of the Morgan Stanley Panic
Trading Records Tell Tale of How Rivals' Bearish Bets Pounded Stock in
PULLIAM, LIZ RAPPAPORT, AARON LUCCHETTI, JENNY STRASBURG and TOM MCGINTY
Two days after
Lehman Brothers Holdings Inc. sought bankruptcy protection, an explosive
rumor spread that another big Wall Street firm, Morgan Stanley, was on the
brink of failure. The chatter on trading desks that Sept. 17 was that Deutsche
Bank AG had yanked a $25 billion credit line to the firm.
That wasn't true, but it helped trigger a cascade of bearish bets against
Morgan Stanley. Chief Executive Officer John Mack complained bitterly that
profit-hungry traders were sowing panic. Yet he lacked a critical piece
of information: Who exactly was behind those damaging trades?
reviewed by The Wall Street Journal now provide a partial answer. It turns
out that some of the biggest names on Wall Street -- Merrill Lynch &
Co., Citigroup Inc., Deutsche Bank and UBS AG -- were placing large bets
against Morgan Stanley, the records indicate. They did so using complicated
financial instruments called credit-default swaps, a form of insurance against
losses on loans and bonds.
A close examination
by the Journal of that trading also reveals that the swaps played a critical
role in magnifying bearish sentiment about Morgan Stanley, in turn prompting
traders to bet against the firm's stock by selling it short. The interplay
between swaps trading and short selling accelerated the firm's downward
was pieced together from the trading documents and more than six dozen interviews
with Wall Street executives, traders, brokers, hedge-fund managers, regulators
sales of credit-default swaps were a profit gold mine for Wall Street. But
ironically, during those tumultuous few days in mid-September, the swaps
market turned on Morgan Stanley like a financial Frankenstein. The market
became a highly visible barometer of the Panic of 2008, fueling the crisis
that ultimately prompted the government to intervene.
also were trading Morgan Stanley swaps on Sept. 17: Royal Bank of Canada,
Swiss Re, and hedge funds including King Street Capital Management LLC and
Owl Creek Asset Management LP.
mounted on another front. There was a surge in "short sales" --
bets against the price of Morgan Stanley's stock -- by large hedge funds
including Third Point LLC. By day's end, Morgan Stanley's shares were down
24%, fanning fears among regulators that predatory investors were targeting
of trading, which previously had battered securities firms Bear Stearns
Cos. and Lehman, now is dogging Citigroup, whose stock fell 60% last week
to a 16-year low.
Investigators are attempting to unravel what produced the market mayhem
in mid-September, and whether Morgan Stanley swaps or shares were traded
improperly. New York Attorney General Andrew Cuomo, the U.S. Attorney's
office in Manhattan and the Securities and Exchange Commission are looking
into whether traders manipulated markets by intentionally disseminating
false rumors in order to profit on their bets. The investigations also are
examining whether traders bought swaps at high prices to spark fear about
Morgan Stanley's stability in order to profit on other trading positions,
and whether trading involved bogus price quotes and sham trades, people
familiar with the probes say.
has emerged publicly that any firm trading in Morgan Stanley stock or credit-default
swaps did anything wrong. Most of the firms say they purchased the credit-default
swaps simply to protect themselves against potential losses on various types
of business they were doing with Morgan Stanley. Some say their swap wagers
were small, relative to all such trading that was done that day.
prices of any security have been manipulated is extraordinarily difficult.
The swaps market is opaque: Trading is done by phone and email between dealers,
without public price quotes.
Erik Sirri, the SEC's director of trading and markets, contends that the
swaps market is vulnerable to manipulation. "Very small trades in a
relatively thin market can be used to
suggest that a credit is viewed
by the market as weak," he said in congressional testimony last month.
He said the SEC was concerned that swaps trading was triggering bearish
bets against stocks.
had entered September in pretty good shape. It made money during its first
two fiscal quarters, which ended May 31. It didn't have as much exposure
to bad residential-mortgage assets as Lehman did, although it was exposed
to commercial-real-estate and leveraged-loan markets. Mr. Mack knew that
third-quarter earnings were going to be stronger than expected.
On Sept. 14,
as Lehman was preparing to file for bankruptcy protection, Mr. Mack told
employees in an internal memo that Morgan Stanley was "uniquely positioned
to succeed in this challenging environment." The following day, the
firm picked up some new hedge-fund clients who had fled Lehman.
were flying as traders worried which Wall Street firm could fall next. The
chatter among hedge funds was that Morgan Stanley had $200 billion at risk
as a trading partner with American International Group Inc., the big insurer
on the brink of a bankruptcy filing, according to traders. That wasn't true.
Morgan reported in an SEC filing that its exposure to AIG was "immaterial."
at rival J.P. Morgan Chase & Co. were suggesting to Morgan Stanley clients
it was risky to keep accounts at that firm, people familiar with the matter
say. Mr. Mack complained to J.P. Morgan Chief Executive James Dimon, who
put an end to the talk, these people say. Deutsche Bank, UBS and Credit
Suisse also marketed to Morgan Stanley's hedge-fund clients, people familiar
with the pitches say.
On Sept. 16,
Morgan Stanley's stock fell sharply during the day, although it rebounded
late. Some hedge funds yanked assets from the firm, worried that Morgan
might follow Lehman into bankruptcy court, potentially tying up client assets.
In an effort to quell concerns, Morgan Stanley released its earnings that
afternoon at 4:10 p.m., one day early.
"It's very important to get some sanity back into the market,"
said Colm Kelleher, Morgan's chief financial officer, in a conference call
with investors. "Things are frankly getting out of hand, and ridiculous
rumors are being repeated."
Glenn Schorr asked Mr. Kelleher about the soaring cost of buying insurance
in the swaps market against a Morgan Stanley debt default. Protection for
$10 million of Morgan Stanley debt had risen to $727,900 a year, from $221,000
on September 10, according to CMA DataVision, a pricing service.
people are focusing on CDS as an excuse to look at the equity," Mr.
Kelleher responded, implying that traders betting on swaps were also shorting
Morgan Stanley shares, betting that the stock price would fall.
to know for sure what was motivating buyers of Morgan Stanley credit-default
swaps. The swap buyers stood to receive payments if Morgan Stanley defaulted
on bonds and loans. Some buyers, no doubt, owned the firm's debt and were
simply trying to protect themselves against defaults.
were also a good way to speculate for traders who didn't own the debt. Swap
values rise on the fear of default. So traders who believed that fears about
Morgan Stanley were likely to intensify could use swaps to try to turn a
Amid the uncertainty
that Sept. 16, Millennium Partners LP, a hedge fund with $13.5 billion in
assets, asked to pull out $800 million of the more than $1 billion of assets
it kept at Morgan Stanley, according to people familiar with the withdrawals.
Separately, Millennium had also shorted Morgan Stanley's stock, part of
a series of bearish bets on financial firms, said one of these people. In
addition, the hedge fund bought "puts," which gave it the right
to sell Morgan shares at a set price in the future.
we have to protect our assets," Israel Englander, Millennium's head,
told a Morgan Stanley executive, according to one person familiar with the
conversation. "This is not a personal thing."
bets, small compared to Millennium's overall size, rose in value as Morgan
Stanley shares fell.
day, Sept. 16, Third Point LLC, a $5 billion hedge-fund firm run by Daniel
Loeb, began to move $500 million in assets out of Morgan Stanley. The following
day, Sept. 17, Third Point, after seeing the surge in swaps prices, made
a substantial bearish bet, selling short about 100,000 Morgan Stanley shares,
trading records indicate. Third Point quickly closed out that position for
a profit of less than $10 million, says one person familiar with the trading.
same time, hedge fund Owl Creek began asking to withdraw its assets, and
ultimately took out more than $1 billion.
On the morning
of Sept. 17, David "Tiger" Williams, head of Williams Trading
LLC, which offers trading services to hedge funds, heard from one of his
traders that a fund had moved an $800 million trading account from Morgan
Stanley to a rival. His trader, who was on the phone with the fund manager
who moved the money, asked why. Morgan Stanley was going bankrupt, his client
details, the fund manager repeated the rumor about Deutsche Bank yanking
a $25 billion credit line. Mr. Williams hit the phones. His market sources
told him they thought the rumor false.
already was being done. By 7:10 that morning, a Deutsche Bank trader was
quoting a price of $750,000 to buy protection on $10 million of Morgan Stanley
debt. At 10 a.m., Citigroup and other dealers were quoting prices of $890,000.
As the rumor
about Deutsche spread, Morgan shares fell sharply, from about $26 at 10
a.m. to near $16 at 11:30 a.m.
swaps dealers began quoting the cost of insurance on Morgan in "points
upfront" -- Wall Street lingo for transactions where buyers must pay
at least $1 million upfront, plus an annual premium, to insure $10 million
of debt. In Morgan Stanley's case, some dealers were demanding more than
$2 million upfront.
day, Merrill bought swaps covering $106.2 million in Morgan Stanley debt,
according to the trading documents. King Street bought swaps covering $79.3
million; Deutsche Bank, $50.6 million; Swiss Re, $40 million; Owl Creek,
$35.5 million; UBS and Citigroup, $35 million each; Royal Bank of Canada,
$33 million; and ACM Global Credit, an investment fund operated by AllianceBernstein
Holding, $28 million, according to the documents.
day, Sept. 18, some of those same names were back in the market. Merrill
bought protection on another $43 million of Morgan Stanley debt; Royal Bank
of Canada, $36 million; King Street, $30.7 million; and Citigroup, $20.7
million, the trading records indicate.
None of the
firms will comment on how much they paid for the swaps, or whether they
profited on the trades.
protection we bought was a simple hedge, not based on any negative view
of Morgan Stanley," says John Meyers, a spokesman for AllianceBernstein.
A Royal Bank of Canada spokesman says the bank bought the swaps to manage
its Morgan Stanley "credit risk," and was not "betting against
Morgan Stanley and conducted no bearish trades on its stock."
a $16.5 billion hedge fund, bought the swaps to hedge its exposure to Morgan
Stanley, which included bond holdings, according to a person familiar with
the fund. The fund didn't hold a short position in the stock, this person
for Deutsche Bank and Citigroup say their trading was relatively small and
meant to protect against losses on other investments with Morgan, and to
handle client orders. An Owl Creek spokesman says it bought the swaps "to
insure collateral we had at Morgan Stanley at the time," and that it
continues to do business with the firm.
and Swiss Re declined to comment on the trading.
Stanley's stock tumbled, the number of shares sold short by bearish investors
soared to 39 million on Sept. 17, nine times the daily average this year,
adding to the 31 million shares shorted in the prior two days, according
to trading records.
Mr. Mack sent
a memo to employees on Sept. 17. "I know all of you are watching our
stock price today, and so am I.
We're in the midst of a market controlled
by fear and rumors, and short sellers are driving our stock down."
and swaps trading were feeding on each other. That afternoon, Mr. Schorr,
the UBS analyst, wrote: "Stop the insanity -- we need a time out."
In an interview that day, he said "the negative feedback loop of stocks
and CDS making each other crazy shouldn't be able to destroy the value of
to stop the crisis of confidence, Mr. Mack phoned Paul Calello, investment-banking
chief at Credit Suisse, and asked whether he knew what was driving the cost
of the swaps up so quickly, say people familiar with the call. Mr. Calello
said he didn't.
chief legal officer, Gary Lynch, once the SEC's enforcement chief, called
New York Stock Exchange regulatory head Richard Ketchum. He said he was
suspicious about manipulation of Morgan Stanley securities, and asked whether
the NYSE would support a temporary ban on short selling, according to people
familiar with the call.
Mr. Mack called
SEC Chairman Christopher Cox, Treasury Secretary Henry Paulson and others.
Trading in Morgan Stanley securities, he groused, was irrational and "outrageous,"
and "there's nothing to warrant this kind of reaction," says a
person familiar with the calls. The steps already taken by the SEC to prevent
certain types of abusive short selling, he argued, didn't go far enough.
In his memo
to employees that day, Mr. Mack had made it clear that he intended to press
regulators to rein in short sellers. When word about that got out, hedge-fund
managers were up in arms. Some yanked business from Morgan Stanley, moving
it to rivals including Credit Suisse, Deutsche Bank and J.P. Morgan. They
said the trading represented legitimate protection and speculation.
veteran Julian Robertson Jr. and James Chanos, a well-known short seller,
both longtime Morgan Stanley clients, were both angry. Mr. Chanos says he
"hit the roof" when he heard about Mr. Mack's memo.
stock market closed that day, Mr. Chanos decided that his hedge fund, Kynikos
Associates, would pull more than $1 billion of its money from a Morgan Stanley
one thing to complain, but another to put out a memo blaming your clients,"
says Mr. Chanos, who adds that the development all but ended a more-than-20-year
relationship with Morgan Stanley. He says his fund hadn't bought any Morgan
Stanley swaps or sold short its stock.
Street executives, concerned about their stocks, were also calling regulators.
At about 8:15 that night, the SEC said it would require more disclosure
of short selling. Late the following day, Sept. 18, the SEC moved to temporarily
ban short selling in financial stocks.
Mr. Mack contacted
hedge-fund clients to tell them he hadn't single-handedly brought on the
ban, and that he was primarily interested in giving the market a temporary
"time out" from the volatile mix of rumors and trading.
days, more than three-quarters of Morgan Stanley's roughly 1,100 hedge-fund
clients had put in requests to pull some or all of their assets from the
firm, according to a person familiar with the operation. Even though most
kept some money at the firm, Morgan Stanley couldn't process all the withdrawal
requests at once, adding to market fear.
was in a precarious position. During the Sept. 17 trading frenzy, Mr. Mack
had begun merger talks with Wachovia Corp. Four days later, Morgan Stanley
shifted course, becoming a bank-holding company and gaining wider access
to government funds. Last month, after raising $9 billion from a Japanese
bank, it received a $10 billion capital injection from the federal government.
must now revise its business strategy to contend with a more risk-averse
environment and the more stringent government oversight that comes with
being a bank-holding company. Earlier this month, it announced it would
fire about 2,300, or 5%, of its employees.
The cost of
insuring its debt has come back down from its peak, but its stock remains
in the doldrums. On Friday, it was trading at $10.05 a share in 4 p.m. composite
trading on the New York Stock Exchange -- less than half of the $21.75 close
on Sept. 17.
A month after
the mayhem, Mr. Mack said in an interview that he had all but given up trying
to get to the bottom of what was driving the trading in his firm's securities
during those chaotic days in mid-September. "It's difficult to say
what's rumor and what's fact," he said.