PLANK MAY 31, 2012
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When we last left Morgan Stanley, the company was taking all manner of abuse for botching the biggest IPO of the millennium. Alas, that turns out to be the least of its problems. Far more pressing is the fact that Moody’s may be on the verge of massively downgrading Morgan Stanley’s bond rating, which could cost the company billions of dollars (perhaps tens of billions) in collateral and increased borrowing costs.
Then yesterday’s Financial Times brought even worse news. To help save some cash in the event of a downgrade, Morgan Stanley was hoping to park a big portion of its $52 trillion derivatives portfolio inside its bank subsidiary—the portion of the company that functions as an old-fashioned loan-maker, not a hedge fund or investment bank. The reason for doing this is that it would lower borrowing costs that would otherwise shoot up when its credit rating dropped. Why? Because being a bank means you have lots of customer deposits, most of them insured by the federal government, and that you have access to really cheap loans from the Federal Reserve. If, say, you suddenly took a multi-billion-dollar bath on your derivatives bets, Uncle Sam would be there to absorb the losses, or at least help you manage them, and the bondholders who'd loaned you money wouldn’t feel the pinch. And, of course, the bondholders know that in advance, which is why they're likely to loan you money at reasonable rates in the first place. Hence the low borrowing costs.
Sounds like an ingenious plan—just have the taxpayers subsidize the riskiest part of your operation! And, indeed, it is. As the FT notes, most of Morgan’s Stanley’s American competitors, chief among them Goldman Sachs, already house something like 90 percent of their derivative book in their bank subsidiaries (versus a mere 3 percent for Morgan Stanley today).
Unfortunately, the folks at Morgan Stanley just can’t catch a break. Just as they were about to follow suit and mosey on over to the federal trough, the feds (well, presumably the FDIC, whose insurance fund would be on the hook for those losses) decided that having taxpayers stand between bondholders and trillions of dollars in derivatives bets might not be the greatest idea in the world. According to the FT:
[R]egulators have not yet ruled on the request. Under a lengthier process introduced by the Dodd-Frank financial reforms, the Fed is required to formally consult on such moves with the Federal Deposit Insurance Corp, complicating the issue.
The Fed, which oversees Morgan Stanley as a financial group and looks to safeguard the stability of the broader financial system, has a different mandate from the FDIC, whose concern is safeguarding bank deposits.
Man—what’s a giant Wall Street firm have to do to catch a break these days!
In all seriousness, I’ve been pretty hard on Dodd-Frank these past two years ago. But if all it does is stop these kinds of shenanigans, then there’s clearly something to be said for it. If, on the other hand, the Fed gets its way on this—the Fed being famous for trying to shield bondholders from losses—then it will have proven itself to be a truly worthless piece of legislation. I’m not holding my breath.
Follow me on twitter: @noamscheiber
9 comments
Great read Noam. There is faint hope the democratic bureaucracy will have it's day through the FDIC; should be made a global organisation. Could have done with something similar ourselves before Geithner royally fucked us, on behave of his future employers, for 30 Billion and change.
- IggyPop
May 31, 2012 at 5:56pm
Well, if Glass-Stegal were reinstated, this sort of thing wouldn't be allowed, since it required a separation between FDIC insured bank deposits, and the Financial vehicles concerned here. It sure would be nice. 52 Trillion Dollars, eh? That's a lot of value to place under "guarantee".
- AllanL5
May 31, 2012 at 6:16pm
Very timely and penetrating report, Noam. One of the respectable financial websites is currently recommending purchase of JP Morgan and Morgan Stanley stocks because their prices have dipped because of recent debacles at those banks and concern about Europe and the economic slowdown generally. It's hard to believe that there are no other problems under the hood. Dodd-Frank is a valiant attempt to bring order to Dodge City. I hope that it works. Barney Frank insists that we can regulate the mega-banks. Maybe so in theory, but hard in practice, in the world of fallible human beings. I'm inclined to agree with AllanL5 that we should go back to Glass-Steagall. The risks of mega-banks have become unmanageable, even by smart competent bankers and thoughtful public officials.
- amidut
May 31, 2012 at 8:03pm
Please keep us updated on this, when the time comes.
- Curran1
May 31, 2012 at 8:15pm
Just to clarify, there are two very different (but related) policy issues here. First is the casino we like to refer to as the efficient market, the casino that led Morgan to gamble billions on a trader's hunch. Second is the protection of bond holders against inflation by the Fed. The irony is that the holders of those inflation-protected bonds aren't satisfied with those low but protected returns on those bonds and are willing to risk all on a financial gamble. What's wrong with this picture? And why isn't Geithner running down Wall Street with his hair on fire screaming "you ungrateful bastards!"
- rayward
May 31, 2012 at 9:20pm
Class war! Class war! Attack the 1%! Appropriate their money!
- skahn
May 31, 2012 at 11:57pm
I see you're recovering quite nicely, skahn. Glad to see it. $52 trillion? Isn't that all the money in the world? The sociopaths on Wall Street have us by the proverbial short hairs, and there's nothing the Fed or the FDIC can do to keep these mad dogs on a leash. Get over it, America.
- magboy47.
June 1, 2012 at 2:13am
Here's to hoping someone at the FDIC has their head screwed on straight and says "Hell No" to this.
If not, I'd say we have a pretty solid argument for why we should let Republicans win this fall, and again in 2016, and maybe in 2020. I mean, it took a long time for the Great Depression to run it's course, but in the end the majority of the country had learned it's lessons. Unfortunately, I know there are many who will never learn their lessons. Until there's a way to contain the damage they'll cause when they get their way, until they learn their lesson and stop hurting themselves or don't learn their lesson and destroy themselves, we just have to keep on top of the issue as best we can.
- GSpinks
June 1, 2012 at 12:07pm
Here's to hoping someone at the FDIC has their head screwed on straight and says "Hell No" to this.
If not, I'd say we have a pretty solid argument for why we should let Republicans win this fall, and again in 2016, and maybe in 2020. I mean, it took a long time for the Great Depression to run it's course, but in the end the majority of the country had learned it's lessons. Unfortunately, I know there are many who will never learn their lessons. Until there's a way to contain the damage they'll cause when they get their way, until they learn their lesson and stop hurting themselves or don't learn their lesson and destroy themselves, we just have to keep on top of the issue as best we can.
- GSpinks
June 1, 2012 at 12:07pm