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US Officials Said to Offer Protection to Japan Investors

Andrew Ross Sorkin|The New York Times
Monday, 13 Oct 2008 | 2:02 AM ET

In what could set an important precedent, federal officials assured a big Japanese bank that its planned investment in the embattled Wall Street giant Morgan Stanley would be protected, according to people involved in the talks.

After two days of tense negotiations, Treasury officials urged a hesitant Mitsubishi UFJ Financial Group to proceed with its $9 billion investment in Morgan Stanley , which has sought the capital infusion to reassure investors and customers about its stability.

The deal is considered a crucial step in the government’s strategy for revitalizing the financial system by luring outside investment while it considers buying stock in banks directly. The transaction’s failure would deal a blow to that effort and potentially unnerve the financial markets.

The Treasury’s assurances amount to another extraordinary move by the government and could serve as a model for future deals. The tense, weekend talks were so critical to the financial markets that they drew in both the Treasury and the Japanese government.

Mitsubishi and the Japanese government pressed the Treasury Department over the weekend to guarantee that if the United States were to inject money into Morgan Stanley at a later time — a step the Treasury has ruled out for now — the move would not wipe out Mitsubishi’s investment.

Investors suffered deep losses when the government effectively nationalized the nation’s largest mortgage finance companies, Fannie Mae and Freddie Mac. The Treasury has said it might use some of the $700 billion bailout package authorized by Congress to take direct stakes in banks, but it has not spelled out how it would do so. Many prospective investors, like sovereign wealth funds, have been sitting on the sidelines, reluctant to invest in financial services companies while the government’s plans remain uncertain.

Officials from the Treasury Department declined to comment Sunday night.

A deal between Morgan Stanley and Mitsubishimight help calm markets worldwide, which sank last week because of escalating concerns about the fate of financial institutions. Investors might read the investment as a sign of confidence in the bank’s future.

Mitsubishi was pressing for more favorable termsafter Morgan Stanley lost nearly half its market value during the stock market plunge last week.

Analysts estimate that Morgan Stanley has more than $100 billion in capital, but the firm has struggled to regain investors’ confidence since the collapse of Lehman Brothers last month. Investors have become so unnerved about the health of the financial industry that Morgan Stanley’s stock has plummeted nearly 82 percent this year, closing at $9.68 on Friday.

Last month, Mitsubishi agreed buy about 21 percent of Morgan Stanley. The investment was to be made in the form of $3 billion in common stock, at $25.35 a share, as well as $6 billion in convertible preferred stock with a 10 percent dividend and a conversion price of $31.25 a share.

Under the proposed new terms being discussed on Sunday night, Mitsubishi would still buy roughly 21 percent of Morgan Stanley, according to people involved in the talks. But all of the investment would be through preferred shares, with a 10 percent annual dividend. About $7.8 billion of those shares would be convertible into common stock at a price of $25.25, lower than originally proposed.

Henry M. Paulson Jr., the Treasury secretary, has urged both companies to devise a private-market solution and has indicated that he does not believe that Morgan Stanley needs capital from the government. However, Treasury officials privately hinted to members of both companies that the government would back Morgan Stanley if it came to that, these people said, suggesting that he does not want to repeat the troubles that resulted from allowing Lehman Brothers to go bankrupt.

George Soros, the prominent investor, wrote in a column in The Financial Times that the United States government needed to rescue Morgan Stanley.

“The Treasury should offer to match Mitsubishi’s investment with preferred shares whose conversion price is higher than Mitsubishi’s purchase price,” Mr. Soros wrote. “This will save the Mitsubishi deal and buy time for successfully implementing the recapitalization and mortgage reform programs.”

While the negotiations remained fluid, people close to both sides expressed confidence that a deal would be struck. The companies are hoping to announce the terms of the transaction and Mitsubishi’s commitment to complete the deal by Monday morning, before the stock market opens in the United States.

Over the last week, Mitsubishi and Morgan Stanley have issued statements insisting that they planned to complete the deal on the original terms. Press officers for Mitsubishi and Morgan Stanley declined to comment on Sunday.

Morgan Stanley converted itself into a bank holding company one week after Lehman Brothers collapsed. That business model makes it easier for Morgan Stanley to borrow from the Federal Reserve. The firm has also lowered its debt-to-capital levels to under 20 times.

Mitsubishi has large ambitions for expansion into the United States. It recently bought the remaining shares of UnionBanCal, a bank in California, for a premium over its share price. Mitsubishi had owned the majority of UnionBanCal since 1996.

-- Edmund L. Andrews and Eric Dash contributed reporting.

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