The SEC's ban on short selling ended Thursday. This creates the conditions to resume the cycle of value destruction that brought down Lehman Brothers Holdings. What happens is that a threat of a credit downgrade causes a spike in the premiums for credit default swaps (CDSs) that insure the bank's debt. That premium spike requires a collateral call which the bank lacks the cash to meet. This jeopardizes its effort to raise capital and sends the stock plunging -- to the profit of the short sellers.
Enter Morgan Stanley (NYSE: MS). A few weeks ago, it announced that it would raise $9 billion from an investment from Japanese bank Mitsubishi UFJ Financial Group, which is due to close on October 14th. However, the $25 a share purchase price is now about double Morgan Stanley's closing stock price Thursday. If the $9 billion capital commitment remains constant, MUFJ would own 65% of Morgan Stanley rather than the original 21%.
And this morning, a report emerges that Moody's (NYSE: MCO) will put $200 billion of Morgan Stanley's debt on downgrade watch -- helping drive its stock down 27% in pre-market. As happened at Bear Stearns and Lehman, hedge fund clients have pulled out their money and its CDS premiums are up so much that it can't issue new debt. Specifically, Morgan Stanley's 5-year CDSs rose to an upfront payment of 28% of the amount insured -- yesterday it was 19% -- plus 5% percent a year. So Morgan Stanley would pay $2.8 million to insure $10 million of debt plus $500,000 a year.
That's too bad because Morgan Stanley needs $30 billion in new capital to address concerns about its $78.4 billion in Level 3 assets -- which are almost impossible to value -- representing 8% of its $900 billion total.Would it surprise me if MUFJ decided not to make its investment? Not at all. It would be cheaper to buy selected Morgan Stanley assets out of bankruptcy.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.










Reader Comments (Page 1 of 1)
10-10-2008 @ 11:05AM
nightnightshark said...
Bush to buy Citibank!
There's a very good chance the United States government will now be buying some of our biggest banks as many now seem to be on the verge of failure. With Wells Fargo winning the battle against Citibank for Wachovia, it appears Citibank "may" not be able to survive without....
continued at....
www.mortgagebreakdown.com
10-10-2008 @ 11:56AM
james said...
Yep yep Yep.
Unless MS merge with someone quick, it is ZERO!
10-10-2008 @ 12:13PM
Joyce Abraham said...
After the week global banking just went through, no scenario is unthinkable. Banks are in trouble throughout Europe and Iceland's all went broke. Britain is buying shares from its biggest banks for hundreds of billions of dollars, essentially part-nationalizing the sector. And Thursday the American treasury secretary hinted that the U.S. might follow in the U.K.'s footsteps. If banks in the U.S., Britain and Europe are nationalized what does that mean for the layman?
What does it really mean... ??? Where do we go from here? I am a member of Myinvestorsplace.com and we are looking for help and any and all suggestions. Thanks
10-10-2008 @ 3:51PM
Denny said...
Someone is fooling with the market. In this market no trader is going to hold over a weekend, let alone a long weekend. Someone is trying to prop it up in this last hour...who? When it started up it was in 50 or 100 point increments, as soon as it falls into the red...it jumps way back up again. It's somebody with very deep pockets, Treasury? Let it do what it will do...it's the only way to shake this thing out.
10-10-2008 @ 4:38PM
Shelley said...
Just please remember to ALWAYS have your protective Exit Strategy in place from the start when investing in the stock market. One that is intelligent. http://www.smartstops.net
10-10-2008 @ 8:05PM
David said...
Morgan Stanley isn't worth saving. Anyone that has done business with them in the last ten years has lost a fortune.
10-11-2008 @ 10:43AM
Wildman69 said...
Just let them fail like they let Lehman Brothers fail. The more of these institutions that we do not bailout, the better off the taxpayer and consumer is. Which these institutions finally fail, it will give the marketplace the opportunity to rebuild, stronger and more self-reliant.
10-12-2008 @ 7:53PM
Jim said...
Those of you who say that Morgan should be allowed to fail clearly have very little understanding of how the market and our financial institutions work. Morgan is an important counterparty to many other institutions and banks. The Treasury learned it's lesson when it made the mistake of letting Lehman fail - although Paulson is pushing MS and MUFJ to work out a private solution, there is no doubt Morgan will get a cash infusion from the government if the deal is not consumated. Morgans failure would deepen the credit freeze and send markets even lower. If MS fails, look for 1929 all over again - just much worse.
It's also very cavalier of you to suggest that somehow they deserve to fail. You forget that just as a Lehman, the vast majority of Morgan employees are middle class worker bees just like you and I. Letting Morgan fail puts 50,000 out of work, the vast majority (99%) of whom didn't make $43 million last year (like Dick Fuld), and have children, husbands and wives, mortgages and dreams just like you and I.
Stop being so callous.
10-13-2008 @ 12:40AM
yani said...
Those of you who say that Morgan should be allowed to fail clearly have very little understanding of how the market and our financial institutions work.
Jim, I guess MS understsands it clearly
same way as the others Lehman...ect..
Let them fail they pretty weak anyway,and the strong will survive.
This bail out smells like COMMUNIST TRICK