Wall St duo bring in new lending systems

Morgan Stanley and Goldman Sachs are responding to the credit crisis with new systems that use the market's view of their own creditworthiness as a basis for lending decisions, according to people familiar with the matter.

Financial Times reports that these arrangements for determining the size of lending commitments to hedge fund clients were being put in place before the collapse of Bear Stearns. But implementation has gathered pace as investment banks seek ways to guard against the sudden loss of confidence - and resulting withdrawal of market funding - that crippled Bear.

Morgan Stanley is essentially tying its promise to provide financing to hedge fund clients to the prices of credit insurance on its own debt. If the cost of the protection rises to a certain level, that would trigger a reduction in Morgan Stanley commitments to hedge funds. Although its lending commitments will not necessarily change from day to day it will generally lend less.

Goldman Sachs is understood to have a similar arrangement that uses its bond prices as a reference point for credit commitments to hedge fund clients. The shift in lending systems is significant because investment banks are powerful forces in prime brokerage, the business of providing loans and other services to hedge funds.

Competitors with commercial banking arms, such as Deutsche Bank, have not adopted such measures because they have more stable sources of funding than investment banks, most notably customer deposits.

Morgan Stanley's use of the credit insurance market as a basis for lending decisions underscores the extent to which the derivatives market has replaced rating agencies as the final word on creditworthiness.

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