naked capitalism

Now I am really going to rant. What is going on here? The financial system is on the verge of a meltdown, we have the Lehman credit default swaps settlement tomorrow, which is a huge test that has investors on Defcon One. Markets are as unhinged as they can be and still be functioning around the margin. So Moody’s decides NOW to put out a possible downgrade alert for Morgan Stanley?

After their DECADES of being slow to downgrade, of almost religiously administering downward revisions after the bond markets had already re-rated the credit on their own, Moody’s decides to become true believers in timeliness when that can have the effect of driving a knife into the markets and giving a twist?

If an investment bank is downgraded beyond a certain level, counterparties stop trading with it because they will get downgraded automatically by virtue of their exposure, Thus concerns over a possible downgrade can lead dealers to start directing business away from a firm that appears to be weakening, creating the beginnings of a run. Morgan Stanley is bigger than Lehman was. After the havoc the collapse of Lehman wrought, Morgan Stanley will not be permitted to fail. But to have that hanging over the markets at this juncture is the worst timing imaginable.

From Bloomberg (hat tip reader Steve):

Morgan Stanley, the U.S. securities firm whose shares dropped 26 percent yesterday, had its long-term credit ratings put on review for a possible downgrade at Moody’s Investors Service.

About $200 billion of long-term debt is affected by the review of Morgan Stanley’s A1 credit rating, Moody’s said in a statement today. The ratings agency affirmed its Prime-1 grade for Morgan Stanley’s short-term debt.

Even though one rating was affirmed, the downgrade shadow is going to rattle some nerves.

Update 12:00 AM: The New York Times reports on the investment bank’s woes:

After briefly beating back those who would bet against Morgan Stanley, the humbled Wall Street giant that he runs, Mr. [john] Mack was once again playing defense on Thursday. His bank came under renewed assault in the stock market, where its share price plummeted nearly 26 percent…..

Once again, questions swirled about the fate of Morgan Stanley, despite the bank’s efforts to quiet them. Short-sellers, those investors who wager against stocks, took renewed aim at the firm. At midnight on Wednesday, regulators lifted a temporary ban on short sales. Mr. Mack had angered many hedge funds by lobbying for the restriction.

Much of the concern centered on Morgan Stanley’s deal to raise $9 billion from Mitsubishi UFJ of Japan. Despite repeated assurances from Mr. Mack and Mitsubishi executives, some investors worry that the decline in Morgan Stanley’s share price, coupled with the steep sell-off in the Japanese stock market this week, might prompt Mitsubishi to reconsider its investment. Morgan Stanley hopes closing the Mitsubishi deal will help ease the burden on its shares the way Warren E. Buffett’s $5 billion infusion helped stabilize Goldman Sachs.

Fears that the deal would not close were evident in the bond market, where Morgan Stanley’s 10-year debt sank to 64 cents on the dollar on Thursday, down from 96 cents a month ago. The price of insuring Morgan Stanley’s debt soared to record heights….

Yves here. So this may explain the downgrade notice, Moody’s does not want to be too far behind the markets. But the fears hinge to a significant degree on the Mitsubishi deal closing. Why not wait till Tuesday to see whether it happens or not?

…assurances about the deal did not assuage nervous investors and analysts who said failure to close the deal could be devastating.

“They need to bring this equity in to restore confidence in the marketplace,” said Brad Hintz, analyst at Sanford C. Bernstein. “It is all about confidence because there is nothing fundamentally wrong with Morgan Stanley.”

However, Mr. Hintz said that if that confidence continued to wane, hedge funds would withdraw balances en masse, counterparties would try to get out of trades and Morgan Stanley could find itself in the same kind of squeeze that hit Bear Stearns, then Lehman Brothers.

In fact, the twisted morass of Lehman’s bankruptcy filing could make things worse, analysts said, because hedge funds and trading counterparties who find themselves owed billions by Lehman could move more swiftly to ensure they do not face similar problems with Morgan Stanley.

Mr. Mack should theoretically be in a much better position to weather the crisis than was Lehman. The bank does not need to tap short-term debt markets, which are currently frozen, until the third quarter of next year. It has reduced its reliance on borrowed money and has about $50 billion in cash and highly liquid securities on its balance sheet. Now that it is a bank holding company (as is Goldman Sachs) Morgan Stanley can borrow directly from the Federal Reserve.

Update 1:10 AM: Moody’s is creating mischief on other fronts, with Goldman. But since Goldman’s debt rating is a notch higher, and the warning (negative watch) is less urgent, this is not (yet) a big deal.

From Bloomberg:

Morgan Stanley’s credit rating may be cut by Moody’s Investors Service, which said the financial market slump may hurt profit at the U.S. securities firm next year.

Moody’s put Morgan Stanley’s A1 long-term credit rating on review for a possible downgrade, according to an e-mailed statement. The ratings assessor also lowered its outlook for Goldman Sachs Group Inc.’s Aa3 long-term rating to negative.