Morgan looks to Wachovia, China for bailout

NEW YORK: Morgan Stanley, the second-biggest US securities firm, whose shares are being battered on fears it may not survive the credit crunch, is considering selling a larger stake to China Investment Corp (CIC) and is in preliminary takeover talks with
Wachovia, the fourth-largest US commercial bank.

The state-owned Chinese fund could buy as much as 49% of Morgan Stanley, said a person, who declined to be identified because the talks aren’t public and may end in no agreement.

CIC bought a 9.9% stake in Morgan Stanley in December after the New York-based investment bank reported a quarterly loss.

Talks about a deal with Wachovia have “advanced,” according to CNBC.
The reason, in Roubini’s estimation: “The entire business model for all of them is fundamentally flawed.” There are several problems with independent broker-dealers, he adds. “The fundamental problem is that all of them borrow short-term in the repo market, leverage like crazy and then invest in the long term.”

If mainstream banks, even solvent banks, faced such a mismatch problem, there would have been a run on them. The problem, in his estimation, is worse with broker-dealers because, unlike banks, they don’t have depository insurance and have only limited access to the lender of last resort (the US Federal Reserve).

Secondly, says Roubini, now that they have access to the Fed’s support, if they have to be regulated like banks —in terms of setting higher liquidity and capital levels and lower leverage — “how are they going to make money?”

Given that fundamental flaw, these broker-dealers “cannot survive as they are,” he reckons. “They have to become part of a larger financial institution, with a commercial banking arm and a stable base of deposits. Otherwise, in my view, they’ll all be gone.”
That consideration may be behind Morgan Stanley’s reported move to initiate capital infusion from or a stake sale to, among others, China’s largest state-owned investment company Citic or the fourth-largest US bank, Wachovia.

China’s appetite low. There has yet been no confirmation of negotiations with Citic Group, but analysts reckon that China’s appetite for suspected “toxic assets” may not run high, particularly in the light of recent unhappy experiences of investing in Western financial institutions in recent months. China’s sovereign wealth fund, China Investment Corporation, already owns 9.9% of Morgan Stanley; the value of that investment has fallen by nearly 60% this year.

“The widely publicised purchase of a stake in Blackstone by China Investment Corp has received strong domestic criticism as its value has halved, even if it’s only a paper loss,” says Moody’s Economy.com economist Sherman Chan. “Making aggressive purchases in such a chaotic environment may be frowned upon by fiscal conservatives.”
Earlier this year, Citic Securities, in which Citic Group has a 24% stake, abandoned a proposed $1 billion investment in Bear Stearns just before the Wall Street brokerage was bought by JP Morgan in a distress sale.

The continued decline of Chinese stock markets has been a cause for concern, notes Chan. “There is mounting pressure on the Chinese government to provide a stimulus, and given that the US government has also played the ‘nationalisation card’, it will not be surprising to see countries like China use sovereign funds in helping distraught domestic firms so as to revive market sentiment.”