With the commercial-paper market evaporating – causing its ability to operate to do the same – Morgan Stanley escalated its frenetic search for a well-capitalized partner to help it restore investor confidence. Morgan Stanley shares have lost more than 40% in the past week, leaving Morgan Stanley Chief Executive John J. Mack seeking a tie-up with a commercial bank.

Mack yesterday held a conference call with the investment bank’s 8,000 brokers to encourage them to do all they could to reassure clients that the firm was financially sound.

A Morgan Stanley spokesman declined to comment on the details of the conference call but said that “it was a message of strength and confidence,” Dow Jones reported.

“How do you prepare for this?” said an anonymous Morgan Stanley broker. “Things are way above my ability to control. I just need to take care of my clients for now.”

Anxious to avoid the fate of former rivals Lehman Bros. and Bear Stearns, Mack has been in talks with Charlotte-based Wachovia Corp. (WB), as well as other potential investors including London’s HSBC Holdings PLC (ADR: HBC), and even state-controlled China Investment Corp., which manages part of that country’s $1.8 trillion in foreign-currency reserves.

The China sovereign wealth fund already purchased a 9.9% stake in Morgan Stanley late last year. According to reports, China Investment is considering a purchase of as much as 49% of the struggling U.S. brokerage house, although a deal has yet to be reached.

“Morgan Stanley must be talking to any suitor,” Roger Lister, a credit analyst at the DBRS Inc. rating firm in New York, told Bloomberg. “I’m not sure whether a merger with a bank will solve the problems. It’s not a deposit-base issue but a crisis of confidence [issue]. And getting a capital infusion from the Chinese or somebody else brings huge dilution due to the depressed stock price, which scares investors even more.”

No Suitors for WaMu

Big Wall Street firms aren’t the only financials in trouble as Seattle-based Washington Mutual, commonly known as WaMu, was officially up for sale yesterday after management hired Goldman Sachs Group Inc. (GS) to conduct an auction for the struggling thrift.

But despite WaMu’s ranking as the sixth-largest U.S. bank, there were no bidders.

Fred Cannon, analyst at Keefe, Bruyette & Woods, said that while WaMu’s franchise and retail branch network on the West Coast of the United States made it an attractive prospect for such East-Coast-based banks as JPMorgan Chase & Co. (JPM), any potential buyer would have to be able to withstand an accounting hit of as much as $37 billion from the thrift’s deteriorating mortgage portfolio, The Financial Times reported.

That’s a bitter pill to swallow and will make the thrift a tougher acquisition to digest – even with its $310 billion in assets, which includes an alluring $140 billion in deposits, that any buyer would get along with the corporate keys for WaMu.

Without a buyer, Goldman will need to investigate other options for its struggling client, including such possibilities as a piecemeal sale of assets, or a creative capital injection. But in a market as dry as this one is from a liquidity standpoint, raising capital in any form figures to be a Herculean task. And WaMu’s overexposure in the subprime mortgage market has made it particularly unattractive.

“The winning business [of the future] is going to the universal bank model, similar to that in Europe and Asia,” Bob Ellis, senior vice-president at Celent, a Boston-based consulting firm that specializes in financial services, told BusinessWeek. “You’ll have a strong retail bank, a retail brokerage, and an investment bank. That’s the winning model-by design or default.”

“The lesson I’m learning from WaMu is that it’s dangerous to be a one-trick pony,” Ellis added.

Buffett to Constellation’s Rescue

While Morgan Stanley and WaMu were still searching desperately search for a White Knight, Constellation Energy found its savior in the energy unit of iconic investor Warren Buffett’s Berkshire Hathaway Inc. (BRK.A, BRK.B).

Berkshire’s MidAmerican Energy Holdings Co. agreed to buy the distressed energy firm for about $4.7 billion, a 50% discount to Constellation’s market value from just one week ago. And while Berkshire isn’t a deposit bank, the rock-solid credit rating of the cash-rich investment holding company will be enough to guide Constellation through the current crisis.

The deal came together quickly as the looming threat of a credit-rating downgrade from both Standard & Poor’s and Fitch Ratings Inc. drove Constellation’s shares down almost 60% in the past week, putting the energy firm in a liquidity squeeze.

“The reality is that it all came together in the last 48 hours,” MidAmerican CEO Gregory E. Abel told Reuters.

“Pretty much from the time we started the dialogue, we’ve been working to see if there’s a balanced outcome we can deliver for all the various stakeholders,” Abel said.

The all-cash deal equates to $26.50 per Constellation share, a 7% premium over Wednesday’s closing price. As part of the deal, MidAmerican will receive Constellation’s power plants – including three nuclear power plants – as well as its flagship utility, Baltimore Gas & Electric.

Once MidAmerican and Constellation iron out the details of the merger agreement, MidAmerican will make a $1 billion emergency cash injection in the liquidity-starved utility.

“Warren’s got the cash and he’s got the platform to fold it into at MidAmerican Energy,” Greg Phelps, who oversees $3.5 billion at MFC Global Investment Management in Boston, told Bloomberg.

“With the deep pockets Berkshire Hathaway’s got, credit risk will be a thing of the past for the trading business,” Phelps added.

Fitch reaffirmed Constellation’s long-term debt rating at “BBB” on the news, with a stable outlook. Standard & Poor’s also left its rating for Constellation at “BBB,” though noting the rating remains under review until after the planned capital infusion.

By Jennifer Yousfi, William Patalon III and Jason Simpkins
Money Morning Editors

Source: The Government’s Financial Crisis Fix-it Plan Sends Stocks Soaring, Though Some Argue There’s no Quick Fix for this Disaster

(Part 3)