Moody's to Cut Bank Ratings as Euro Worries Persist
Rumors that Moody's is looking to cut its credit ratings on UBS (NYSE: UBS), Credit Suisse (NYSE: CS), and Morgan Stanley (NYSE: MS) was met with a drop in European markets, also hit by continued concern that a Greek deal may fall apart thanks to a lack of political cohesion both in the country and in the EU at large. European financials were down, with Deutsche Bank (NYSE: DB) dropping over 3.5 percent in early morning, although the stock has since recovered to a loss of just 1.8 percent.
European bears today are chipping away at previous gains, but not erasing them. Shares in the German banking giant are still up over 11 percent from a month ago, and UBS is up almost 20 percent. A broad equity rally in the new year has brought hope that financial firms are returning to health and the European debt crisis is coming to an end.
Little beyond hope has fueled those sentiments, however. One day of good news from Greece is followed by one day of bad news, and trading volumes remain thin in equity markets while European sovereign debt remains an uncertain proposition.
While this is an overlooked side of the financial industry, the tax rate of investment banks is an indirect indicator of the range and health of investment opportunities in bond, equity, and commodity markets. A lower tax rate reflects the fact that Goldman has been investing in tax preference items because there are few safe bets beyond them. In the firm's last quarterly reports, Goldman reported a tax rate of 18.8 percent, lower than in previous quarters and lower than most middle class wage earners. This is because Goldman has focused on things like untaxed municipal bonds and qualifying small business stock, whose tax status offsets significant risk for the company. These investments were largely chosen over equity, currency, and commodity bets that had driven the company's bottom line before 2008.
The market, however, has ignored this warning sign that the investment banking market is contracting. The market also ignored Morgan Stanley's loss of $275 million last quarter, which caused the stock to rally 8 percent last month. Since then, the stock has gone up a further 9.2 percent.
Morgan's loss was thanks to lower revenues and lower investment opportunities, which hit the firm's Institutional Securities division and caused its results to plummet by over $4 billion. Institutional Securities is the firm's investment banking, management, consulting, and trading arm, and was hit hard for the same reason that Goldman paid lower taxes: less investment opportunities have led to a flight to safe havens.
Thus gold is up. The U.S. dollar is up. Stocks in Europe and globally are down and the euro continues to weaken.
These recent developments do not erase the steep rally of the last two months, but they are a significant challenge. They are also a reminder that investment banking and investing in general are nowhere near the stability that the market would like to see, and that the fate of the euro needs to be decided soon before the market can continue its optimistic climb.
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