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Reggie Middleton

Reggie Middleton

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It Appears That Mack Can't Take His Own Medicine

The Wall Street Journal ran an interesting, well researched piece on the run on Morgan Stanley that has been well covered in the blogoshere. From a journalistic perspective, it was excellent, but it was lacking from an actual hard core investor's perspective - the very same hard core perspective that drives my patrons to pay for my blog. So, lest I disappoint my readers, let's throw some analytical and historical facts into this debate. I feel the need to throw my two cents in because nobody is calling a spade a spade, thus partially justifying the nonsense that was the short sale ban that came down from the highly hypocritical industry. Yeah, the same industry whose prop desks short other companies and industries,,, the same industry that profits heavily form enabling their clients (through prime brokerage) to short other companies and industries. With the final fall of the big sell side brokerages, there is even a bigger dearth of services left on Wall Street. Honest, unbiased research. That is, I believe, the draw that the BoomBustBlog has. That is what is lacking throughout nearly all of Wall Street. That is what this blogging medium has allowed me to provide - and I'm just luv'in it.

I, personally, went short Morgan Stanley last year at $60 - way before the crowd even considered it. Let's run through an analytical chronology of my views on Morgan Stanley, and at the same time let's keep in mind my track record in these matters:

1. December Seventeenth, 2007: Morgan issues a short sell call on Citibank (see Citigroup: Morgan Stanley's Top Short Idea for 2008). I call them both hypocrites (and at that time, I didn't know the least of it since they cry foul if someone shorts THEIR stock) and the riskiest bank on the street, quoting the fact that they had the highest level three assets to equity on the entire Street. The title of the post was aptly named, "Banks Brokers and Bullshlt, pt one" (complete with graphics). I then went on to illustrate in detail the risks that the investment banks, Morgan Stanley leading the charge, took with the massive compounding leverage on the books in the seminal "Banks, Brokers, & Bullsh1+ part 2".

2. In January, I stated that there was a strong chance of Bear Stearns going out of business (I was the only one), drawing strong correlations to its brethren - Is this the Breaking of the Bear?

3. February Eleventh, 2008: I publish in detail why I call Morgan Stanley the "Riskiest Bank on the Street", citing extreme credit risk exposure, high stated leverage, dwindling value drivers and plethora of off balance sheet vehicles (ex. VIEs) that make it impossible to figure out what their true leverage is - not to mention the toxic trash rotting on their books. See The Riskiest Bank on the Street. I put a target of $20 on MS way Back in February when the rest of the street said $70. Credibility, my dear friend, credibility...

4. March Nineteenth, 2008: A Quick Morgan Stanley update from my lab shows that things are getting worse for this company, not better.

5. April Sixth, 2008: I issue Reggie Middleton on the Street's Riskiest Bank - Update. Things are getting worse, not better. Again, my value on this company is LESS than HALF that of the Street's. Again, credibility my friend. It's all about credibility.

6. April Sixteenth, 2008: I bust Lehman and Morgan "fudging numbers to save their asses" - Banks, Brokers & Bullsh1t 3.0: Shenanigans at Morgan and Lehman (scroll down to about half way down the page).

7. May Twenty First, 2008: The ineffective hedging and leverage that I warned about in the Bullshlt series comes home to roost for Lehman and Morgan - I warned you about the risk of those I Banks

8. September Sixteenth, 2008: Morgan issues earnings report, the Street and media are all gushing with glee at this investment bank that produced profits and results "better than expected". For one, I hate the "better than expected" line since they were not better than I expected. Secondly, the Street lowers their expectations at will to make sure everyone can beat them. It's a damn shame if you can't beat kiss ass lowered expectations, particularly when you are the one issuing the guidance to lower the expectations... Thirdly, Morgan Stanley's earnings report appeared to have had more contribution from the marketing department than the accounting staff. Reference my post - I am fairly heavily concentrated in the I Banks, but I am considering shorting Morgan even more:

I believe Morgan Stanley is doing the smoke and mirrors thing again. I have a relatively heavy bearish position and don't want to concentrate any more, but I smell opportunity. Contrary to what management has to say, Reggie Middleton says this company is in trouble. One of us is wrong! Hey, I'm putting my money where my mouth is.

Let's walk through what we know thus far about Morgan's last quarter (keep in mind that the 10Q has not been released yet - but when it is I will be all over it):

Key highlights:

  • Morgan Stanley's reported revenues increased 1% y-o-y to $8,049 mn. However excluding a pre-tax gain of $745 mn and $1.5 bn impact of widening credit spreads on firms own debt, revenues declined 27% to $5,804 mn in 3Q2008 over 3Q2007.

  • As result of slowdown in capital markets activity, Morgan Stanley's M&A transactions, global IPO and debt volumes declined 63%, 66% and 46%, respectively.

  • Morgan Stanley's leverage declining to 23.5x in August 2008 from 25.1x in May 2008. However Morgan Stanley's level 3 assets-to-total assets increased from 6.7% as of May 2008 to 8.0% as of August 2008.

  • As of August 2008, Morgan Stanley's exposure towards U.S. subprime mortgage stood at a 44.3% of its shareholder's equity.

September Eighteenth, 2008: I penn the inflammatory piece, "When blatant government market manipulation won't help you... the Run on Morgan Stanley." This blog post ties in directly with the WSJ article I spoke of earlier, and we will get to shortly, but first an excerpt -

Note to Commissioner Cox: You have doomed the last two independent investment banks. Congratulations. By actually trying to directly manipulate the US capital markets by literally banning the short selling of a certain cadre of stocks (while allowing the long buying of those same stocks) you have upset the natural equilibrium of our capitalistic environ. You must learn to wrap you mind around, and grasp the difference between, price and value. The short sellers were driving the prices of these investment banks down to match their value. Now, with your short sighted interference, you have allowed - no, let's be more accurate, you have overtly facilitated the divergence between price and value.

For one, you cannot prevent astute investors from taking bearish positions on a company. You preside over the most advanced, and complex financial markets in the history of the world, not some third world nation that is just opening its first exchange as an extension of the town food market!

Word has it that the clients of Morgan Stanley are fleeing, despite (or maybe even because - due to the drastic socialist nature of) your actions. Because you have allowed longs to bid prices up way above their intrinsic economic value, you have injected an unprecedented amount of volatility into the system. This increases the cost of capital, my friend, not decrease it. When the truth meets reality, what do you think will happen to share prices? That's right, they will fall that much more. A market needs two sides to a trade, not just one. I hear you plan on preventing investors from selling stocks at a loss next, which will be music to the ears of those at the IRS!

9. Speaking of Credibility, even as recently as September you can notice that the Street's consensus really has none. See As I said, the Riskiest Bank on the Street.

10. October Ninth, 2008: The lollygagging ratings agencies finally get around to considering lowering the investment banks ratings - A year after I flagged the risk of these companies and after two of them literally disappeared. If I am not mistaken, both Bear and Lehman had investment grade rated debt going into failure and bankruptcy. I clearly stated these companies may be done for months in advance. It's all about credibility. The ratings agencies have none, so why in the hell is anyone paying them any attention???? See "A nine month delay in ratings downgrades for the investment banks???!!!"

Now, after nearly a year's worth of history and education on my perspective held on the BoomBustBlog, we are ready to get to that interesting WSJ article:

Anatomy of the Morgan Stanley Panic, Trading Records Tell Tale of How Rivals' Bearish Bets Pounded Stock in September

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? Why doesn't anybody look to Morgan Stanley's performance and balance sheet for an answer to this question? I think I have gathered enough info above to garner a gander.

Trading records 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... So what??? Morgan urged their clients to short Citibank stock last year. As a matter of fact, they stated, and I quote, "Citibank was the short sale of the year". These guys have some damn nerve, don't they???

For years, 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 hypocrisy of it all.

Pressure also 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 investment banks... We know. Those predatory investors are called.... Investment Banks. Morgan not only had their analysts/ sales force call Citigroup the short sale of the year, but one of their most profitable division is (well, was - at least until the run on the bank) their prime brokerage desk where they facilitated shorting by lending money on margin, and finding and hypothecating securities for hedge funds to short other companies. Its just business, right, unless you're the one being shorted. Then you have to go crying to Big Daddy Cox...

That pattern 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... Uh, I think this statement can easily be recast as, "The pattern of balance sheet maladies that has pulled $60 billion of tax payer monies into Bear Stearns, has bankrupt Lehman causing global disruptions in the financial markets, and is now causing the US government to guarantee and additional $300 billion + of assets for Citibank..." Look at these companies' balance sheets... and you actually try to blame the traders for the share price drop. Come on guys, let's do a little analysis here.


Investigators are attempting to unravel what produced the market mayhem in mid-September, and whether Morgan Stanley swaps or shares were traded improperly... Like I said earlier, that dastardly bastard "Swiper the Fox" is hiding from you guys in the balance sheet...

Morgan Stanley 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... Here we go with that "stronger than expected" BS again. Just in cases it got loss in the morass, this is what Morgan really did for the quarter. When I miss my next 4 mortgage payments, I will simply tell the credit ratings agencies that they should raise my FICO score. After all, I did better than I expected...

"Certain people are focusing on CDS as an excuse to look at the equity," Mr. Kelleher (Morgan's CFO) responded, implying that traders betting on swaps were also shorting Morgan Stanley shares, betting that the stock price would fall... Taking a cue out of your playbook as you bet, or recommended to your clients to bet that Citigroups stock would fall (again, see Citigroup: Morgan Stanley's Top Short Idea for 2008). Maybe the Andrew Cuomo, the NYS AG, should just tell all the banks to pay a fine for being hypocritical assholes. Not one bank is innocent of what they are charging traders, other banks, and hedge funds of doing - yet they were the first ones to run to the government crying for special treatment and protection after the shlt that hits the fan splatters on their starched collars. Make anybody who granted margin to short stock a fine, or just leave the whole matter alone (like it should have been done in the first place).

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.

"Listen, 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."... Not to mention that Millennium probably used Morgan's own margin dollars and hypothecated securities to short them over Morgan's very own prime desk. The trade ticket may have sat right beside the short sale recommendation of Citibank, from Morgan. If your ass gets singed when sitting next to the stove, stay the hell out of the kitchen.

That same 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. Around the 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 responded.

Pressed for 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. Okay, so false rumors occur. You know, like that rumor that Bear Stearns had absolutely no liquidity problems (see Is this the Breaking of the Bear?)... Or how about that rumor that Lehman's balance sheet was intact and that David Einhorn was just talking his book (see Is Lehman really a lemming in disguise? and Lehman, the lying lemon lemming anecdotal timeline?) Oh yeah, then there's that rumor that Ackman was inaccurate in stating that MBIA and Ambac were undercapitalized, as those CEOs droned on about how stable and conservatively run their companies were (see A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton and Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion)... Here is another one for the comic strip section of the history books. You know, that rumor that blogger's analyses are trash and that GGP (the nation's second largest REIT) will have absolutely no problem re-financing their debt in 2008 and 2009 (share price $60 to $0.40 in a year - see GGP and the type of investigative analysis you will not get from your brokerage house).

But damage 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... Yeah, those damn rumors. Imagine the damage the rumors did when Bear Stearns, Lehman, MBIA, Ambac and GGPs stock collapsed to near zero, after being propped up artificially by..... RUMORS. These are people's retirements, jobs and investments and livelihoods we are talking about here. If the truth were know, I bet a lot of these people could have gotten out in time to salvage something. Most have no idea how many people email me to thank them about warning on MBIA/Ambac/HIG/GGP/Lehman, etc. Yet, these rumors, spread right out in public and even on international TV during prime time, nonetheless, seem to get absolutely attention from the AGs and the regulators. Persecute a hedge fund manager that catches a corporate manager lying. And people wonder why the average man considers the stock market a gamble. Without fair, even and proper regulation, it is.

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." HYPOCRITE - see Citigroup: Morgan Stanley's Top Short Idea for 2008

Morgan Stanley's 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. Why??? Are we going to get a temporary ban on long selling to make sure companies with trashy balance sheets do not rise to far in share price???? Hey, wait a minute, don't you run a very large prime brokerage business that facilitates short selling, which is the life blood (or at least the stuff coming back through the veins) of many of your institutional clients? Wouldn't that be tantamount to stabbing them I the back (since they need to short to hedge, as well as speculate and follow your analyst's recommendations to short Citibank)???

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. Ya' damn skippy there were, as they had every right to be. 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.

Other Wall Street executives, concerned about their stocks, were also calling regulators. Hey, you mean those other Wall Street executives that were shorting Morgan Stanley, the retail, home builder, and insurance stocks as well. Well, gosh darn it, isn't this a damn turn in events. I'm not even going to say what goes around comes around. 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. An idiotic move, to say the least.

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. This was a pretty dumb move to, see below.

But 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. Even though most kept some money at the firm, Morgan Stanley couldn't process all the withdrawal requests at once, adding to market fear.

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. Well, Mr. Mack, just ask me. I can tell 'ya. A fact is something that drives your stock price up, and a rumor is something that drives your stock price down. I mean, like, Golly Gee Dude. You didn't know that.


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