Wednesday, February 9, 2011

Morgan Stanley's Liquidity Pool

It’s now official: the week of September 15, 2008 was a really bad week to work in Morgan Stanley’s prime brokerage. And the next week wasn’t so hot either. Various internal documents released with the FCIC report provide a fairly detailed picture of Morgan Stanley’s liquidity position during the crisis, and it’s not pretty. Prime brokers like Morgan Stanley relied heavily on customer cash held in prime brokerage accounts (known as “free credits”) to fund themselves. So when hedge funds all pulled their cash from Morgan Stanley’s prime brokerage after Lehman failed, that had a direct effect on Morgan Stanley’s liquidity pool.

On one day alone (Wednesday, September 17th), Morgan Stanley’s prime brokerage lost $36.6 billion in free credits. That’s $36.6 billion instantly gone from the firm’s liquidity pool. To add insult to injury, that same day, prime brokerage customers also withdrew $12.3 billion of excess margin, which dealers also count toward their liquidity pool. For the week, Morgan Stanley’s prime brokerage lost an amazing $86.5 billion in liquidity. And the next week, they suffered an additional $43.3 billion of outflows, for a two-week total of $129.8 billion. That’s a hell of a fortnight!

Overall, Morgan Stanley’s liquidity pool was falling by tens of billions per day — the firm was basically imploding. Without the government bailout, it’s pretty clear that they wouldn’t have lasted another week.


Unfortunately, I had to pull the stats on Morgan Stanley’s liquidity pool from the internal documents posted on the FCIC’s website, because the FCIC absolutely mangled the liquidity pool numbers in the actual report. They constantly confuse the parent company’s liquidity pool with the firm’s overall liquid assets, which are two completely different measures. They include several dramatic statements like, “Morgan Stanley’s liquidity pool had dropped from $130 billion to $55 billion in one week,” which isn’t even close to right. In fact, they seem to have simply pulled that $130 billion number out of thin air, as it’s not in any of the underlying documents. At one point, they say that “By the end of September, Morgan Stanley’s liquidity pool would be $55 billion,” and then cite to an email written on September 19th. (And the email was talking about parent company liquidity anyway!) Basically, it’s clear from the report that the FCIC didn’t understand anything about liquidity management — which, given the prominent role liquidity management played in the financial crisis, is pretty sad.


Anonymous said...

It would be interesting to find out where all the money pulled out actually went. You'd need a pretty big pillow to stick $86 billion under. Was there $86 billion of hedge fund redemptions from MS prime brokerage clients effected in 2 weeks?

Anonymous said...

The money pulled out of Morgan Stanley prime brokerage was transferred to other prime brokers that were considered to be less unstable. At the time, the biggest beneficiaries of the run on the bank at MS were JP Morgan, Credit Suisse, and Deutsche Bank.

Anonymous said...

It was actually the Bank of Tokyo Mitsubishi that helped to bailout MS during the crisis.

Carter the Examiner said...

For a detailed discussion of the liquidity events that occurred (without specifically naming names), I would recommend reviewing the Senior Supervisors Group Report "Lessons from the Global Banking Crisis of 2008" at They devote a good 13 pages to describing liquidity "lessons learned"

John Haskell said...

How is it that brokerages are allowed to use these appallingly misnamed "free credits" to run their business? Do prime broker agreements include a carve-out that excludes clients from the protections afforded by the 1933 Act? How could MS just grab this money for their various gamblings, and what, if anything, has been done to stop it from happening again?

I ask because Andrew Ross Sorkin recently managed to write a 500 page book without answering any of these questions.

threetrap said...

I remember our invested HFs doing that when the crisis hit. Good work on doing the math and figuring out how it affected MS' liquidity position.

Notwithstanding how, if at all, we got out of this bind, it was certainly a very close run thing!

Anonymous said...

John Haskell, exactly which part of the 1933 act do you think counting the securities deposited by clients with their broker then being used as collateral by their broker violates?


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The cash got outgw2 gold of Morgan Stanley leading brokerage firm ended up being used other excellent stockbrokers which are considered to be less volatile. During the time, the largest beneficiaries from the run using the financial institution at Master of science were being JP Morgan, Credit ratings Diablo 3 itemsSuisse, along with Deutsche Traditional bank.

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