Morgan Stanley reported the first quarterly loss in its 72-year history yesterday, heightening fears that the financial toll would keep mounting from the fast-spreading crisis in the subprime mortgage market.
The company took a $9.4 billion charge on subprime-linked investments for the fiscal fourth quarter and, in a stark reflection of its diminished status, said it would sell a $5 billion stake to a Chinese investment fund to shore up its capital.
Wall Street banks so far have reported more than $40 billion in losses as a result of the crisis in the mortgage market. Worst-case estimates put the eventual bill at $200 billion or more. The tally is likely to rise again today when Bear Stearns Cos. is expected to report a quarterly loss.
The developments yesterday were a stunning turn of events for Morgan Stanley, an offshoot of the Morgan banking dynasty that has counseled corporate America since the Depression. John J. Mack, the bank's chief executive, said he took full responsibility and would forgo a bonus for 2007.
Like Citigroup Corp. and UBS of Switzerland, Morgan Stanley has turned to a wealthy investor from the East after losing billions of dollars on subprime-tainted investments. Morgan Stanley lost $3.59 billion for the fourth quarter. It said its remaining subprime exposure was $1.8 billion.
The drastic losses may heighten speculation about the fate of Mack, who returned to the firm in 2005 after the removal of his predecessor, Philip J. Purcell.
One of Mack's signature changes was to push the firm further into trading using its own capital, an effort to emulate its profitable archrival, Goldman Sachs.
His strategy worked for a while but then backfired when trades in tricky subprime-linked securities went wrong, resulting in the biggest write-down in the firm's history.
While Mack is expected to keep his job, his compensation will plummet - one of the harshest punishments meted out on Wall Street, short of showing an executive the door. Last year, he made $40 million; this year, he will take home about $800,000.
His paycheck is particularly humiliating since Lloyd C. Blankfein, the chief executive of Goldman Sachs, is likely to receive a $70 million bonus. James E. Cayne, the chief executive of Bear Stearns, is also expected to forgo a bonus.
In a conference call yesterday, Mack was quick to take responsibility. "The results are embarrassing for me and the firm," he said.
But he also pointed out that the bulk of the $9.4 billion loss occurred on one trading desk and that other areas of the firm, particularly the investment banking, asset management, retail brokerage and hedge fund servicing businesses, performed well.
As for the investment from China, Mack framed the transaction not as a desperate act but as a strategic move. And he refused to concede that Morgan Stanley was a weakened firm. "We remain bullish on Morgan Stanley's significant growth potential," he said.
Still, the investment shows how reliant Morgan Stanley and Wall Street are on foreign funds and gives additional credence to the joke now circulating on trading floors. The joke is: "Shanghai, Dubai, Mumbai or goodbye."
The fund, the China Investment Corp., has agreed to purchase almost 10 percent of the company. It will have no role in the management of Morgan Stanley.
Citigroup recently sold a stake to a Middle East fund.
The deal is an abrupt shift in strategy for China's $200 billion sovereign fund and underlines the extent to which it appears to be under the direct control of the country's leaders.
Morgan Stanley executives first began discussing an investment with the fund this summer, but it wasn't until recently that the deal was struck. For Morgan Stanley, the terms are severe. The firm will pay annual interest of 9 percent on bonds that will be convertible into Morgan Stanley stock in 2010.
The China Investment Corp. is under the control of China's finance ministry, with some influence as well from the People's Bank of China, the country's central bank.
There has been discussion in the Chinese government over whether even more foreign currency should be injected into the investment fund, as the People's Bank of China continues to accumulate $1 billion a day as it buys up dollars to prevent the value of China's currency from rising in international markets.
The loss at Morgan Stanley highlights a sense of strategic confusion within the firm. Going back to the firm's early days when it broke off from Morgan Bank, Morgan Stanley's strength has been its investment banking and advisory business areas; both did well this year.
But Mack was eager to strike a more aggressive pose when he took over from Purcell, who had been criticized for his cautious approach. By encouraging his traders to take on more risk, Mack plunged Morgan Stanley into a complex, sophisticated and dangerous area that has never been a core area of competence for the firm.
Investors seemed to give Mack the benefit of the doubt. Morgan Stanley shares rose $2.01 to $50.08.