Morgan Stanley CEO blames rout on short sellers

NEW YORK (Reuters) - Morgan Stanley (MS.N) Chief Executive John Mack lashed out at short sellers Wednesday after watching his firm's shares plunge as much as 42 percent and seeing prices for its debt-default insurance soar into distressed territory.

A day after Morgan Stanley announced better-than-expected third-quarter earnings and delivered greater profit and revenue than its larger rival Goldman Sachs Group (GS.N), investors pushed its stock to a 10-year low and traded some of its bonds as if the No. 2 investment bank were near default.

In a memo, Mack told employees there was no "rational" reason for the movement in its stock or credit default swaps, which serve as insurance policies for debt.

"What's happening out there? It's very clear to me -- we're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down," Mack said in a memo obtained by Reuters.

Short-sellers are investors who sell borrowed shares and then hope the stock falls. They record a profit when they return the shares, now purchased at the lower price.

Mack also said he spoke with federal officials to enlist their help and spoke with clients and counterparties to assure them Morgan's financial health was sound.

"We have talked to (U.S. Treasury) Secretary Paulson and the Treasury. We have talked to Chairman (Christopher) Cox and the Securities and Exchange Commission.

Morgan shares closed Wednesday trading down 24 percent.

Like Morgan, Goldman contends that a 14 percent drop in its share price and widening CDS spreads were driven by speculation.

"Goldman's view is that the movement in our share price is the result of completely irrational fear and is not based on any fundamentals," Goldman spokesman Lucas van Praag said.

He also confirmed that Goldman CEO Lloyd Blankfein received a call from Cox. The two discussed the market moves and concerns about potentially improper short selling activity.

Morgan Stanley and Goldman Sachs, though complaining about short sellers, are also the biggest prime brokers on Wall Street -- meaning they routinely help hedge funds short companies' shares.

But both banks believe they are the victims of "bear raids," where short sellers gang up on a stock to try to manipulate it, rather than having a considered investment thesis.

"There are plenty of reasons why somebody might short a stock, but if the motivation is inappropriate, then it shouldn't be allowed," Goldman's van Praag said.

PRESSURE'S RISING

Investment banks have found themselves under pressure all year, after anxiety in the market place triggered a run on Bear Stearns, which collapsed in mid March.

Lehman Brothers in the following days complained that it was short sellers who actively worked to bring down Bear and who had then turned their cannons on Lehman.

"There are a lot of rumors in the marketplace that are totally unfounded. We are suspicious that the rumors are being promulgated by short sellers of our stock that have an economic self-interest," a Lehman spokeswoman said on March 27.

In the months that followed, Lehman engaged in a war of words with hedge fund manager David Einhorn, who revealed he was shorting Lehman shares. Einhorn contended the firm had too much mortgage and commercial real estate exposure and not enough capital.

Six months later, those views were largely vindicated, as Lehman's shares plunged and its real estate losses required more fresh capital than it could raise quickly. On Monday Lehman filed for bankruptcy.

"When management teams complain (about short sellers), it is a sign that management is attempting to distract investors from serious problems." Einhorn said in May.

(Additional reporting by Dan Wilchins; Editing by Gary Hill)