naked capitalism

Note: variants of the word “protect” as regards the US Treasury’s stance towards the pending $9 billion Mitsubishi UFJ investment in Morgan Stanley, appeared in the headline and first paragraph of the New York Times discussing the state of the deal. But the text of the article suggests the Treasury may be engaging in a bit of tap dancing, since the Japanese want a guarantee and the US Treasury appears loath to go that far. But the difference between a guarantee and “protection” appears to be semantic, so one has to wonder about the careful use of terminology.

From the New York Times:

In what could set an important precedent, federal officials assured a big Japanese bank late Sunday that its planned investment in the embattled Wall Street giant Morgan Stanley would be protected, according to people involved in the talks.

After two days of tense negotiations, Treasury officials urged a hesitant Mitsubishi UFJ Financial Group to proceed with its $9 billion investment in Morgan Stanley, which has sought the capital infusion to reassure investors and customers about its stability…

The Treasury’s assurances amount to another extraordinary move by the government and could serve as a model for future deals. The tense, weekend talks were so critical to the financial markets that they drew in both the Treasury and the Japanese government.

Mitsubishi and the Japanese government pressed the Treasury Department over the weekend to guarantee that if the United States were to inject money into Morgan Stanley at a later time — a step the Treasury has ruled out for now — the move would not wipe out Mitsubishi’s investment.

Investors suffered deep losses when the government effectively nationalized the nation’s largest mortgage finance companies, Fannie Mae and Freddie Mac. The Treasury has said it might use some of the $700 billion bailout package authorized by Congress to take direct stakes in banks, but it has not spelled out how it would do so. Many prospective investors, like sovereign wealth funds, have been sitting on the sidelines, reluctant to invest in financial services companies while the government’s plans remain uncertain….

Yves here. We said at the time of the Freddie and Fannie conservatorship that eliminating the preferred dividends, which led to immediate large losses on those instruments, was very short sighted and would hurt future efforts to raise bank capital from private sources, particularly since preferred stock is the best investment vehicle in a weak entity. That chicken has already come home to roost.

Mitsubishi was pressing for more favorable terms after Morgan Stanley lost nearly half its market value during the stock market plunge last week…Last month, Mitsubishi agreed buy about 21 percent of Morgan Stanley. The investment was to be made in the form of $3 billion in common stock, at $25.35 a share, as well as $6 billion in convertible preferred stock with a 10 percent dividend and a conversion price of $31.25 a share.

Under the proposed new terms being discussed on Sunday night, Mitsubishi would still buy roughly 21 percent of Morgan Stanley, according to people involved in the talks. But all of the investment would be through preferred shares, with a 10 percent annual dividend. Many of those shares would be convertible into common stock, but the Japanese bank was trying to set a conversion price far lower than originally proposed, probably close to $20.

Henry M. Paulson Jr., the Treasury secretary, has urged both companies to devise a private-market solution and has indicated that he does not believe that Morgan Stanley needs capital from the government. However, Treasury officials privately hinted to members of both companies that the government would back Morgan Stanley if it came to that, these people said, suggesting that he does not want to repeat the troubles that resulted from allowing Lehman Brothers to go bankrupt.

George Soros, the prominent investor, wrote in a column in The Financial Times that the United States government needed to rescue Morgan Stanley.

“The Treasury should offer to match Mitsubishi’s investment with preferred shares whose conversion price is higher than Mitsubishi’s purchase price,” Mr. Soros wrote. “This will save the Mitsubishi deal and buy time for successfully implementing the recapitalization and mortgage reform programs.”.