September 26, 2008 – 3:53 pm

Morgan Stanley is having trouble keeping hedge funds’ confidence. In the midst of market turmoil last week, JP Morgan morphed from an investment bank to a commercial bank, and the hedge funds fearing a Lehman-esque catastrophe took flight:

“Many of the world’s biggest hedge funds moved their assets to commercial banks regarded as safer last week, as they and their investors worried that Morgan Stanley could follow Lehman into trouble,” the Financial Times said.

The bleeding off of Morgan Stanley’s deposits depletes the bank’s capital base, making it more difficult to fund loans:

The flight of cash and stock out of the division occurred as spreads in the credit default swap market ballooned, but has since slowed to a trickle. Several of Morgan Stanley’s hedge fund clients said they were likely to return to the bank once markets stabilised. The prime brokerage, which provides hedge funds with custody and loans and assists short selling, is highly rated by many managers. Many of the world’s biggest hedge funds moved their assets to commercial banks last week.

It will be interesting to see how much of the run returns. Morgan Stanley may be making deals to hedge funds in the near future.

Or it may not.

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