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.

Continue reading Is Morgan Stanley the next to fail?

Is Morgan Stanley the next to fail? originally appeared on BloggingStocks on Fri, 10 Oct 2008 09:35:00 EST. Please see our terms for use of feeds.

Reuters reports that Morgan Stanley (NYSE: MS) will sell between 10% and 20% of its equity to Mitsubishi UFJ -- Japan's largest bank. It is not sure how much it will buy because it has not yet conducted due diligence. "MUFG said it would decide on the amount it would pay after carrying out due diligence," according to Reuters.

This -- combined with the announcement this morning that Morgan Stanley would change into a Bank Holding Company (BHC) -- increases the odds that it will remain independent. But its survival depends on raising more capital. In order to boost its ratio of assets to equity from 30.3:1 to 11:1 to meet the BHC capital standard, for example, Morgan Stanley would either need to reduce its assets or raise $60 billion in capital. If MUFJ bought a 20% stake at the current market price -- for $6 billion -- it would only go 10% of the way to reaching the $93.7 billion in capital needed to support its $1,031 billion in assets at an 11:1 ratio.

Nevertheless, investors are happy about the news, driving Morgan Stanley up 13% in pre-market.

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.

Morgan Stanley sells up to 20% stake to Mitsubishi UFJ originally appeared on BloggingStocks on Mon, 22 Sep 2008 09:30:00 EST. Please see our terms for use of feeds.