Morgan Stanley: US Plan Is A 'Game-Changer'

This story was originally published Sept. 20, 2008.

Morgan Stanley's board was expected to meet over the weekend to discuss a merger with Wachovia Corp, the Wall Street Journal reported on Saturday.

A deal could include sovereign wealth fund China Investment Corp taking a significant stake in the combined company, the newspaper said, citing people familiar with the matter.

CIC's interest may be contingent on Wachovia being able to offload some of its mortgage assets, the Journal said. The CIC discussion has been preliminary and has not been raised with Wachovia's board, the paper said.

CIC dampened speculation on Friday that it could be ready to increase its stake in Morgan Stanley as a senior CIC official was quoted by the Xinhua news agency as saying Morgan Stanley and Goldman Sachs were capable of tackling their problems on their own.

However, sources familiar with the plans told Reuters on Thursday that CIC, which bought 9.9 percent of Morgan Stanley last December, is in talks to raise its holdings to as much as 49 percent.

One roadblock to a deal between Morgan Stanley and Wachovia could be how the U.S. government's rescue plan addresses the mortgage portfolio at Wachovia, the Journal said. Other issues include price and Morgan Stanley's leverage.

In the past week, Morgan's stock plunged and its debt insurance prices surged amid fear that even large broker-dealers could not weather the current crisis. A series of moves by the U.S. government to limit short sales and to sop up toxic bank assets sparked a rally in financial shares.

The U.S. government said on Friday said it is preparing to take on hundreds of billions of dollars in bad mortgage debt from the banks' balance sheets, after curbing short selling and guaranteeing mutual funds in an effort to stabilize financial markets.

officials said Friday that Treasury Secretary Hank Paulson's plan to tackle the financial crisis gripping the country is a potential "game-changer" to the plans it has been laying out this week.

Morgan Stanley is continuing to pursue all options, giving priority to remaining independent, according to officials at the investment bank. However, these people say they expect the U.S. government's plan provides stabilization and a better bargaining position for them.

Morgan Stanley has been in talks with several other companies, primarily Wachovia for a possible merger, and China Investment Corp. for some sort of investment arrangement. 

Morgan and Wachovia declined to comment on the status of their talks.

Regarding the government plan, Wachovia called it "important news" for the markets, economy and the financial services industry. It says it continues to monitor events, while focusing on growing the value of its franchise.

The bank is saddled with a large number troubled mortgages it inherited through its 2006 acquisition of Golden West Financial. If it can pass these mortgages into government hands, its financial profile would improve dramatically.

Many continue to question the business model of investment banks like Morgan, with its dependence on short-term borrowing to fund longer term investments. The current vogue is for these firms to merge with commercial banks like Wachovia.

Commercial banks' broad and steady deposit base would help to improve the perceived creditworthiness of the investment banking unit of a merged company, making it easier for that side of the business to access the short term funding markets.

This week, Morgan was forced to explore its options when its stock began to plunge and its debt-insurance prices surged on market fears that all broker-dealers were at risk in the credit crisis. But a series of moves by federal officials Thursday to limit short sales and to remove toxic assets from banks sparked a rally in financial shares.

On Friday morning, Morgan shares surged 25 percent to $28.12 and the price of its credit default swaps fell.

Earlier Friday, a China Investment official said Morgan Stanley and Goldman Sachs Group could solve their problems independently. While a vote of confidence in the firms, the statement was also interpreted as a signal that China did not want to boost its $5 billion investment in Morgan Stanley.

But with "everything on the table," Morgan Stanley executives would not dismiss the possibility of the China fund boosting its stake to as high as 49 percent.

Hedge fund clients both overseas and in the United States are staying with Morgan Stanley, and the company has been able to complete 16 deals in Europe, primarily equity and debt underwriting, within the last 48 hours, officials at Morgan said.

-Reuters contributed to this report.

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