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A single catastrophic mistake by traders at the heart of Morgan Stanley's mortgage business has blown a US$8 billion ($10.6 billion) hole in the bank's finances, it emerged yesterday.
In what might be the biggest single loss by a trading desk on Wall St, Morgan Stanley said it
was stuck holding vast quantities of mortgage derivatives that had plunged in value since mid-year and kept on plunging in November.
John Mack, chief executive, called it "an error of judgment". Colm Kelleher, chief financial officer, said the bank had learned "a very expensive and humbling lesson".
The hit to the company's balance sheet forced Mack to seek a rescue refinancing from an arm of the Chinese Government, which said yesterday it would pay US$5 billion for a stake of up to 10 per cent in the company. Its shares rose 4 per cent in early trading on news of the cash injection.
Investors had been braced for big losses from Morgan Stanley but the scale of the disaster eclipsed even the worst predictions. It stood in sharp relief to the results a day previously from arch-rival Goldman Sachs, which had made so much money from bets against the mortgage market that it did not post any losses at all.
Ironically, Morgan Stanley was also betting that the mortgage market would deteriorate and a small group of traders were licensed to place big bets against the riskiest mortgage derivatives. However, they tried to defray the cost of those bets with interest from other, less risky mortgage-backed derivatives.
Disastrously, after Americans began defaulting on home loans in record numbers, even supposedly safe mortgage derivatives plunged in value.
Where Morgan Stanley had predicted at the end of October that it would have to write off US$3.7 billion of the value of the position, yesterday it admitted the situation had got even worse and the final figure was US$7.8 billion. Other write-downs related to the mortgage market took the final figure for one-time losses to US$9.4 billion.
Morgan Stanley also announced a net loss of US$3.59 billion for its fourth quarter.
"The results we announced today are embarrassing to me and the firm," said Mack. "They are the result of an error of judgment on one desk in our fixed income area and a failure to manage that. Make no mistake, we have held people accountable."
Mack sacked the company's co-president and heir apparent, Zoe Cruz, at the end of last month amid criticism of her management style. Executives said yesterday that none of the traders involved, their bosses or the risk management officers at the firm had properly "stress tested" the mortgage positions on Morgan Stanley's books.
The company refused to say whether the individual traders were still in their posts.
China Investment Corp will hand Morgan Stanley a cash infusion of US$5 billion, initially in return for annual interest of 9 per cent but with the investment converting into Morgan Stanley shares by 2010. In just the past month, Abu Dhabi invested US$7.5 billion in Citigroup and Singapore invested 11 billion Swiss francs ($12.6 billion) in UBS.
Litany of woes
* Morgan Stanley yesterday announced a net loss of US$3.59 billion for its fourth quarter.
* It also announced it was writing off US$9.4 billion which it mainly blamed on loss-making investments in the mortgage market.
* State-controlled China Investment Corporation is to pay about US$5 billion for a shareholding of up to 10 per cent.
Executives give up bonuses
John Mack donned a hair shirt for Morgan Stanley's horrible financial results presentation yesterday - and he is not alone in promising to forgo a bonus this year.
Jimmy Cayne, the chief executive of rival Wall St bank Bear Stearns, is expected to follow Mack's lead and announce neither he nor other top executives will dip into their ring-fenced bonus pool.
The self-denial frees up a few more millions for spreading among the middle-ranking talent that Bear and Morgan Stanley need to keep on board as they struggle to right their businesses in the coming year.
But most importantly, it shows to employees and to beleaguered shareholders that those at the top are sharing in some of the financial pain wrought by the credit crisis on Wall St.
"Ultimately, accountability for our results rests with me, and I believe in pay for performance," Mack said yesterday.
"I've told our compensation committee that I will not accept a bonus for 2007."
Last year, he was paid a US$40 million ($53 million) bonus, more than 100 times his salary.
Morgan Stanley's bonus pool for the financial year just ended is US$16.6 billion, it announced yesterday, up 18 per cent on last year but a long way shy of what had been expected before the credit crisis broke.
- Independent