Stock Market Euphoric Over Ongoing Recovery from Great Recession; Credit Ratings Indicate Ongoing Crash into Great Depression. Which is it?
Today’s news gave rise to outspoken hopes that the Great Recession is ending … again. This seems to have the whole world excited, except me. The stock market is soaring this morning as the U.S. Federal Reserve and the European Central Bank announced an agreement to loan U.S. money to European banks at lower rates. Jobs were up by an amount that was, after many months, finally substantial. Black Friday was a roaring success, even as Occupy Wall Street tried to Unoccupy Walmart.
That’s a bad-news day for a vulture like me, feeding on the carrion of fallen civilization. (Well, that is how some see the “profits of doom an gloom,” meaning those with web sites that focus on the dark side of the economy while making money off of their advertising.) It could mean my fodder for articles will dwindle, and I’ll be out of business soon.
Great Recessions and Great Depressions happen like train wrecks, not plane wrecks
Well, it would be a bad-news day for the doom-and-gloom business, except that I know this bounce means very little (and I’d be glad to see the economy recover and would easily switch to writing more at other web sites on brighter topics … like comets crashing into the earth.) It’s just an air pocket. The reason the good news does not lift my economic predictions to match the euphoric gasps of the stock market as it climaxes to new heights is that the fundamentals causing our economic downfall remain completely unimproved. In fact, the indicators just got notably worse today in other news.
I also think it is absurd to believe that a little loan help from the U.S. is going to significantly ease Europe’s economic crisis. I bear in mind that it took over two years for the Great Depression to firmly become a fact of existence after the Wall Street crash of 1929. I bear in mind that the Great Depression was cemented by the collapse of a single EUROPEAN bank in a tiny European country, which spread throughout Europe like fire in a ammunition depot, bringing a European economic collapse. (See this article for more on the European crash that was the final stroke to establish the Great Depression as long-lasting fact.) There were many meteoric rises and plunges of the stock markets between these major events. I also bear in mind that more U.S. help with European debt only means we are hanging further over the cliff with them.
Depressions are like train wrecks. They are not a single crash in a ball of flames, but a cumulative crash where many cars go off the rails sequentially in different directions and run into things on the sidelines, broadening the path of damage. There are numerous impacts before the dust settles recovery can begin. We are living through a train wreck in slow motion.
Credit rating downgrades are the next impact in the ongoing economic crash
I have no fear that my days as a monger of dark news are about to end, any more than I have a desire to live through dark times. I simply look at the underlying facts and face the facts. Those facts are that, while the U.S. Federal Reserve has made this announcement of helping Europe, Moody’s has on this same day announced that their own rating system for national debt has been so flawed that it has overstated the credit worthiness of entire nations, and Standard Poor’s has announced that it is downgrading the credit ratings of almost ALL U.S. banks because its rating criteria for banks has been equally flawed up to now.
Remember that these credit-rating agencies completely failed to see the first crashes of massive U.S. banks in 2008. Those banks failed while they had flawless AAA credit ratings! That is how far off the credit-rating agencies have been. While they are now acknowledging they were a only little bit off, that acknowledgment will have cascading effects going forward as everyone readjusts their portfolios to take the re-evaluations of the banks in mind.
First, let’s start with the downgraded credit ratings of European nations by examining Moody’s rating of Greece. The New York Times reported yesterday that…
Moody’s held off dropping its strong A rating of Greece’s bonds despite growing political turmoil and economic woes through 2009. Investor fears over Greece’s short-term financing needs were “misplaced,” Moody’s said in a report in early December 2009. Twenty days later, after a review, the agency downgraded the nation’s debt, the last of the major ratings agencies to do so.
After that, the ratings of the debt-ridden country went into a virtual free fall, and within six months Moody’s assessed its debt as much riskier for investors, giving it junk status.
Part way through the recent Greek catastrophe, Moody’s was still telling its investors that Greece was completely sound — a rock-solid “A” investment … top tier. If the ratings had any reality to them, they would have long ago seen that Greece’s debt was climbing out of reach while its interest rates were rising, and they would have started downgrading the country one notch at a time as its debt situation became more top-heavy with less bottom support. This week’s admission to some failure is as though the diagnostician has just looked at the nearly dead patient and said, “I think she had a cold,” even though she had serious signs of trouble when she came into the hospital and was given a perfect bill of health by that diagnostician.
“If you look at the fact that this is going to be a country that is going to default on its debt, and two years before it was still single A, that is a very, very precipitous fall,” conceded Pierre Cailleteau, Moody’s head of sovereign debt ratings until he left in spring 2010.
Moody’s corrections of their first prognosis for Greece are a tepid re-evaluation of how far off they were. Of course, no one wants to admit they were dumber than a stuffed turkey. Having held the worst of Europe’s sovereign debts in a high rating until very recently, Moody’s suddenly pronounced this week that there are rising prospects for multiple sovereign debt defaults by countries all over the Eurozone. How do we go from “A” ratings of the worst of these nations to the prospect of multiple defaults even by the better nations like Italy in so short a time, except that the ratings agencies never saw the track was out before the train got there? They were only reporting on what was happening on the train before it hit the bad rails. At that point, all was running smoothly. So what!
The New York Times article goes on to report…
That rapid deterioration underscores how, critics say, the credit ratings agencies that judged Greece’s debt as investment grade for most of the last decade missed or badly misread signs of trouble. Moody’s held its rating steady even after Greece in 2004 admitted lying about its deficits to join the countries using the euro in 2001. Now, the ratings agencies are under fire from European regulators about whether their recent downgrades of Italy and Spain worsened an already tenuous situation.
Credit downgrades bring Euro crisis forward from the horizon
The European crisis is developing so quickly toward a nightmare that another news story by Sky News reported today that the Organisation for Economic Cooperation and Development (OECD) said Eurozone exits may trigger a “deep global depression.” Not just a global depression, but a “deep” global depression like the Great Depression. The report admitted that, if a country like Greece does choose to exit the Eurozone…
There would also be strong incentives for households and businesses to withdraw deposits from these vulnerable countries, creating a potential for bank runs to add to economic instability.
If everything came to a head, with governments and banking systems under extreme pressure in some or all of the vulnerable countries, the political fall-out would be dramatic and pressures for euro area exit could be intense.
The establishment and likely large exchange rate changes of the new national currencies could imply large losses for debt and asset holders, including banks that could become insolvent.
Such turbulence in Europe, with the massive wealth destruction, bankruptcies and a collapse in confidence in European integration and cooperation, would most likely result in a deep depression in both the exiting and remaining euro area countries as well as in the world economy.
Now, the OECD did not say these defections have a high probably of unfolding, but the scenario is part of their report about the Sword of Damocles that now hangs over the global economy. And today’s economic news says that Europe is moving closer to this as credit ratings are downgraded to more accurately reflect reality. That only makes Greece’s burden more difficult if it wants to cover its remaining debt to stay in the euro zone, and it raises the prospects of other nations entering the same zero zone.
How could the credit rating agencies get everything so wrong?
The last line quoted above from the NY Times article sheds some light on one reason these companies have done such a poor job of forecasting sovereign debt troubles: “Now, the ratings agencies are under fire from European regulators about whether their recent downgrades of Italy and Spain worsened an already tenuous situation.” Simple political fact: no one wants to hear the truth because a credit downgrade will always trigger a cascade to deeper credit problems by raising the cost to finance the existing debt.
While reporting the accurate facts of a nation’s credit worthiness can trigger a collapse, not reporting them can allow the problem to continue to build toward a worse and more certain collapse. Many are saying that, had Moody’s slowly downgraded Greece’s credit, starting a few years ago, Greece would not have been able to pile up such a mountain of bad debt that has now gone into default as banks and nations all over the world are having to write off 50% of the Greek debt. Moody’s reluctance to give an earlier downgrade resulted in investors being encouraged to take on billions of euros more in Greek debt than they would have with an accurate report. Moody’s failure created moral hazard for politicians, too: “The higher credit ratings made it easier to raise debt than to raise taxes or make other unpopular and painful economic adjustments.”
The NY Times continues…
“The credit rating agencies failed in their job,” said Wolf Klinz, a European Parliament member from Germany and author of a critical 2010 report on ratings agencies. “They held on artificially too long to their original rating. They should have started earlier.”
Because no agency wants the flack that Standard & Poors took from the U.S. government and from other agencies and economists when it downgraded the U.S. credit rating, S&P remains the only U.S. credit-rating agency that that has downgraded U.S. debt. You’re going to get a lot of heated argument when you tell an entire nation their credit-worthiness is starting to stink like death. Other agencies and Wall Street investors booed Standard and Poor’s downgrade of U.S. credit back in August, but those are the same agencies that rated Greek debt as prime. So, why should they be believed when it comes to the U.S.? Those listening to the agencies suffer from the same economic denial as the agencies themselves. No one wants to hear the news, so no one wants to be first to speak or write bad news, and everyone is ready to criticize the agency that starts the economic avalanche by rolling the first pebble down the cliff.
In short, the shear size of nations and the long periods that they have had stellar credit beguiles onlookers to think something that big — like the Titanic — could not possibly go under. Yet, like the Titanic, nations can hit an iceberg and go down in a precipitous fall that is breathtaking. The former Soviet Union is an example of such rapid decline due to financial implosion. Then the shear size of the disaster that will ensue once one credit agency is first to start the cascade makes all credit agencies reluctant to be economy wreckers for the entire world by being first to give the true bad news about the credit-worthiness of nations. Thus, there is great inertia against downgrading sovereign credit ratings.
A third problem that can be assumed is that nations and banks and other businesses all do their best to understate their problems in the reports used by ratings agencies. Remember how Enron carried a high credit rating with almost all agencies only days before it declared bankruptcy? Remember, too, the Greek lies?
Then there is this little fact — a fourth reason credit agencies have grossly overrated some nation’s debt:
Moody’s was paid $330,000 to $540,000 each year by Greece to rate its debt. The other agencies received the same amounts.
Moody’s has retorted that…
“the commercial and analytical aspects of our business operate separately.”
Oh. Well, alrighty then!
All of this adds up to European sovereign debt problems definitely being worse than has been stated by the ratings agencies, and that is only now starting to get the kind of press and talk that it should. The same problems are true to a smaller degree for credit ratings of the largest banks in the United States:
Banks get credit rating downgrades today only because they were always overrated
Many of the largest banks have also gone overrated throughout this crisis. In being first to recognize that, Standard and Poor’s announced today that it had revised its ratings criteria, which led to a one-step downgrade today for many of America’s largest banking institutions, including Bank of America, Citicorp, JP Morgan Chase & Co., Wells Fargo, and Goldman Sachs. These lenders have, in turn, stated that the downgrade will result in each of them needing to raise billions of dollars in additional capital.
S&P … has been changing the way it looks at debt after its faulty grades contributed to the credit-market seizure that brought down Lehman Brothers Holdings Inc. and Bear Stearns Cos. (See full report on Bloomberg.)
Bank of America stated in its quarterly report that downgrades “could likely have a material adverse effect on our liquidity, potential loss of access to credit markets, the related cost of funds, our businesses and on certain trading revenues, particularly in those businesses where counterparty creditworthiness is critical.”
S&P wrote that the new shift in bank ratings reflect something much larger in the making — “a potential shift in the power balance of global banking.”
While S&P attempts to get its credit-rating criteria in line with what the real world already knows (or should know) about the condition of these behemoth banks, it has made some serious blunders in the past month. It caused undue turbulence in world bond markets when it “accidentally” (and wrongly according to its own admission) downgraded France and Brazil. But this is why S&P’s top executives make the big bucks. They should not be held to too high a standard. It is, after all, only the wealth of nations at stake, and they are only a “Wall Street” firm where the heads at the top are unoccupied yet richly paid.
So, the stock market can do what it wants, and I’m not going to pay much attention
Today’s news that credit situations of major banks and major nations are all worse than previously reported is the reason today’s announcement by the Fed along with the surge in consumer spending on Black Friday and the rise in job rates do not mean much. There is a lot of darkness on the horizon that has moved noticeably closer today. The problems with banks, which caused the Great Recession in the first place, are WORSE. They are not worse than I suspected, but today what I was suspecting has become common news that will, itself, change the news in days ahead.
Remember, too, that government organizations taking major steps, like the U.S. underwriting more European debt, are really signs of just how bad the government thinks the problem is. Crisis times cause major government moves, which cause big spikes in a stock market that is likely to whipsaw. Such big actions by government to correct each problem are why the stock market is so volatile during times of great economic depression.
Thus, today’s news also said:
The aggressive intervention, which harkened back to the moves after Lehman Brothers collapsed and sparked a global credit crisis, pushed major indices up more than 3 percent and banks higher by nearly 5 percent. But once the euphoria ends, banks still will have plenty of issues to confront…. Standard & Poor’s helped pull the curtain back somewhat on Tuesday when it downgraded most of the big U.S. banks. (Why Bank Stocks Are Stuck In a ‘Crushing Bear Market’)
And U.S. presidential hopeful Ron Paul said the following about the way markets should have responded to this announcement by the Fed that it is helping bail out Europe:
Rather than calming markets, these arrangements should indicate just how frightened governments around the world are about the European financial crisis.
If you want to know whether the clearing water in the stream means anything, do not look at the water in front of you. Look upstream at the source to see if it has cleared. It has not. The bank’s problems just got deeper. So did those of nations. When credit agencies find their rating systems are seriously broke and begin correcting their criteria to better reflect the true condition of institutions, their correction creates new problems for the institutions as those who do business with them make demands based on those ratings. A downgrade in the report’s summery analysis (even if it is not due to any change in the facts the report was based on) raises the cost of interest and causes further downgrades.
Today was one more domino that fell.
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