The financial reform proposals, designed to eliminate systemic risk, could actually trigger another meltdown upon the bill’s passage. This is due to the ratings notching approach that has given rating credit to government support since the meltdown. A change in the expectation of support – both emergency and on-going would result in ratings downgrades for certain banks. Standard and Poor’s for example, gives a three notch upgrade to the counterparty ratings of Bank of America Corp., Citigroup Inc and Morgan Stanley and two notches to Goldman Sachs and UBS AG. Reverting to a lower stand alone rating could trigger collateral calls, terminations or other nasty events, not unlike what we have seen over the last three years. My bank analyst colleagues are more sanguine about the likely outcome. They suggest the banks would raise more capital, and by the time of passage, the underlying stand alone ratings could be improved. But the House bill requires bondholders to take it on the chin before federal monies could be used. And if the goal is to withdraw federal support, where would the capital come from? While this issue may be better-understood by bank analysts I thought this should e brought to the attention of the municipal finance readership here. Caveat counterparty.
