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Net Net: Promoting innovation and managing change

Goldman Tries to Give Morgan Stanley a Boost

The Goldman Sachs booth on the floor of the New York Stock Exchange
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Just a few days after Goldman Sachs warned clients that widened credit spreads could pose real problems for Morgan Stanley, Goldman derivatives analysts are reportedly telling clients to buy $16 October call options and sell short-dated credit default swaps (CDS). In other words, make a bullish directional bet on Morgan Stanley.

Here's how Brett Philbin at DealJournal described Goldman's view earlier this week.

Although reasons for declines in Morgan Stanley’s stock and the company’s widening CDS spreads are potentially overdone, Goldman Sachs says the “unfortunate reality” may be felt in segments of Morgan Stanley’s business where counterparty credit and the cost to hedge are “decisive trading factors.”

The “why” on spread-widening is unclear, but Goldman says any mid- or long-term continuation of industrywide CDS spreads is likely to have a real impact on business trends.

In other words, the panic over Morgan Stanley's exposure to losses from the European crisis might be pushing the CDS spreads out beyond what is warranted by reality. Those wider spreads have serious costs to Morgan Stanley's trading, however, as counterparties require more collateral and higher fees in deals.

But if CDS really is priced too high, then shouldn't institutional investors start selling more swaps, with the plan to back-to-back them once the price drops?

That seems to be what Goldman is saying today.

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