NEW YORK (Reuters) - Anxious investors hacked away at Morgan Stanley (MS.N) and Goldman Sachs (GS.N) on Wednesday, sending shares of the two largest investment banks lower and boosting their debt-insurance prices higher amid rising fears over their ability to survive a deepening financial crisis.
Stronger-than-expected earnings from Goldman Sachs Group Inc and Morgan Stanley Tuesday failed to reassure investors who staged a run on Bear Stearns in March and drove Lehman Brothers Holdings Inc LEH.P into bankruptcy Monday.
And despite assurances from Goldman and Morgan Stanley — the two remaining major investment banks — that they had ample cash and capital, investors fled.
Morgan Stanley shares sank 42 percent, below the depths reached during the 1998 Asia debt crisis and the collapse of Long-Term Capital Management a decade ago. Goldman stock dropped as much as 26 percent to a three-year low. This year, Goldman shares have tumbled 53 percent, while Morgan’s are down by two-thirds.
“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,” Morgan Stanley Chief Executive John Mack told employees in a memo obtained by Reuters.
“There is no rational basis for the movements in our stock or credit default spreads.”
More ominously, investors bid up the price of protecting against a default by the banks, indicating concern that Wall Street’s biggest companies are at risk and may seek some measure of safety by merging with a commercial bank.
Morgan Stanley bonds also fell, with some issues trading at distressed levels. Its 6 percent notes due in 2015 traded at 61 cents on the dollar, down from 94 cents a week ago, and yield 12.25 percentage points over Treasuries.
“The credit crunch and credit contraction is intensifying,” said Peter Boockvar, equity strategist at Miller Tabak & Co in New York. “The action in Morgan Stanley in light of what were better-than-expected numbers last night is disconcerting.”
On Tuesday evening, Morgan Stanley rushed to release quarterly results, a day ahead of schedule, after investors sent its shares reeling 11 percent and increased debt-default insurance costs.
Morgan out-earned larger Goldman, which posted a 70 percent decline in profit but exceeded expectations.
Yet the same panic that pushed Lehman into bankruptcy Monday and prompted Merrill Lynch & Co Inc MER.N to agree to a merger with Bank of America Corp (BAC.N) over the weekend weighed on Goldman and Morgan Stanley.
“Goldman Sachs and Morgan Stanley reported great earnings. But the thing is, it doesn’t matter,” said William Smith, president of Smith Asset Management in New York. “You’ll see Morgan Stanley owned by a bank this weekend. You won’t see them fail, but you could see more shotgun marriages.”
A growing number of analysts argue that investment banks, which tap capital markets to fund their business, need to combine with commercial banks and their stable pools of deposits to avoid a Lehman-like collapse when markets turn jittery.
Investors are also punishing investment banks because their extensive use of leverage — piling up debt to boost trading and investment returns — puts them at risk when markets tumble.
Goldman Chief Financial Officer David Viniar and Morgan CFO Colm Kelleher both said their companies performed very well despite unprecedented turmoil. They also contended they do not want or need to merge with a commercial bank.
“We think the markets will positively differentiate those financial institutions that have global, diversified business models and that outperformed through his crisis,” Goldman spokesman Lucas van Praag said. “The issue that really matters is performance.”
On the New York Stock Exchange, Goldman shares were off $21.92, or 16 percent, to $111.30 after falling as low $97.78. Morgan Stanley stock dropped $7.71, or 27 percent, to $20.90, after falling as low as $16.55.
Even so, many of the same market pressures that weighed on Bear Stearns in March and against Lehman last week are now turned on Morgan Stanley and Goldman.
The cost of protecting $10 million of Morgan Stanley debt against default jumped to a point where sellers are demanding buyers make an upfront payment equal to 16 percent of the debt insured.
That indicates traders view the company as distressed and at a high risk of default.
Morgan Stanley’s credit default swaps earlier traded at an annual cost of $825,000 a year for five years, up $144,000 from Tuesday’s close.
Goldman’s swap costs likewise surged, rising by $190,000 to $610,000 a year from Tuesday’s close.
“People are looking at this business model and questioning it. They’re trying to figure out how they are going to resolve all these problems,” said William Larkin, fixed-income manager at Cabot Money Management.
Additional reporting by Ellis Mnyandu, Jonathan Spicer, Elinor Comlay, Dan Wilchins and Karen Brettell; Editing by John Wallace, Maureen Bavdek and Jeffrey Benkoe