Morgan Stanley

Remember when Morgan Stanley pulled out the kitchen sink two weeks ago in support of its surging CDS (which incidentally will be the sole reason for the bank's "surprising" EPS beat when the bank pulls a DV(D)A page right out of JPMorgan's playbook) by enlisting the support of Japanese JV Mistubishi UFG with promises that it would never let its bigger US brother down? Well, we now have the first indication of just "how" said plan will look like. As Reurters reports, the JV "is planning to cut 1,200 to 1,300 jobs, or about 20 percent of the total workforce, a source familiar with the matter said on Monday. A spokesman at Mitsubishi UFJ Morgan Stanley said his firm made a call for early retirements earlier this month but declined to say how many workers responded. A previous call for early retirements in February cut about 270 jobs. The company had about 6,600 employees at the end of March." And there you have it. With supporting JV partners such as these, who needs CDS vigilantes, or the difference between gross and net exposure when bilateral netting is discovered to be the biggest fraud ever?

Since one can not get a downgrade of a bank during market hours for fears of springing who knows what circuit breakers, Fitch had to wait until just after the market close to release its latest market surprise which consisted of a "watch negative" announcement on the following banks Barclays, BNP Paribas, Credit Suisse, Deutsche Bank, Goldman, Morgan Stanley; others it just slashed some by multiple notches, among which: Landesbank Berlin IDR downgraded to A+ from AA-; Lloyds Banking Group IDR downgraded to A from AA-; RBS IDR downgraded to A from AA-; and most importantly UBS IDR downgraded to A from A+. The reason for the action: "the ongoing Eurozone crisis continues to feed intense market speculation regarding the potential or bank recapitalisation schemes. Therefore for the near term the agency is maintaining a 'single A' range support rating floors for banks in its highest rated Eurozone countries." The Euro is not liking this announcement one bit.

Update: For those curious to learn more about this phenomenon, here is ZeroHedge's first take on this paradox from April 2009!

Stocks added to their rally today when Gasparino leaked news that MS was going to have a "solid" quarter and they were going to beat GS. Morgan Stanley has $187 billion of public debt according to Bloomberg.  Just eyeballing it, the average maturity looks close to 4 years, but let's be conservative and assume it is 3 years. So MS 3 year bonds widened by over 300 bps during the quarter.  3 year MS CDS widened by 380 bps (from 113 to 493), so the move in bonds actually outperformed the move in CDS. Is MS planning on taking a massive gain on marking their own bonds?  There were stories of MS buying back their own bonds - a great move if they though they were cheap, but a critical move if they were planning on taking a gain and didn't want to have to give it back in the future if their credit spreads tightened. Goldman has slightly less debt at $178 billion, but the spread widened far less. Is this why the MS CEO is so confident they will have a good quarter and beat GS?  I honestly hope not.  If the CEO of MS is playing accounting games (totally legal, but stupid) on their own spreads and thinks the markets will respect that, than I am very nervous about what is going on there.

Remember how the market rally back in March 2009 started with Citi leaking its "great" numbers? Well, Morgan Stanley has just one upped them, not only "leaking" their own numbers, via Fox Business' Gasparino who a week ago was theatrically complaining that Morgan Stanley wanted him dead, but also somehow leaking Goldman's numbers. How Morgan Stanley got Goldman's Q3 numbers? We don't know. But all is fair in love and preserving the ponzi. Lastly, if the actual numbers of Mack The Knife's firm end up being far worse than expected (remember all that stuff about VaR being taken down in in Q3 after it soared in Q2), they can just blame Gasparino for not knowing the difference between Gross and Net EPS, net of European bank exposure.

• GASPARINO SAYS MS CEO TELLING INVESTORS EVERYTHING IS 'OK'
• GASPARINO SAYS MS CEO TELLING EXECS 3Q RESULTS TO BEAT GOLDMAN
• FOX'S GASPARINO SAYS MORGAN STANLEY CEO SAYING 3Q LOOKS 'SOLID'

Synopsis: Questions about MS's French bank exposure and level of derivatives exposure. While June results were good, MS' French bank exposure (all asset and off balance sheet classes except derivatives) is estimated at $39B (57% of equity of $68B and 150% of market cap of $26B) of which interbank placements is believed to be a small component. These exposures are significant and unusually large as a percentage of capital. Of equal concern is the estimated $1.78T in notional value of CDS' on MS' books although EJR does acknowledge the netting effect (the net estimated exposure is $457M). The US is likely to provide MS additional support if needed, despite wind-down procedures contained in Dodd Frank. We are downgrading with a neg outlook.

We must have missed the moment when Jim Cramer defended Morgan Stanley today, but judging by the company's CDS which is +30 to a ridonculous 610/650, he must have said something positive. In fact, the bank's "outperformance" is only matched by that of Waffled which as we have been saying since Friday is going to meet Dexia about halfway. Today it is +23 to 290/300, the worst performer of any country in the world.

Just because outright denials by Dick Bove, Alliance Bernstein, Credit Suisse, Jim Cramer and Wells Fargo were not enough to prevent a rout of Morgan Stanley stock after someone dared to point out one simple observation, here comes the 2008 deja vu when the Asians had to step up and protect their "strategic alliance" partners, also known as deeply underwater investments. We expect another Eureka moment from the Orkimedes Of Omaha (and grand tax vizier) shortly.

Minutes ago Jim Cramer, reverting to his traditional inverse bank psychic, whose track record needs just one word of reminder, and that is Bear Stearns, told everyone that Morgan Stanley is fine. It may well be. However, we doubt it, as does the market, which just sent out the firm's CDS up another 32bps to 528bps, the widest since 10/13/08 having only traded wider than this level from 9/16/08 to 10/13/08. Critically for those looking at CDS not being as bad as during the peak of the crisis and gaining comfort from that - CDS did not trade gently to those extremes - it gapped unmercifully wider with incredible day to day volatility. Furthermore, for those talking about how illiquid CDS are and easily manipulated, we remind them that it is bonds that cracked first (a much more broadly owned and traded set of instruments) and only very recently has CDS started to catch up to the wide/risky levels at which bonds trade.

The move in Morgan Stanley CDS has been grabbing some attention.  It has moved wider than any of the other banks.  Its exposure to French banks in particular has been part of the reason.  Potential hedging of counterparty exposure has also been listed as a reason. (Once again I can’t help but wonder why derivatives in general, and CDS in particular, didn’t get forced into clearing or exchanges after Lehman). I don’t know whether Morgan Stanley is rich or cheap at these levels, but I think there is more digging that needs to be done and it should focus on Asian exposures because that seems to correlate best to the recent moves.

We have been discussing US (and European) financial risk for some time (especially recently with regard MS exposure to French banks). Since we published that article, we have seen incredible shifts in MS CDS and bonds even as stocks appear to shrug of some of the reality of the situation. An excellent article on Bloomberg last evening pointed out that not only was MS CDS at rather extreme levels, it was quietly as risky (if not more so) than many of the European banks that are making the headlines. Not only is MS CDS its highest since its spike highs in Q4 2008, the curve is inverted with 1Y risk trading 500/550 against 5Y risk at 455/470 which strongly suggests jump risk (or counterparty risk) is being aggressively hedged. With over $4.5bn of debt maturing in Q4 (which we have been pointing out for months - TLGP issues) and the increasingly binary nature of any outcomes, it seems the only real buyer of any MS debt are basis traders as the difference between bond spreads and CDS has halved in the last few weeks.

The latest quarterly report from the Office Of the Currency Comptroller is out and as usual it presents in a crisp, clear and very much glaring format the fact that the top 4 banks in the US now account for a massively disproportionate amount of the derivative risk in the financial system. Specifically, of the $250 trillion in gross notional amount of derivative contracts outstanding (consisting of Interest Rate, FX, Equity Contracts, Commodity and CDS) among the Top 25 commercial banks (a number that swells to $333 trillion when looking at the Top 25 Bank Holding Companies), a mere 5 banks (and really 4) account for 95.9% of all derivative exposure (HSBC replaced Wells as the Top 5th bank, which at $3.9 trillion in derivative exposure is a distant place from #4 Goldman with $47.7 trillion). The top 4 banks: JPM with $78.1 trillion in exposure, Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure. As historically has been the case, the bulk of consolidated exposure is in Interest Rate swaps ($204.6 trillion), followed by FX ($26.5TR), CDS ($15.2 trillion), and Equity and Commodity with $1.6 and $1.4 trillion, respectively. And that's your definition of Too Big To Fail right there: the biggest banks are not only getting bigger, but their risk exposure is now at a new all time high and up $5.3 trillion from Q1 as they have to risk ever more in the derivatives market to generate that incremental penny of return.

Earlier today some blog pulled up some factual data that suggested that Morgan Stanley had $39 billion in total exposure against French banks at the end of 2010, up $30 billion from the year prior, and enough to wipe out its entire market cap and then some should French banks be pulled under. Sure enough, the stock tanked even though as CNBC pointed out "there was absolutely no news." Since then, first Credit Suisse defended Morgan Stanley for its "European exposure" (we wonder how long before Morgan Stanley returns the favor and has to defend Credit Suisse for its US exposure: judging by Credit Suisse's maximum outlier 3M USD Libor rate, not too long). And now it is bank #2's turn, in this case Alliance Bernstein, whose conclusion is that "we estimate that total risk to France and its banks is less than $2 billion net of collateral and hedges." Ah yes, collateral and hedges, which, lest we recall incorrectly, did miracles when Lehman blew up and the very fabric of net hedging offset was threatened when the viability of the initiator in the "gross" CDS chain was put into question (thank you AIG). Naturally, if and when the 3 Big French banks go down, everyone will be perfectly normal and have no problem netting of hedges. Naturally. As for the coup de grace in the AB report, it is this piece of rhetorical brilliance: "Over the last six months, there have been 5,600+ articles published by the press on the subject of "French Banks" and "Credit Risk". We believe Morgan Stanley's risk management staff and its trading units are fully aware of the highly publicized risks emanating from Europe and warnings about the firm's potential exposure to a European Sovereign crisis." And there you have it: just because everyone is aware the bank is doomed, means the bank is ok. See, this is nothing like the logic that comedy entertainment icons such as Cramer and Dick Bove used to endorse Bear and Lehman days before both imploded. Then again, the downside for AB to actually tell the truth is substantially higher (as in contagion which takes down the entire banking system, AB included), than the upside from, well, prevaricating. As for abovementioned blog, we are just waiting for the third bank to come to Morgan Stanley's defense to know it was 100% correct.

With French banks now a daily highlight in the market's search for the next source of contagion, and big, multi-syllable words such as conservatorship and nationalization being thrown about with increasingly reckless abandon, perhaps it is time to consider the downstream effects of a French bank blow up. And we are not talking French sovereign troubles, which are about to get far worse with the country's CDS once again at record highs means the country's AAA rating is as good as gone. No: banks, as in those entities that are completely locked out from the dollar funding market, and which will be toppled following a few major redemption requests in native USD currency. Which in turn brings us to...Morgan Stanley, the little bank that everyone continues to ignore for assumptions of a pristine balance sheet and no mortgage exposure. Well, hopefully we can debunk one of these assumptions by presenting the bank's Cross-Border Outstandings, which "include cash, receivables, securities purchased under agreements to resell, securities borrowed and cash trading instruments but exclude derivative instruments and commitments. Securities purchased under agreements to resell and Securities borrowed are presented based on the domicile of the counterparty, without reduction for related securities collateral held." We'll leave it up to readers to find the relevant number.

And so the Twist spin (pun and all that) begins after Morgan Stanley's Jim Caron tells clients that OpTwist will remove "more duration risk than expected." He says that the operation will remove more than $500 billion in 10 Year equivalents of duration risk from the market, which is far higher than the firm's expectations, and adds that he was "most aggressive on the street" saying the consensus was for $300 billion in 10 Yr equivalents, especially with QE2 removing $490 billion in 10 Yr equivalents. Well, Jim, the problem is that you are right about bonds - when it comes to Twist a lot of it was priced in, but judging by the 30 year reaction, not all. However, when it comes to stocks, the robots had been expecting not just Twist but a significant LSAP component, potentially up to $1 trillion. Which explains the unwind. And as for the opportunity cost of Twist, it is shown in the chart below. As SMRA just predicted, the average maturity on the Fed's balance sheet is about to soar by 33%, from 75 months to an all time record 100 months. This means the Fed goes all in on being able to control rates. Should the Fed have to print, and it will before long, at that time the Fed's interest rate risk will be unprecedented, and should it lose control, it will lose not only that, but all credibility it is capable of keeping something, anything, be it inflation, unemployment or price stability, under control. Then, it will be truly time to panic.

While Goldman continues to resolutely predict that the EURUSD will any minute now go back to 1.50 (and 1.55 in 12 months or so), Morgan Stanley has for once decided not to ape its far more capable and client "fornicating" competitor Goldman and has thrown up all over the EUR, slashing its EURUSD forecast "significantly lower"  to 1.30 by year-end and 1.25 in Q1 2012, before stabilizing in the second half of next year because the now second rate bank believes that "economic, political, constitutional and monetary policy developments in Europe have now become more challenging for the EUR, while international support is likely to decline." Its conclusion: "As a result, the EUR's attraction as an alternative reserve currency is likely to be reduced." So, let's do the math: EUR: not a reserve currency? Check.  CHF: not a reserve currency? Check (and pegged to the former). USD: about to be gang banged by the windowless corner office at the Marriner Eccles building housing America's central planners? Check. So.... what is left if one is looking for a reserve currency?