben Bernanke.
The downgrades result from a decrease in the probability that the U.S. government would support the three lending institutuions, if needed. Moody's believes that the government is likely to continue to provide some level of support to systemically important financial institutions. However, it is also more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled, as the risks of contagion become less acute.
"To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Federal Open Market Committee (FOMC) decided to extend the average maturity of its holdings of securities," said Bernanke. "The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of six years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of three years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."
Despite Bernanke's comments, Moody's downgraded Bank of America Corporation's rating to Baa1 from A2 for long-term senior debt and to Prime-2 from Prime-1 for short-term debt. The long-term deposit ratings of Bank of America N.A. (BANA) were downgraded to A2 from Aa3, while BANA's short-term rating was affirmed at Prime-1. Moody's downgraded the long-term ratings of Wells Fargo & Company (holding company senior debt to A2 from A1) and of its major subsidiaries including Wells Fargo Bank NA (rating on the bank for deposits to Aa3 from Aa2). Moody's confirmed the A3 long-term rating of Citigroup and the A1 long-term and Prime-1 short-term ratings of Citibank. At the same time, Moody's downgraded the short-term rating of Citigroup (the holding company) to Prime-2 from Prime-1. The actions taken by Moody's concludes a review for possible downgrade announced on June 2, 2011. The outlook on the long-term senior ratings for all three lending institutions remains negative.
“Money market funds don’t want to be caught with their pants down as they did during the last panic in 2008,” said Josephine Nicholas, owner of the CMPS Institute. “Many investment funds are only allowed to invest in AAA rated investments. This means they will have to either (1) change their bylaws in order to keep their U.S. Treasuries and mortgage bonds; or (2) sell their US Treasuries and mortgage backed securities. This will cause Treasury and mortgage bond yields to fluctuate considerably over the next few months, adding even more uncertainty to an already fragile mortgage and housing market.”
The FOMC also decided to keep the target range for the federal funds rate at zero to 0.25 percent, and currently anticipates that economic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
"To help support conditions in mortgage markets, the FOMC will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities," said Bernanke in a statement Wednesday. "In addition, the FOMC will maintain its existing policy of rolling over maturing Treasury securities at auction."