From the WSJ:
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…
…during those tumultuous few days in mid-September, the swaps market turned on Morgan Stanley like a financial Frankenstein.
Disclaimer:
No evidence 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.
Indeed it would be madness for Merrill, Citigroup, DB et al to actually be trying to bring down MS as the article suggests, given the systemic risks that kind of collapse would pose.
The picture is much more subtle and insidious than the WSJ and Andrew Cuomo et al make out. Sure there was a panic at MS – and a run on the bank – but it wasn’t caused by some cabal of CDS traders, or puppets whose strings were being pulled from the C-suite floors of rival banks. It was just a perfect example of human behaviour – and a series of fallacies.
Just look what happened after John Mack started lobbying to have short-selling banned, for example:
…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.
Hedge-fund 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.
After the 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 account.
“It’s 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.
Indeed, the collapse of MS’s prime brokerage operation was a serious crisis, if not the serious crisis.
…within 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.
Enough of a crisis to cause the collapse of the bank.
No one is denying that the market was boiling with rumours in the days after LEH. But you have to ask yourself, what allowed those rumours to take hold? Why did no-one believe the protestations of John Mack? Take a look at any bank’s regulatory filing in Q2 2007 and you can see why. No disclosure. No clarity about off-balance sheet risk, or exposures before hedging or netting. Little wonder that rumours such as this -
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.”
- could gain so much currency. Never mind what was said in the SEC filing. Was that, afterall, “immaterial” in the sense that there was none, or “immaterial” in the sense that its exposure had been rehedged using other counterparties?
To boot: rumours about Morgan Stanley did not start after Lehman collapsed – they were running for days if not weeks concurrently with those surrounding Lehman. After Lehman was allowed to go under, MS was – according to an extant twelve month narrative of surprise writedowns and out-of-the-blue losses – the natural next domino to fall.
And most of all, forget not that the collapse of Lehman was a veritable earthquake on Wall Street.
CDS on investment banks were not spiking anomalously, they were spiking because more than ever it was likely that there would be another actual default. If ever there was a time to go crazy buying protection on MS, this was it!
In the days after Lehman it wasn’t just likely that another bank would collapse, it was – save a government bailout or the shuttering of the markets – inevitable.
Little wonder people were panicking.
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