Morgan Stanley (MS)

MS is trying to make money over the credit crunch as well. There are Level1, Level 2 and Level 3 assets. Level 1 assets are the easy to price, liquid holdings on the banks balance sheets. Think US Treasuries. Level 2 assets may be less liquid, but they are priced according to comparable marketable assets, even if they arent' actively trading themselves. Level 3 assets, though, are the illiquid holdings that have gotten everyone in trouble lately - the mortgage backed structured products, derivatives, all that toxic waste. Those are illiquid, and have been priced according to "mark to model" theoretical pricing programs. Basically they are prices made up out of thin air. Keep with us here - last month there was an offer to the investment banks to come to the discount window of the Fed (something not done for over 70 years) and use those level 3 assets for collateral for 100 cents on the dollar FULLY LIQUID, US TREASURY-NOTE BASED LOANS. Now think about that! It's truly turning lead into gold with this type of accounting alchemy.

We saw, in most banks quarterly earnings releases, huge transfers of assets from "level 2" into "level 3", basically (we suspect) to take advantage of this total windfall of taxpayer cash to the banks. And yes, you can thank Henry Paulsen (of Goldman Sachs pedigree) for this $200 billion taxpayer funded program. Morgan Stanley has $32 billion now in Level 3 assets (it increased by 45% in Q108)

Setting aside the discussion of the morality / ethicality of bailing out the Wall Street banks with taxpayer money, this happened last month and we have to figure out how to make an investment return on it. The Wall Street investment banks are now in a position to swap off the worst toxic waste on their balance sheets for US Treasury notes. That's exactly what they're doing, and there's nothing you or I, or Congress, or the President of the United States can do about it. As a matter of fact, they're looking at this $200 or $300 billion program as the cost of maintaining our financial system's integrity. I guess every once in a while the roots of the tree of global finance have to be replenished with the US taxpayers' capital. (Apologies to Thomas Jefferson's great quote regarding the tree of Liberty).

n the first quarter, MS increased its Level 3 assets by 45%, to a total of $32 billion, (with a total current market cap of $55 billion, that is a significant number). We believe this positions them to participate in this asset swap in a meaningful manner. The stock is down about $0.40 this morning, but we feel in the near term we'll see a strong move upward in the stock, along with all the other investment banks. Thank you Mr. and Mrs. Taxpayer. And oh yes, enjoy your $600 tax rebate checks this month.

Morgan Stanley, formerly the second biggest U.S. securities firm, had $36 billion of deposits and three million retail accounts at the end of August, Bloomberg reported. The company will also convert its Morgan Stanley Investment Bank, an industrial bank based in Utah, into a national bank.

"This new bank holding structure will ensure that Morgan Stanley is in the strongest possible position," said company Chairman and Chief Executive Officer John Mack. "It also offers the marketplace certainty about the strength of our financial position and our access to funding."

Of course, Morgan Stanley’s new structure also means the company will have to reevaluate its partnerships going forward.

"This means Morgan Stanley is reassessing its plan for a merger with [Wachovia Corp. (WB)]," Tony Plath, a finance professor at the University of North Carolina. "Morgan Stanley is going to try to go it alone, and I expect it will try to buy a bank with a market-to-book ratio that is next to nothing.

Spinning off Discover should make Morgan Stanley a more focused and profitable investment firm.

Morgan Stanley's large gains in 2006, especially given its internal managerial upheaval in 2005 likely indicate that new management can take the company in a better direction.

Many of Morgan Stanley's individual sectors have been poorly managed and even if John Mack can only bring them onto a level playing field with its peers, the profit should be noticeable.