Morgan Stanley, Goldman Sachs Lead Decline in Bank Bond Risk

Morgan Stanley and Goldman Sachs Group Inc. led a drop in the cost of protecting bank bonds from default as the U.S. government broadened the scope of its plan to stem the financial crisis, reported Bloomberg.

Credit-default swaps on the securities firms fell to the lowest in a week after the Federal Reserve approved their bids to become banks and Mitsubishi UFJ Financial Group Inc. said it may buy as much as a fifth of Morgan Stanley. Contracts on banks including Wachovia Corp. and Bank of America Corp. also fell as U.S. Treasury Secretary Henry Paulson submitted a plan to Congress to buy $700 billion of devalued assets.

``The scope of the government's purchase program is quite significant,'' Merrill Lynch & Co. strategists Akiva Dickstein, Roger Lehman and Kamal Abdullah wrote in a note to clients today. At distressed prices, the Treasury could acquire as much as 10 percent of the outstanding residential and commercial mortgages that aren't already owned or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, they said.

Treasury's plan and the approval of Morgan Stanley and Goldman as bank holding companies boosted investor confidence that the government has calmed the financial turmoil that last week drove Lehman Brothers Holdings Inc. into bankruptcy, while prompting the government to bail out insurer American International Group Inc. and Merrill Lynch & Co. to sell itself to Bank of America Corp.

The U.S. Treasury late yesterday gave Congress revised guidance on its plan, which may allow the government to also buy other devalued assets such as car loans and credit-card debt. Paulson also has proposed as much as $400 billion to guarantee money-market mutual funds.

Contracts on Morgan Stanley dropped 132 basis points to 415 basis points, according to CMA Datavision in London. Mitsubishi UFJ, Japan's biggest bank by assets, agreed to invest up to 900 billion yen ($8.4 billion) in Morgan Stanley, the bank said in a statement today. Contracts on Goldman fell 87 basis points to 280 basis points.

Converting Morgan Stanley and Goldman into banks ``seems to be a sensible solution for them,'' said Andrea Cicione, a credit strategist at BNP Paribas SA in London. ``The broker business model seems broken. Turning them into commercial banks helps take care of the funding problem. It takes some pressure off them to go into a quickly decided wedding with some other banks.''

The Markit CDX North America Investment Grade Index, a benchmark gauge of credit risk tied to the bonds of 125 companies in the U.S. and Canada, was unchanged at 151 basis points, according to broker Phoenix Partners Group.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates deterioration in the perception of credit quality; a decline signals improvement.

A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

Contracts on Charlotte, North Carolina-based Wachovia Corp., the fourth-largest U.S. bank, fell 14 basis points to 464 basis points. Bank of America Corp. fell 21 basis points to 134 basis points, and Merrill fell 58 basis points to 271 basis points.

Contracts on the Markit iTraxx Financial index of 25 European banks and insurers dropped 9 basis points to 99, according to JPMorgan Chase & Co. In Tokyo, the Markit iTraxx Japan index dropped 5 basis points to 144.5, Morgan Stanley prices show.

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