In defense of markets that sometimes close

Heading into the Columbus Day weekend of 2008, Morgan Stanley looked likely to become the next domino to fall in the Great Financial Crisis.

The bank began the week with $130 billion of cash on the books, which management believed was more than enough to weather the storm. 

But the hedge funds whose withdrawals had sealed the fate of Bear Stearns, Lehman Brothers, and Merrill Lynch were now pulling their money from Morgan Stanley, too — $65 billion of it in a single day.

It was a bank run, and the only thing that seemed likely to stop it was an influx of equity capital from a large investor.

“If we didn’t do a deal, it was over,” CEO John Mack said later. “We couldn’t stay in business.”

Fortunately, Mack had agreed to a deal.

Two weeks earlier, Japan’s Mitsubishi UFJ Financial Group (MUFG), the second-largest bank in the world with $1 trillion of customer deposits, had agreed to buy 21% of Morgan Stanley for $9 billion. 

Unfortunately, the deal hadn’t closed yet. 

And the market increasingly doubted it ever would. The deal valued Morgan Stanley at $25.25 a share, but investors did not seem convinced: the shares closed at just $14.22 the day it was announced.

Nine days later, they had fallen to below $10.

This was a problem.

The more the shares went down, the less likely the deal was to close. The less likely it was to close, the more the shares went down.

Even worse: the more the shares went down, the more customers withdrew their money. The more… well, you get the idea.

Morgan Stanley was at the mercy of its stock price, which traded lower day after day.

“We just needed to make it to the weekend,” Smith said later.

The weekend was a circuit breaker — a two-day window for Morgan Stanley to close the deal with MUFG without having to worry about where its shares were trading.

On Saturday, MUFG said it remained committed to investing but needed to renegotiate. By Sunday, a new deal was agreed, with MUFG receiving mostly preferred shares instead of mostly common.

This left just the issue of payment. 

Announcing a renegotiated deal would not have stopped the doom loop that was sure to restart as soon as trading resumed Monday morning. To restore confidence in Morgan Stanley, the deal had to close.

“We knew that if this money could not be delivered,” MUFG Chair Nobuyuki Hirano recounted, “the markets will sell Morgan Stanley stock down, to possibly zero.” 

MUFG was ready to deliver the money, but there was a problem: the Fed celebrates Columbus Day and the stock market does not. 

Morgan Stanley needed the money before its stock resumed trading on Monday morning, but the Fedwire payment system that handles giant transfers like this wouldn’t reopen until Tuesday.

With the market in panic mode, Tuesday might have been too late for the $9 billion to do any good. Morgan Stanley may have lost many times that amount in withdrawals by then.

So there was only one thing for it: MUFG would have to write a check.

Morgan Stanley Vice Chairman Rob Kindler suggested it on Sunday and MUFG agreed. At 7:30 am Monday morning, Kindler was in a conference room at the offices of Wachtell Lipton awaiting delivery of a physical check. 

“He looked like hell,” Aaron Sorkin wrote in Too Big to Fail. “He hadn’t slept in at least a day.”

Expecting the check to arrive by messenger, Kindler hadn’t bothered shaving or changing out of the khaki pants and flip flops he was still wearing from his cancelled vacation in Cape Cod.

Instead, it was delivered by an entourage of suited MUFG executives. And a camera crew.

Kindler hastily borrowed a suit jacket from one of his lawyers, who turned out to not be as broad-shouldered as Kindler. It tore down the back.

“I assure you, I am vice chairman of Morgan Stanley,” the haggard looking Kindler told his Japanese saviors.

Despite his appearance, MUFG handed over the check — in plenty of time for Morgan Stanley to announce it to the world before the shares resumed trading. 

They traded up as much as 70% that day.

The bank run was over thanks to a weekend circuit breaker — which may soon cease to exist.

The pause that saves

If the S&P 500 falls 7%, trading is halted for a minimum of 15 minutes. If it falls 20%, trading is halted until the next day.

These market-wide circuit breakers were instituted after the Black Monday crash in 1987 as a means to interrupt panic selling before it becomes self-reinforcing. 

Exchanges also have discretionary authority to halt individual stocks for pending material news or even just an order imbalance — anything that investors might need some extra time to think about.

Companies report earnings either before or after the market’s regular hours for the same reason. Berkshire Hathaway even reports on Friday evenings so that investors have the entire weekend to think things through.

This is also the time when regulators most often attempt to halt bank runs. Continental Illinois, Barings Bank, and Bear Stearns were all rescued over a weekend.

The FDIC almost always closes failed banks after the close of business on Friday so they have enough time to reorganize them under new ownership without disrupting depositors’ access to their money.

Nights and weekends are a natural circuit breaker for the entire financial system.

But perhaps not for much longer.

Yesterday, the London Stock Exchange became the latest major exchange to announce plans to move to 24-hour trading, five days a week. NYSE, Nasdaq, and the CBOE are planning the same.

Can 24/7 trading be far behind?

Exchanges are expanding their trading hours to fend off the competitive threat of tokenized equities, which trade on blockchains that never close. 

Nasdaq says this will also “broaden investor access, expand wealth-building opportunities, and redefine how markets function.”

And I'm sure that’s true. But at what cost?

Morgan Stanley is now a $340 billion bank — employing 83,000 people — because markets paused long enough for someone to rescue it.

MUFG still owns 24%.

— Byron Gilliam