Morgan Stanley was right to trim trade risk-Mack

NEW YORK (Reuters) - Critics who complain Morgan Stanley (MS.N) dropped the ball by not taking enough first- quarter trading risk have a fair point, but Chief Executive John Mack contends being cautious was the right move.

Last week, analysts came down hard on Morgan Stanley's fixed-income trading results: $1.3 billion of revenue compared with $6.56 billion at Goldman Sachs Group Inc (GS.N) and $4.9 billion at JPMorgan Chase & Co (JPM.N).

The weak trading performance contributed to Morgan Stanley reporting a quarterly loss, while its two rivals took advantage of market conditions to report surprisingly large profits.

"That's fair criticism," Mack told Reuters in a brief interview just after the firm's annual shareholder meeting. "Could we have taken more risk? Without question we could have, but we didn't think it was the right thing to do given the volatility and, really, the fragility of the market."

Mack, who rose through the ranks as a bond trader, said the bank's $578 million net loss was largely the result of real estate writedowns and a charge related to the rising value of certain Morgan Stanley debt.

Morgan's biggest losses during the past two years came mainly from hard-to-sell instruments such as structured mortgage debt, commercial real estate and leveraged buyout loans. The bank was stuck with these assets when markets froze.

"If you think about some of the trades we've done in the past, we put those on our books. But when you want to reverse those trades, you don't do it by picking up the phone and doing a trade. It can take a month or so to get out of those trades."

Yet Mack stressed Morgan Stanley has not abandoned trading. Rather, it will focus on more liquid assets.

"Clearly we will use our capital when we think it makes sense. There will be unique opportunities, even within our proprietary trading, so I'm sure we'll be there," he said.

Morgan Stanley also is expanding its "flow trading" business, or buying and selling on behalf of clients.

"The flow business is what were doing. We've hired a number of more people and we've given our teams the green light to build out more on the distribution side," Mack said.

By contrast, trading and investments that draw on the balance sheet and carry high risks will be cut back or even eliminated, Mack added.

Morgan Stanley currently is considering options for its process-driven trading, or PDT business -- a team that manages more than $1 billion through a successful computer-driven investment strategy.

Options include spinning out the team into a new entity, with Morgan holding either a majority or minority stake. The team may also be transferred from the securities trading division to Morgan Stanley's asset management unit, where it will accept outside investor money for the first time.

PDT could wind up either on or off Morgan's balance sheet, a person familiar with the discussions said. In any case, Morgan will still have the same amount of capital invested with the group.

Mack said the bank is also changing its approach to real estate investing, reducing the money it will put up for funds it manages. Since the early 1990s, Mack said, Morgan put up as much as 20 percent of an investment fund.

As the bank raised larger and larger funds, the bank's exposures grew too large, he said.

"We need to reallocate what percentage we're going to take," he added.

(Reporting by Joseph A. Giannone; Editing by Andre Grenon)