Morgan under siege as other banks rally

Shares of Morgan Stanley and Goldman Sachs, the last two big investment banks, plunged again Friday as fears about the fate of the banking sector remained front and center in the ongoing global financial crisis.

The two companies have been among the hardest hit stocks during this devastating market decline. But shares of several other big bank stocks rallied during a wild, tumultuous day for the broader market.

Morgan Stanley (MS, Fortune 500) plummeted as much as 46% at one point Friday on news that the rating agency Moody's was weighing a potential downgrade of the long-term debt ratings of the company and its subsidiaries. The company's stock bounced back a bit at the end of the day but still finished 22% lower.

Earlier this week, Morgan Stanley was forced to deny rumors that its proposed $9 billion stock sale to the Japanese bank Mitsubishi UFJ was in danger of falling apart.

Still, despite several reassurances from Morgan Stanley and Mitsubishi that the deal would close as scheduled next week, investors remained jittery about Morgan's fate.

"The fundamental issue with financial stocks is that fear in the market can become self-fulfilling," said Benjamin Wallace, an analyst at the Westborough, Mass.-based wealth management firm Grimes and Company Inc.

Shares of Goldman Sachs also fell Friday after Moody's issued a similar warning about the Goldman's debt. Goldman (GS, Fortune 500) stock fell 12% on the news.

Calls to both Morgan Stanley and Goldman Sachs requesting comment about the Moody's reports were not immediately returned.

But other big banks which some analysts have deemed as relatively safer than the investment banks, such as Bank of America (BAC, Fortune 500) and JPMorgan Chase (JPM, Fortune 500), bucked the trend, gaining over 6% and 13% respectively.

San Francisco-based Wells Fargo (WFC, Fortune 500), which claimed victory in its battle with Citigroup (C, Fortune 500) to buy struggling bank Wachovia (WB, Fortune 500) on Thursday, closed up nearly 4%.

The KBW Banking Index and S&P Banking Index, two key barometers of the sector that also include many regional banks, both finished more than 7% higher Friday.

Shares of regional banks SunTrust (STI, Fortune 500), KeyCorp (KEY, Fortune 500) and US Bancorp (USB, Fortune 500) all ended about 5% higher on the day.

Many worries remain
Investors were juggling a host of other concerns about banks Friday, including an auction of credit default swaps for bankrupt Lehman Brothers.

A number of big U.S. and European banks, such as Morgan Stanley, Citigroup, HSBC, BNP Paribas, Goldman Sachs and Deutsche Bank, found themselves on the hook after the auction valued the insurance against a Lehman collapse at just 8.625 cents on the dollar, according to credit derivatives processor Creditex.

But one analyst downplayed the impact that the results of the auction were having on bank stocks.

"In the context of more than [$200 billion] of payments that will be made, it's not that significant and on the bright side, this auction gives us clarity to pricing and closure to this situation and now the players can quantify fully their exposure to this particular event," Peter Boockvar, market analyst for Miller Tabak, wrote in a note to clients.

In the end, a lack of confidence remained the key driver in Friday's selloff of many banks.

World governments have unleashed numerous initiatives in recent days in the hopes of restoring some much-needed calm to markets worldwide including a coordinated cut interest rates by a number of central banks. Still, those efforts have proved ineffective as the selloff continues and credit markets remain frozen.

Starting today, finance ministers from the Group of Seven, including U.S. Treasury Secretary Henry Paulson, are scheduled to meet to discuss other coordinated efforts to help stop the global market slide.

Still, Paulson and other top domestic officials are weighing other courses of action to help prop up the U.S. banking system.

One widely speculated move would involve injecting much-needed capital into banks through the purchase of shares in bank stocks. This option was made available to the Treasury under the recently passed $700 billion rescue plan.

President Bush's chief economic adviser, Edward Lazear, told CNN Thursday that this was being considered. Many experts believe that doing so would encourage banks to lend to one another more freely.

Libor, a key rate banks use when lending to each other, has soared to record levels in recent weeks. Even as banks showed some willingness to lend on a short-term basis on Friday, longer-term Libor rates jumped to their higher level so far this year.

There is also talk that U.S. officials may take a page from the playbook of other world governments such as the U.K., which backed billions of dollars in bank debt earlier this week.

At the same time, top U.S. officials are also considering removing the deposit insurance cap on all domestic bank deposits, The Wall Street Journal reported Friday. European countries including Greece, Ireland and Germany have already done so in recent days.

The thinking behind such bold measures is that they could provide a psychological boost to an industry which has been shaken to its core.

But John Douglas, a former general counsel at the Federal Deposit Insurance Corp., has warned that removing deposit caps altogether could have unintended consequences.

Lifting the deposit caps might make it tougher for regulators to identify banks in trouble since a run on deposits is typically a warning signal. And commercial depositors would be less likely to take their money out of banks if all the deposits are insured, Douglas said.

In addition, Douglas, who currently serves as a partner in charge of the bank and financial institutions group at the law firm Paul Hastings, warned that lifting the cap could require financial institutions to pay higher premiums to support the insurance fund that covers deposits of failed banks.

That could prove to be an expensive proposition for capital-hungry banks.

"[The money] has to come from somewhere," Douglas said.