Credit Crunch

Morgan Stanley Meltdown

Remember that thing about November being the worst month ever in the fixed-income markets? It's definitely showing up in bank earnings.

Morgan Stanley (nyse: MS - news - people ) took a $9.4 billion hit for its fiscal fourth quarter, $5 billion more than most people were expecting, as it aggressively wrote down its exposures to credit derivatives and mortgage securities. Chief Executive John Mack said he shouldered the blame for a loss of $3.5 billion in the quarter, and he wouldn't take a 2007 bonus because of it.

On a conference call Wednesday, Mack called the performance "embarrassing" and laid the blame on an "error in judgment" by one desk of traders in the firm's mortgage operation.

"Across the firm, we have moved aggressively to make the necessary changes, and these isolated losses by a small trading team in one part of the firm should not overshadow the momentum we see in virtually all of our other businesses," Mack said in a statement.

The quarterly loss, which amounted to $3.61 a share, was far greater than the 39-cent-per-share loss analysts had forecast. Investors are bracing for bad news from Bear Stearns (nyse: BSC - news - people ) as well, where fourth-quarter losses are expected to be around $1.79 a share when it announces results on Thursday.

There was speculation this week that Bear Stearns' board of directors was considering the future of Chief Executive James Cayne, who along with other senior managers, reportedly won't be taking a 2007 bonus. Cayne already fired the firm's president, Warren Spector, this summer amid mounting mortgage-related losses and the closing of two of Bear Stearns' hedge funds.

The portfolio manager of those funds, Ralph Cioffi, quit the firm at the end of the fourth quarter in November, a spokeswoman confirmed Wednesday. Federal prosecutors and the Securities and Exchange Commission are said to be investigating withdrawals from the funds by insiders before their collapse this summer.

Morgan Stanley's write-down is among the largest yet as Wall Street tries to get a handle on the credit crunch and the firm joins UBS (nyse: UBS - news - people ) and Citigroup (nyse: C - news - people ) in securing an investment from a sovereign investment fund to help shore up its capital base. China Investment is taking a 9.9% passive stake in Morgan Stanley, or $5 billion.

UBS said earlier this month it sees fourth-quarter write-downs of $10 billion. It got an $11.5 billion infusion of capital from Singapore and an unnamed Middle Eastern investor. Citigroup is facing additional write-downs of $13 billion by some estimates after receiving $7.5 billion from Abu Dhabi's investment fund.

Merrill Lynch (nyse: MER - news - people ), now under new Chief Executive John Thain, is seen announcing bigger fourth-quarter write-downs than the $8.4 billion it estimated in November. Analysts see that number going up by another $3 billion to $6 billion. Merrill and Citi won't report earnings until mid-January.

CIBC (nyse: CM - news - people ) said Wednesday that it is a hedge counter-party with ACA Financial Guaranty, which Standard & Poor's downgraded to CCC from A, for $3.5 billion of U.S. subprime exposure. "CIBC believes there is a reasonably high probability that it will incur a large charge in its financial results for the first quarter ending Jan. 31, 2008," the bank said.

Meanwhile, Bank of America (nyse: BAC - news - people ) said last week it is anticipating another $3.3 billion in write-downs and provisions, and Wachovia (nyse: WB - news - people ) is setting aside $1 billion for expected credit costs.

Among the banks to report so far, Goldman Sachs (nyse: GS - news - people ) is the lone standout. It posted surprisingly strong profits, $7.01 a share, for the quarter and record profits of more than $11 billion for the year.

What's ironic is that the firms having the biggest problems with credit exposures tried the hardest to mimic Goldman. Morgan Stanley and Merrill threw more capital at their proprietary trading desks in recent years and took riskier bets, hoping to take advantage of booming fixed income and equity markets. Both also bought up mortgage companies near the peak of the housing boom. Both actions have led to losses.

Goldman bet against the mortgage markets earlier this year while people were still piling into it, and profited big because of it. Morgan Stanley also bet against the mortgage market, putting on a $2 billion short position in the lower tranches of collateralized-debt obligations, and taking a $14 billion long position in the senior tranches. The long position spelled disaster, as the value of the senior tranches plummeted when the credit markets seized up this fall.

In a double dose of irony, while many firms are now regretting their investments in subprime mortgage companies earlier this year if not last year, Goldman is jumping in. Last week it bought Litton Loan Servicing, a subprime mortgage loan-servicing company. On a conference call Tuesday, Goldman's Chief Financial Officer David Viniar said the purchase takes advantage of distressed prices for these businesses.

"It's a business we want to be in," he said. Warning: Don't try this at home.