Morgan Stanley's fate still hangs in the balance

By Joseph A. Giannone

NEW YORK (Reuters) - Despite its best efforts to fortify its defenses, Morgan Stanley's fate hangs in the balance after the market's relentless assault last week.

Come this Tuesday, Morgan Stanley's agreement to sell a 21 percent stake to Japan's Mitsubishi UFJ Financial Group Inc for $9 billion could be completed. Yet many investors are convinced that Morgan will not make it that long, hammering Morgan's stock price to its lowest in 14 years and valuing the entire company at about $10 billion.

Both sides last week insisted the deal would still close as written, but investors are not so sure. At the same time, rising default insurance costs and the plunging price of some debt also raise worries that trading and prime brokerage businesses could be hurt.

"It comes down to confidence," Ladenburg, Thalmann & Co banking analyst Richard Bove said in a client note. "The company must have the ability to roll over its debt and operate with counterparties in the market on a daily basis. If it can do this, it will survive and ultimately thrive."

Bove declined to predict whether Morgan would be able to resolve its problems, sticking to a "neutral" rating for its shares.

Morgan Stanley officials did not return calls and messages seeking comment.

In a related development, European leaders raced against the clock on Sunday to craft a rescue strategy for banks hit by the worst financial crisis since the 1930s, focusing on pledges to recapitalize banks or buy debt they issue.

According to a draft statement circulated at a summit in Paris, leaders from the euro currency area were working on a plan that includes commitments to provide capital, and to insure or directly buy into debt issues.

Meanwhile, Goldman Sachs Group Inc, the fourth-largest U.S. bank, is by no means out of the woods. Despite raising $10 billion from Berkshire Hathaway Inc, the holding company run by billionaire Warren Buffett, and public investors, Goldman's stock price also came under attack.

PLAN B

Insiders at Morgan Stanley are confident that once a deal closed, the Mitsubishi partnership would give the company access to deep pockets that would reassure investors and clients.

But if Mitsubishi did back out, some investors would bank on another well-heeled investor stepping in: the U.S. government. With the U.S. Treasury Department's $700 billion troubled assets bailout plan failing to calm markets, Secretary Henry Paulson has proposed buying stakes in banks, and Morgan Stanley could emerge as the first recipient.

Paulson and the Federal Reserve famously chose not to bail out Lehman Brothers Holdings Inc last month -- a decision that some market observer now blame for increasing anxiety in the markets and contributing to the plunge in financial services stocks in the past week.

That Morgan Stanley finds itself on the precipice has left many employees at the fifth-largest U.S. bank frustrated. Under John Mack, who took over as chief executive in June 2005, Morgan Stanley took on more trading risk and expanded in lending and mortgage businesses that have proven to be the biggest money losers of the credit crunch.

Yet since the bank wrote down more than $9 billion of assets last December, Morgan Stanley shifted to defense. It shed assets, reduced leverage and raised $5 billion of capital from China Investment Corp -- a move that made it look smart as Bear Stearns Cos Inc and Lehman Brothers crumbled for lack of willing investors.