Single error costs mighty Morgan Stanley $8bn

A single catastrophic mistake by traders at the heart of Morgan Stanley's mortgage business has blown an $8bn (4bn) hole in the bank's finances, it emerged yesterday.

In what might be the biggest single loss by a trading desk on Wall Street, Morgan Stanley said it was stuck holding vast quantities of mortgage derivatives that had plunged in value since the summer, and kept on plunging in November.

John Mack, chief executive, called it "an error of judgment". Colm Kelleher, chief financial officer, said the bank had learnt "a very expensive and humbling lesson".

The hit to the company's balance sheet forced Mr Mack to seek a rescue refinancing from an arm of the Chinese government, which said yesterday it would pay $5bn for a stake of up to 10 per cent the company. Its shares rose 4 per cent in early trading on news of the cash injection.

Investors had been braced for big losses from Morgan Stanley but the scale of the disaster eclipsed even the worst predictions. It stood in sharp relief to the results a day previously from arch-rival Goldman Sachs, which had made so much money from bets against the mortgage market that it did not post any losses at all.

Ironically, Morgan Stanley was also betting that the mortgage market would deteriorate and a small group of traders were licensed to place big bets against the riskiest mortgage derivatives. However, they tried to defray the cost of those bets with interest from other, less risky mortgage-backed derivatives.

Disastrously, after Americans began defaulting on home loans in record numbers, even supposedly safe mortgage derivatives plunged in value.

Where Morgan Stanley had predicted at the end of October that it would have to write off $3.7bn of the value of the position, yesterday it admitted the situation had got even worse and the final figure was $7.8bn. Other write-downs related to the mortgage market took the final figure for one-time losses to $9.4bn.

"The results we announced today are embarrassing to me and the firm," said Mr Mack. "They are the result of an error of judgment on one desk in our fixed income area and a failure to manage that. Make no mistake, we have held people accountable."

Mr Mack sacked the company's co-president and heir apparent, Zoe Cruz, at the end of last month as the escalation of the losses was becoming apparent and amid criticism of her management style. Executives said yesterday that none of the traders involved, their bosses or the risk management officers at the firm had properly "stress tested" the mortgage positions on Morgan Stanley's books.

The company refused to say whether the individual traders were still in their posts.

China Investment Corp will hand Morgan Stanley a cash infusion of $5bn, initially in return for annual interest of 9 per cent but with the investment converting into Morgan Stanley shares by 2010. So-called "sovereign wealth funds" the investment arms of emerging market governments have become an important prop to Wall Street's disaster-stricken banks as they look for ways to recapitalise. In just the past month, Abu Dhabi invested $7.5bn in Citigroup and Singapore invested 11bn Swiss francs in UBS.

Wall Street executives forego bonuses

John Mack donned a hair shirt for Morgan Stanley's horrible financial results presentation yesterday and he is not alone in promising to forego a bonus this year.

Jimmy Cayne, the chief executive of rival Wall Street bank Bear Stearns, is expected to follow Mr Mack's lead and announce today that neither he nor other top executives will dip into their ring-fenced bonus pool.

The self-denial frees up a few more millions of dollars for spreading among the middle-ranking talent that Bear and Morgan Stanley need to keep on board as they struggle to right their businesses in the coming year. But most importantly, it shows to employees and to beleaguered shareholders that those at the top are sharing in some of the financial pain wrought by the credit crisis on Wall Street.

"Ultimately, accountability for our results rests with me," Mr Mack said yesterday, "and I believe in pay for performance. I've told our compensation committee that I will not accept a bonus for 2007." Last year, he was paid a $40m bonus, more than 100 times his salary.

Morgan Stanley's bonus pool for the financial year just ended is $16.6bn, it announced yesterday, up 18 per cent on last year, but a long way shy of what had been expected before the credit crisis broke. In the parts of the bank exposed to the mortgage markets, bonuses could be down by as much as 40 per cent, consultants said.

Bear Stearns is expected today to post its first ever quarterly loss.

Stephen Foley