Avalanche of Downgrades Overwhelming Bondholders! What to Do …

Maybe it’s because we got our first genuine “cold” front here in South Florida — dropping the mercury all the way to 53 degrees. But the image I have when it comes to the banking sector and sovereign debt downgrades is of an avalanche. One that starts slowly … gathers steam along the way … and ultimately mows down everything in its path!

Just in the past several days, for instance …

* Moody’s Investors Service warned of a “rapid escalation” in Europe’s debt crisis. The ratings agency added that “the likelihood of even more negative scenarios has risen” and that “multiple defaults” could be looming. As a result, it could be close to slashing European sovereign ratings across the board!

* Standard and Poor’s is on the verge of cutting France’s AAA rating or changing its debt outlook, according to a report in a French newspaper. That would follow up on the agency’s cut last week for Belgium, which was lowered to AA from AA+.

* As for Fitch Ratings, it just slashed its credit outlook for the U.S. to “negative” from “stable.” The firm cited “declining confidence” that policymakers will actually do anything to tame our massive budget deficits and sovereign debt load.

On Tuesday, S&P downgraded its ratings on 15 global banks. You can expect more to follow.

* Meanwhile, Egan-Jones just lowered its rating on France to “A” from “AA-” The smaller agency also put the country on negative watch.

That’s just on the sovereign front too. Moody’s also said it was going to review 87 different banks in 15 countries and decide whether to downgrade their subordinated bonds due to the ongoing credit crisis. S&P went a step further, cutting its debt ratings on firms like Bank of America, Goldman Sachs, and Citigroup.

Sure, they’re a day late and a buck short!
But their moves do matter!

Now let’s stipulate something right up front: The ratings agencies have a long and storied history of being a day late and a buck short.

They didn’t downgrade Enron when they should have. They didn’t downgrade investment banks like Lehman Brothers early enough. And they sure as heck missed the mark during the mortgage crisis, rating all kinds of awful securities AAA!

Despite all that, ratings DO matter. Many investment firms or investment funds can only hold securities that are rated above a certain level. If the rating on the bank, sovereign, or other instrument in question gets cut, those investors have to sell. That only exacerbates the existing downward pressure in the market.

Lower credit ratings also reflect the increasing chance that the entity in question will default. And they drive up financing costs over time.

So sure, Weiss Ratings, Martin and I have been warning for a long time about the problems that Moody’s, Fitch, and S&P are now using as catalysts for their downgrades. Indeed, Weiss rates the U.S. a “C-,” Belgium a “C-,” and France a “C” — rather than the much higher grades the major agencies are carrying.

But you simply can’t ignore the downward momentum we’re seeing now in ALL ratings, both for sovereigns and banks. Those ratings moves will exacerbate the funding crisis both here and abroad, and continue to drive interest rates higher and bond prices lower.

So what about the latest policy “bazooka?”
Is it really a big deal?

So what about the move by global central banks on Wednesday to make it cheaper for foreign institutions to obtain dollars via currency swap lines? Is it a game changer?

The recent rally is bound to disappoint buyers.

I sure don’t think so. These swap lines are not a new “bazooka.” They’ve been in place for a while. All the Federal Reserve and the central banks in Japan, Switzerland, Canada, the euro zone and the U.K. did was make it a bit cheaper, by a half a percentage point, for banks to use them.

Sure, it might give us a short-term rally. But if you’re buying into it, I believe you’re making a mistake. Every single other attempt to stand in the way of the markets has failed. Both banks and sovereign nations have too much debt, and adding more liquidity to the system doesn’t change that insolvency problem.

Or in other words, the rumblings are getting louder. The credit avalanche is gaining steam. Please don’t let it sweep your wealth away! And if you’re ready to grab bucketloads of profits as this crisis unfolds, check out my latest report.

Until next time,

Mike