Why A Credit Downgrade For The Biggest Banks Is Great News For Taxpayers


Four of the largest American banks had their credit rating downgraded on Thursday by Moody’s Investors Services, signaling that the ratings agency believes government efforts to put a stop to bailouts have succeeded. The decision is bad news for Morgan Stanley, Goldman Sachs, JPMorgan Chase, and Bank of New York Mellon, but good news for taxpayers.

The downgrade means that Moody’s believes the banks to be a slightly less safe investment than before. The firm justified that assessment by citing regulator efforts to make bailouts a relic of the past by establishing a system for winding down a failed megabank rather than rescuing it from its own errors. “We believe that U.S. bank regulators have made substantive progress in establishing a credible framework to resolve a large, failing bank,” Moody’s said, adding that the changes mean shareholders would shoulder losses “rather than relying on public funds to bail out one of these institutions.”


Such a change stems from a key provision of the Dodd-Frank reform package passed in 2010. The law required the largest banks to pay into a fund that will be used to dismantle a failed bank and sell off its holdings. Republicans in Congress have frequently portrayed that orderly liquidation authority as a “permanent bailout” in a re-labeling of the measure that will prevent future bailouts by taxpayers.

Meanwhile, many less-partisan observers have questioned the whether the orderly liquidation fund and other Dodd-Frank provisions aimed at ending the problem of too-big-to-fail banks are actually sufficient for curbing the problem. There are numerous strong arguments for simply breaking up the biggest banks rather than trying to design a cushion to protect the economy from future crises. But Thursday’s decision from Moody’s indicates that a major Wall Street player believes the Dodd-Frank mechanism will work. While ratings agencies were in many ways complicit in the last financial crisis, “they’re still excellent sources of knowledge,” one investment firm manager told Bloomberg.

Moody’s left its rating of four other giant banks stable. Bank of America, Citigroup, State Street, and Wells Fargo all had their current ratings affirmed. Three of those four had previously been downgraded by Moody’s in 2011 under the same rationale as Thursday’s downgrades.