Edgar Filing: MORGAN STANLEY

QUARTERLY REPORT FOR THE PERIOD ENDED MARCH 31, 2009

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2009

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

Commission File Number 1-11758

LOGO

(Exact Name of Registrant as specified in its charter)

Delaware

(State or other jurisdiction of

incorporation or organization)

1585 Broadway

New York, NY 10036

(Address of principal executive

offices, including zip code)

36-3145972

(I.R.S. Employer Identification No.)

(212) 761-4000

(Registrant’s telephone number,

including area code)

November 30

(Former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large Accelerated Filer x		Accelerated Filer ¨
Non-Accelerated Filer ¨		Smaller reporting company ¨
(Do not check if a smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of April 30, 2009, there were 1,081,842,362 shares of the Registrant’s Common Stock, par value $0.01 per share, outstanding.

LOGO

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended March 31, 2009


Table of Contents						Page


Part I—Financial Information
Item 1.	Financial Statements (unaudited)	1
	Condensed Consolidated Statements of Financial Condition—March 31, 2009, December 31, 2008 and November 30, 2008	1
	Condensed Consolidated Statements of Income—Three Months Ended March 31, 2009 and 2008 and One Month Ended December 31, 2008	3
	Condensed Consolidated Statements of Comprehensive Income—Three Months Ended March 31, 2009 and 2008 and One Month Ended December 31, 2008	4
	Condensed Consolidated Statements of Cash Flows—Three Months Ended March 31, 2009 and 2008 and One Month Ended December 31, 2008	5
	Condensed Consolidated Statements of Changes in Total Equity—For the One Month Ended December 31, 2008 and the Three Months Ended March 31, 2009	6
	Condensed Consolidated Statement of Changes in Total Equity—For the Three Months Ended March 31, 2008	7
	Notes to Condensed Consolidated Financial Statements (unaudited)	8
	Note 1. Basis of Presentation and Summary of Significant Accounting Policies	8
	Note 2. Fair Value Disclosures	16
	Note 3. Collateralized Transactions	31
	Note 4. Securitization Activities and Variable Interest Entities	33
	Note 5. Goodwill and Net Intangible Assets	41
	Note 6. Long-Term Borrowings	42
	Note 7. Derivative Instruments and Hedging Activities	43
	Note 8. Commitments, Guarantees and Contingencies	52
	Note 9. Regulatory Requirements	58
	Note 10. Total Equity	61
	Note 11. Earnings per Common Share	63
	Note 12. Interest and Dividends and Interest Expense	64
	Note 13. Other Revenues	65
	Note 14. Employee Benefit Plans	65
	Note 15. Income Taxes	65
	Note 16. Segment and Geographic Information	66
	Note 17. Joint Ventures	69
	Note 18. Transition Period Financial Information	70
	Note 19. Subsequent Event	70
	Report of Independent Registered Public Accounting Firm	71
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	72
	Introduction	72
	Executive Summary	74
	Certain Factors Affecting Results of Operations	80
	Business Segments	81
	Other Matters	93
	Critical Accounting Policies	97
	Liquidity and Capital Resources	101
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	114
Item 4.	Controls and Procedures	127
	Financial Data Supplement (Unaudited)	128


		i


						Page


Part II—Other Information
Item 1.	Legal Proceedings	129
Item 1A.	Risk Factors	131
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	132
Item 4.	Submission of Matters to a Vote of Security Holders	132
Item 6.	Exhibits	132


		ii

AVAILABLE INFORMATION

Morgan Stanley files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). You may read and copy any document we file with the SEC at the SEC’s public reference room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including Morgan Stanley) file electronically with the SEC. Morgan Stanley’s electronic SEC filings are available to the public at the SEC’s internet site, www.sec.gov.

Morgan Stanley’s internet site is www.morganstanley.com. You can access Morgan Stanley’s Investor Relations webpage at www.morganstanley.com/about/ir. Morgan Stanley makes available free of charge, on or through its Investor Relations webpage, its proxy statements, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Morgan Stanley also makes available, through its Investor Relations webpage, via a link to the SEC’s internet site, statements of beneficial ownership of Morgan Stanley’s equity securities filed by its directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

Morgan Stanley has a Corporate Governance webpage. You can access information about Morgan Stanley’s corporate governance at www.morganstanley.com/about/company/governance. Morgan Stanley posts the following on its Corporate Governance webpage:

•

Amended and Restated Certificate of Incorporation;

•

Amended and Restated Bylaws;

•

Charters for our Audit Committee; Internal Audit Subcommittee; Compensation, Management Development and Succession Committee; and Nominating and Governance Committee;

•

Corporate Governance Policies;

•

Policy Regarding Communication with the Board of Directors;

•

Policy Regarding Director Candidates Recommended by Shareholders;

•

Policy Regarding Corporate Political Contributions;

•

Policy Regarding Shareholder Rights Plan;

•

Code of Ethics and Business Conduct;

•

Code of Conduct; and

•

Integrity Hotline.

Morgan Stanley’s Code of Ethics and Business Conduct applies to all directors, officers and employees, including its Chief Executive Officer, its Chief Financial Officer and its Controller and Principal Accounting Officer. Morgan Stanley will post any amendments to the Code of Ethics and Business Conduct and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange, Inc. on its internet site. You can request a copy of these documents, excluding exhibits, at no cost, by contacting Investor Relations, 1585 Broadway, New York, NY 10036 (212-761-4000). The information on Morgan Stanley’s internet site is not incorporated by reference into this report.


		iii

Part I—Financial Information.

Item 1.

Financial Statements.

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in millions, except share data)

(unaudited)


	March 31, 2009		December 31, 2008		November 30, 2008
Assets
Cash and due from banks	$	8,019	$	13,354	$	11,276
Interest bearing deposits with banks		40,522		65,316		67,378
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		23,094		24,039		25,446
Financial instruments owned, at fair value (approximately $70 billion, $73 billion and $62 billion were pledged to various parties at March 31, 2009, December 31, 2008 and November 30, 2008, respectively):
U.S. government and agency securities		26,997		28,012		20,251
Other sovereign government obligations		23,899		21,084		20,071
Corporate and other debt		82,687		87,294		88,484
Corporate equities		34,260		42,321		37,174
Derivative and other contracts		79,149		89,418		99,766
Investments		9,482		10,385		10,598
Physical commodities		2,484		2,126		2,204

Total financial instruments owned, at fair value		258,958		280,640		278,548
Securities received as collateral, at fair value		7,088		5,231		5,217
Federal funds sold and securities purchased under agreements to resell		120,540		122,709		106,419
Securities borrowed		92,589		88,052		85,785
Receivables:
Customers		25,894		29,265		31,294
Brokers, dealers and clearing organizations		6,545		6,250		7,259
Other loans		6,698		6,547		6,528
Fees, interest and other		6,635		7,258		7,034
Other investments		3,816		3,709		3,309
Premises, equipment and software costs (net of accumulated depreciation of $3,206, $3,073 and $3,003 at March 31, 2009, December 31, 2008 and November 30, 2008, respectively)		6,018		5,095		5,057
Goodwill		2,226		2,256		2,243
Intangible assets (net of accumulated amortization of $228, $208 and $200 at March 31, 2009, December 31, 2008 and November 30, 2008, respectively) (includes $159, $184 and $220 at fair value at March 31, 2009, December 31, 2008 and November 30, 2008, respectively)		849		906		947
Other assets		16,532		16,137		15,295

Total assets	$	626,023	$	676,764	$	659,035

See Notes to Condensed Consolidated Financial Statements.


		1

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—(Continued)

(dollars in millions, except share data)

(unaudited)


	March 31, 2009			December 31, 2008			November 30, 2008
Liabilities and Shareholders’ Equity
Commercial paper and other short-term borrowings (includes $1,074, $1,246 and $1,412 at fair value at March 31, 2009, December 31, 2008 and November 30, 2008, respectively)	$	3,411		$	10,102		$	10,483
Deposits (includes $10,677, $9,993 and $6,008 at fair value at March 31, 2009, December 31, 2008 and November 30, 2008, respectively)		59,922			51,355			42,755
Financial instruments sold, not yet purchased, at fair value:
U.S. government and agency securities		7,854			11,902			10,156
Other sovereign government obligations		10,866			9,511			9,360
Corporate and other debt		8,832			9,927			9,361
Corporate equities		18,445			16,840			16,547
Derivative and other contracts		54,088			68,554			73,521
Physical commodities		—			33			—

Total financial instruments sold, not yet purchased, at fair value		100,085			116,767			118,945
Obligation to return securities received as collateral, at fair value		7,088			5,231			5,217
Securities sold under agreements to repurchase		69,641			92,213			102,401
Securities loaned		19,106			14,580			14,821
Other secured financings, at fair value		10,515			12,539			12,527
Payables:
Customers		108,213			123,617			115,225
Brokers, dealers and clearing organizations		1,719			1,585			3,141
Interest and dividends		3,022			3,305			2,584
Other liabilities and accrued expenses		11,986			16,179			15,963
Long-term borrowings (includes $31,258, $30,766 and $28,830 at fair value at March 31, 2009, December 31, 2008 and November 30, 2008, respectively)		182,108			179,835			163,437

		576,816			627,308			607,499

Commitments and contingencies
Equity
Morgan Stanley shareholders’ equity:
Preferred stock		19,208			19,168			19,155
Common stock, $0.01 par value;
Shares authorized: 3,500,000,000 at March 31, 2009, December 31, 2008 and November 30, 2008;
Shares issued: 1,211,701,552 at March 31, 2009, December 31, 2008 and November 30, 2008;
Shares outstanding: 1,081,607,788 at March 31, 2009, 1,074,497,565 at December 31, 2008 and 1,047,598,394 at November 30, 2008		12			12			12
Paid-in capital		429			459			1,619
Retained earnings		35,577			36,154			38,096
Employee stock trust		4,167			4,312			3,901
Accumulated other comprehensive loss		(471	)		(420	)		(125	)
Common stock held in treasury, at cost, $0.01 par value; 130,093,764 shares at March 31, 2009, 137,203,987 shares at December 31, 2008 and 164,103,158 shares at November 30, 2008		(6,233	)		(6,620	)		(7,926	)
Common stock issued to employee trust		(4,167	)		(4,312	)		(3,901	)

Total Morgan Stanley shareholders’ equity		48,522			48,753			50,831
Non-controlling interests		685			703			705

Total equity		49,207			49,456			51,536

Total liabilities and equity	$	626,023		$	676,764		$	659,035

See Notes to Condensed Consolidated Financial Statements.


		2

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(dollars in millions, except share and per share data)

(unaudited)


	Three Months Ended March 31,						One Month Ended December 31,
	2009			2008			2008
Revenues:
Investment banking	$	886		$	971		$	198
Principal transactions:
Trading		1,091			2,793			(1,714	)
Investments		(1,272	)		(516	)		(205	)
Commissions		772			1,265			215
Asset management, distribution and administration fees		984			1,473			335
Other		432			1,015			238

Total non-interest revenues		2,893			7,001			(933	)

Interest and dividends		2,524			12,712			1,145
Interest expense		2,375			11,796			1,017

Net interest		149			916			128

Net revenues		3,042			7,917			(805	)

Non-interest expenses:
Compensation and benefits		2,082			3,843			615
Occupancy and equipment		342			292			125
Brokerage, clearing and exchange fees		269			470			101
Information processing and communications		296			311			99
Marketing and business development		118			197			37
Professional services		326			369			117
Other		494			397			110

Total non-interest expenses		3,927			5,879			1,204

Income (loss) before income taxes		(885	)		2,038			(2,009	)
(Benefit from) provision for income taxes		(695	)		606			(724	)

Net income (loss)	$	(190	)	$	1,432		$	(1,285	)
Net income (loss) applicable to non-controlling interests	$	(13	)	$	19		$	3

Net income (loss) applicable to Morgan Stanley	$	(177	)	$	1,413		$	(1,288	)

Earnings (losses) applicable to Morgan Stanley common shareholders	$	(578	)	$	1,311		$	(1,624	)

Earnings (losses) per basic common share	$	(0.57	)	$	1.27		$	(1.62	)

Earnings (losses) per diluted common share	$	(0.57	)	$	1.26		$	(1.62	)

Average common shares outstanding:
Basic		1,011,741,210			1,034,342,428			1,002,058,928

Diluted		1,011,741,210			1,039,026,879			1,002,058,928

See Notes to Condensed Consolidated Financial Statements.


		3

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in millions)


	Three Months Ended March 31,						One Month Ended December 31,
	2009			2008			2008
	(unaudited)						(unaudited)
Net income (loss)	$	(190	)	$	1,432		$	(1,285	)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments(1)		(59	)		42			(96	)
Net change in cash flow hedges(2)		3			3			2
Net gain (loss) related to pension and other postretirement adjustments(3)		—			—			(200	)
Amortization of net loss related to pension and postretirement benefits(4)		7			5			—
Amortization of prior service credit related to pension and postretirement benefits(5)		(2	)		(1	)		(1	)

Comprehensive income (loss)	$	(241	)	$	1,481		$	(1,580	)
Comprehensive income (loss) applicable to non-controlling interests	$	(13	)	$	19		$	3

Comprehensive income (loss) applicable to Morgan Stanley	$	(228	)	$	1,462		$	(1,583	)

(1)	Amounts are net of provision for (benefit from) income taxes of $31 million and $(161) million for the quarters ended March 31, 2009 and March 31, 2008, respectively, and $(52) million for the one month period ended December 31, 2008.

(2)	Amounts are net of provision for (benefit from) income taxes of $2 million for the quarters ended March 31, 2009 and March 31, 2008, respectively, and $1 million for the one month period ended December 31, 2008.

(3)	Amounts are net of provision for (benefit from) income taxes of $(132) million for the one month period ended December 31, 2008.

(4)	Amounts are net of provision for (benefit from) income taxes of $4 million and $3 million for the quarters ended March 31, 2009 and March 31, 2008, respectively.

(5)	Amounts are net of provision for (benefit from) income taxes of $(1) million for the quarters ended March 31, 2009 and March 31, 2008.

See Notes to Condensed Consolidated Financial Statements.


		4

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)


	Three Months Ended March 31,						One Month Ended December 31, 2008
	2009			2008			One Month Ended December 31, 2008
	(unaudited)						(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	(190	)	$	1,432		$	(1,285	)
Adjustments to reconcile net income (loss) to net cash (used for) provided by operating activities:
Compensation payable in common stock and options		204			657			79
Depreciation and amortization		155			81			104
Loss (gain) on business dispositions		19			(698	)		—
Impairment charges		278			—			—
Changes in assets and liabilities:
Cash deposited with clearing organizations or segregated under federal and other regulations or requirements		945			(1,552	)		1,407
Financial instruments owned, net of financial instruments sold, not yet purchased		1,711			6,499			2,412
Securities borrowed		(4,537	)		(19,204	)		(2,267	)
Securities loaned		4,526			(34,993	)		(241	)
Receivables and other assets		2,771			6,902			1,479
Payables and other liabilities		(18,000	)		55,257			10,625
Federal funds sold and securities purchased under agreements to resell		2,169			(31,442	)		(16,290	)
Securities sold under agreements to repurchase		(22,572	)		16,978			(10,188	)

Net cash (used for) provided by operating activities		(32,521	)		(83	)		(14,165	)

CASH FLOWS FROM INVESTING ACTIVITIES
Net (payments for) proceeds from:
Premises, equipment and software costs		(1,127	)		(520	)		(107	)
Business acquisition, net of cash acquired		—			(8	)		—
Business dispositions		(8	)		752			—

Net cash (used for) provided by investing activities		(1,135	)		224			(107	)


CASH FLOWS FROM FINANCING ACTIVITIES
Net (payments for) proceeds from:
Short-term borrowings		(6,691	)		(4,353	)		(381	)
Derivatives financing activities		(53	)		(1,448	)		(3,354	)
Other secured financings		(2,024	)		15,115			12
Deposits		8,567			4,001			8,600
Excess tax benefits associated with stock-based awards		10			39			—
Net proceeds from:
Issuance of common stock		19			207			4
Issuance of long-term borrowings		19,433			8,859			13,590
Payments for:
Repayments of long-term borrowings		(14,414	)		(13,260	)		(5,694	)
Repurchases of common stock for employee tax withholding		(14	)		(55	)		(3	)
Cash dividends		(645	)		(314	)		—

Net cash provided by financing activities		4,188			8,791			12,774

Effect of exchange rate changes on cash and cash equivalents		(661	)		685			1,514

Net (decrease) increase in cash and cash equivalents		(30,129	)		9,617			16
Cash and cash equivalents, at beginning of period		78,670			24,659			78,654

Cash and cash equivalents, at end of period	$	48,541		$	34,276		$	78,670

Cash and cash equivalents include:
Cash and due from banks	$	8,019		$	11,077		$	13,354
Interest bearing deposits with banks		40,522			23,199			65,316

Cash and cash equivalents, at end of period	$	48,541		$	34,276		$	78,670

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash payments for interest were $2,360 million and $11,594 million for the quarters ended March 31, 2009 and March 31, 2008, respectively, and $867 million for the one month period ended December 31, 2008.

Cash payments for income taxes were $97 million and $157 million for the quarters ended March 31, 2009 and March 31, 2008, respectively, and $113 million for the one month period ended December 31, 2008.

See Notes to Condensed Consolidated Financial Statements.


		5

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY

For the One Month Ended December 31, 2008 and the Three Months Ended March 31, 2009

(dollars in millions)

(unaudited)


	Preferred Stock		Common Stock		Paid-in Capital			Retained Earnings			Employee Stock Trust			Accumulated Other Comprehensive Income (Loss)			Common Stock Held in Treasury at Cost			Common Stock Issued to Employee Trust			Non- controlling Interest			Total Equity

BALANCE AT NOVEMBER 30, 2008	$	19,155	$	12	$	1,619		$	38,096		$	3,901		$	(125	)	$	(7,926	)	$	(3,901	)	$	705		$	51,536
Net income (loss)		—		—		—			(1,288	)		—			—			—			—			3			(1,285	)
Dividends		—		—		—			(641	)		—			—			—			—			(5	)		(646	)
Issuance of common stock		—		—		(1,305	)		—			—			—			1,309			—			—			4
Repurchases of common stock		—		—		—			—			—			—			(3	)		—			—			(3	)
Preferred stock accretion		13		—		—			(13	)		—			—			—			—			—			—
Compensation payable in common stock and options		—		—		150			—			411			—			—			(411	)		—			150
Net excess tax benefits (shortfall) associated with stock-based awards		—		—		(4	)		—			—			—			—			—			—			(4	)
Employee tax withholdings and other		—		—		(1	)		—			—			—			—			—			—			(1	)
Net change in cash flow hedges		—		—		—			—			—			2			—			—			—			2
Pension and other postretirement adjustments		—		—		—			—			—			(201	)		—			—			—			(201	)
Foreign currency translation adjustments		—		—		—			—			—			(96	)		—			—			—			(96	)


BALANCE AT DECEMBER 31, 2008	$	19,168	$	12	$	459		$	36,154		$	4,312		$	(420	)	$	(6,620	)	$	(4,312	)	$	703		$	49,456
Net income (loss)		—		—		—			(177	)		—			—			—			—			(13	)		(190	)
Dividends		—		—		—			(360	)		—			—			—			—			(5	)		(365	)
Issuance of common stock		—		—		(103	)		—			—			—			122			—			—			19
Repurchases of common stock		—		—		—			—			—			—			(14	)		—			—			(14	)
Preferred stock accretion		40		—					(40	)		—			—			—			—			—			—
Compensation payable in common stock and options		—		—		92			—			(145	)		—			279			145			—			371
Net excess tax benefits (shortfall) associated with stock-based awards		—		—		(19	)		—			—			—			—			—			—			(19	)
Net change in cash flow hedges		—		—		—			—			—			3			—			—			—			3
SFAS No. 158 pension adjustment		—		—		—			—			—			5			—			—			—			5
Foreign currency translation adjustments		—		—		—			—			—			(59	)		—			—			—			(59	)


BALANCE AT MARCH 31, 2009	$	19,208	$	12	$	429		$	35,577		$	4,167		$	(471	)	$	(6,233	)	$	(4,167	)	$	685		$	49,207

See Notes to Condensed Consolidated Financial Statements.


		6

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN TOTAL EQUITY

For the Three Months Ended March 31, 2008

(dollars in millions)

(unaudited)


	Preferred Stock		Common Stock		Other Morgan Stanley Common Equity			Non- controlling Interest			Total Equity
BALANCE AT DECEMBER 31, 2007	$	1,100	$	12	$	30,665		$	1,571		$	33,348
Net income		—		—		1,413			19			1,432
Dividends		—		—		(314	)		(7	)		(321	)
Issuance of common stock		—		—		207			—			207
Repurchases of common stock		—		—		(55	)		—			(55	)
Compensation payable in common stock and options		—		—		925			—			925
Net excess tax benefits associated with stock-based awards		—		—		36			—			36
Employee tax withholdings and other		—		—		3			—			3
Net change in cash flow hedges		—		—		3			—			3
SFAS No. 158 pension adjustment		—		—		(15	)		—			(15	)
FIN 48 tax adjustment		—		—		(45	)		—			(45	)
Foreign currency translation adjustments		—		—		42			—			42

BALANCE AT MARCH 31, 2008	$	1,100	$	12	$	32,865		$	1,583		$	35,560

See Notes to Condensed Consolidated Financial Statements.


		7

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.	Basis of Presentation and Summary of Significant Accounting Policies.

The Company. Morgan Stanley (or the “Company”) is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Global Wealth Management Group and Asset Management.

A summary of the activities of each of the Company’s business segments is as follows:

Institutional Securities includes capital raising; financial advisory services, including advice on mergers and acquisitions, restructurings, real estate and project finance; corporate lending; sales, trading, financing and market-making activities in equity and fixed income securities and related products, including foreign exchange and commodities; benchmark indices and risk management analytics; and investment activities.

Global Wealth Management Group provides brokerage and investment advisory services covering various investment alternatives; financial and wealth planning services; annuity and other insurance products; credit and other lending products; cash management services; retirement services; and trust and fiduciary services.

Asset Management provides global asset management products and services in equity, fixed income, alternative investments, which includes hedge funds and funds of funds, and merchant banking, which includes real estate, private equity and infrastructure, to institutional and retail clients through proprietary and third-party distribution channels. Asset Management also engages in investment activities.

Change in Fiscal Year End.

On December 16, 2008, the Board of Directors of the Company approved a change in the Company’s fiscal year end from November 30 to December 31 of each year. This change to the calendar year reporting cycle began January 1, 2009. As a result of the change, the Company had a one month transition period in December 2008. The unaudited results for the one month period ended December 31, 2008 are included in this report. The Company has also included selected unaudited results for the one month period ended December 31, 2007 for comparative purposes in Note 18. The audited results for the one month period ended December 31, 2008 will be included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

In addition, the results for the quarter ended March 31, 2009 are compared with the results of the quarter ended March 31, 2008, which have been recast on a calendar basis due to the change in the Company’s fiscal year end from November 30 to December 31.

Basis of Financial Information. The condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which require the Company to make estimates and assumptions regarding the valuations of certain financial instruments, the valuation of goodwill, the outcome of litigation and tax matters, incentive-based accruals and other matters that affect the condensed consolidated financial statements and related disclosures. The Company believes that the estimates utilized in the preparation of the condensed consolidated financial statements are prudent and reasonable. Actual results could differ materially from these estimates.

Certain reclassifications have been made to prior-period amounts to conform to the current period’s presentation. All material intercompany balances and transactions have been eliminated.

The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended November 30, 2008 (the “Form 10-K”). The condensed consolidated financial statements reflect all


		8

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

adjustments that are, in the opinion of management, necessary for the fair statement of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.

Consolidation. The condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and other entities in which the Company has a controlling financial interest including certain variable interest entities (“VIEs”). The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”) on January 1, 2009. Accordingly, for consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to as non-controlling interests. The portion of net income attributable to non-controlling interests for such subsidiaries is presented as Net income (loss) applicable to non-controlling interests on the condensed consolidated statements of income, and the portion of the shareholders’ equity of such subsidiaries is presented as Non-controlling interests on the condensed consolidated statements of financial condition.

For entities where (1) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (2) the equity holders bear the economic residual risks of the entity and have the right to make decisions about the entity’s activities, the Company consolidates those entities it controls through a majority voting interest or otherwise. For entities that do not meet these criteria, commonly known as VIEs, the Company consolidates those entities where the Company is deemed to be the primary beneficiary when it absorbs a majority of the expected losses or a majority of the expected residual returns, or both, of such entities.

Notwithstanding the above, certain securitization vehicles, commonly known as qualifying special purpose entities (“QSPEs”), are not consolidated by the Company if they meet certain criteria regarding the types of assets and derivatives they may hold, the types of sales they may engage in and the range of discretion they may exercise in connection with the assets they hold (see Note 4).

For investments in entities in which the Company does not have a controlling financial interest but has significant influence over operating and financial decisions, the Company generally applies the equity method of accounting with net gains and losses recorded within Other revenues. Where the Company has elected to measure certain eligible investments at fair value in accordance with SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”) net gains and losses are recorded within Principal transactions—investments (see Note 2).

Equity and partnership interests held by entities qualifying for accounting purposes as investment companies are carried at fair value.

The Company’s U.S. and international subsidiaries include Morgan Stanley & Co. Incorporated (“MS&Co.”), Morgan Stanley & Co. International plc (“MSIP”), Morgan Stanley Japan Securities Co., Ltd. (“MSJS”) and Morgan Stanley Investment Advisors Inc.

Income Statement Presentation. The Company, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. In connection with the delivery of the various products and services to clients, the Company manages its revenues and related expenses in the aggregate. As such, when assessing the performance of its businesses, the Company considers its principal trading, investment banking, commissions, and interest and dividend income, along with the associated interest expense, as one integrated activity for each of the Company’s separate businesses.

Revenue Recognition.

Investment Banking. Underwriting revenues and advisory fees from mergers, acquisitions and restructuring transactions are recorded when services for the transactions are determined to be completed, generally as set


		9

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

forth under the terms of the engagement. Transaction-related expenses, primarily consisting of legal, travel and other costs directly associated with the transaction, are deferred and recognized in the same period as the related investment banking transaction revenue. Underwriting revenues are presented net of related expenses. Non-reimbursed expenses associated with advisory transactions are recorded within Non-interest expenses.

Commissions. The Company generates commissions from executing and clearing customer transactions on stock, options and futures markets. Commission revenues are recognized in the accounts on trade date.

Asset Management, Distribution and Administration Fees. Asset management, distribution and administration fees are recognized over the relevant contract period. Sales commissions paid by the Company in connection with the sale of certain classes of shares of its open-end mutual fund products are accounted for as deferred commission assets. The Company periodically tests the deferred commission assets for recoverability based on cash flows expected to be received in future periods. In certain management fee arrangements, the Company is entitled to receive performance-based fees (also referred to as incentive fees) when the return on assets under management exceeds certain benchmark returns or other performance targets. In such arrangements, performance fee revenue is accrued (or reversed) quarterly based on measuring account/fund performance to date versus the performance benchmark stated in the investment management agreement. Performance-based fees are recorded within Principal transactions—investment revenues or Asset management, distribution and administration fees depending on the nature of the arrangement.

Financial Instruments and Fair Value.

A significant portion of the Company’s financial instruments is carried at fair value with changes in fair value recognized in earnings each period. A description of the Company’s policies regarding fair value measurement and its application to these financial instruments follows.

Financial Instruments Measured at Fair Value. All of the instruments within Financial instruments owned and Financial instruments sold, not yet purchased, are measured at fair value, either through the fair value option election (discussed below) or as required by other accounting pronouncements. These financial instruments primarily represent the Company’s trading and investment activities and include both cash and derivative products. In addition, Securities received as collateral and Obligation to return securities received as collateral are measured at fair value as required by other accounting pronouncements. Additionally, certain Commercial paper and other short-term borrowings (primarily structured notes), certain Deposits, Other secured financings and certain Long-term borrowings (primarily structured notes and certain junior subordinated debentures) are measured at fair value through the fair value option election.

Gains and losses on all of these financial instruments carried at fair value are reflected in Principal transactions—trading revenues, Principal transactions—investment revenues or Investment banking revenues in the condensed consolidated statements of income, except for derivatives accounted for as hedges (see “Hedge Accounting” section herein and Note 7). Interest income and expense and dividend income are recorded within the condensed consolidated statements of income depending on the nature of the instrument and related market conventions. When interest and dividends are included as a component of the instruments’ fair value, interest and dividends are included within Principal transactions—trading revenues or Principal transactions—investment revenues. Otherwise, they are included within Interest and dividend income or Interest expense. The fair value of over-the-counter (“OTC”) financial instruments, including derivative contracts related to financial instruments and commodities, is presented in the accompanying condensed consolidated statements of financial condition on a net-by-counterparty basis, when appropriate. Additionally, the Company nets fair value of cash collateral paid or received against fair value amounts recognized for net derivative positions executed with the same counterparty under the same master netting arrangement.


		10

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Fair Value Option. SFAS No. 159 permits the irrevocable fair value option election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The Company applies the fair value option for eligible instruments, including certain loans and lending commitments, certain equity method investments, certain structured notes, certain junior subordinated debentures, certain time deposits and certain other secured financings.

Fair Value Measurement—Definition and Hierarchy. Under the provisions of SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), effective December 1, 2006, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

In determining fair value, the Company uses various valuation approaches. SFAS No. 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the observability of inputs as follows:

•

Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

•

Level 2—Valuations based on one or more quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

•

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

The availability of observable inputs can vary from product to product and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, the liquidity of markets and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3.

The Company uses prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or Level 2 to Level 3 (see Note 2). In addition, a continued downturn in market conditions could lead to further declines in the valuation of many instruments.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined based on the lowest level input that is significant to the fair value measurement in its entirety.


		11

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Valuation Techniques. Many cash and OTC contracts have bid and ask prices that can be observed in the marketplace. Bid prices reflect the highest price that a party is willing to pay for an asset. Ask prices represent the lowest price that a party is willing to accept for an asset. For financial instruments whose inputs are based on bid-ask prices, the Company does not require that the fair value estimate always be a predetermined point in the bid-ask range. The Company’s policy is to allow for mid-market pricing and adjusting to the point within the bid-ask range that meets the Company’s best estimate of fair value. For offsetting positions in the same financial instrument, the same price within the bid-ask spread is used to measure both the long and short positions.

Fair value for many cash and OTC contracts is derived using pricing models. Pricing models take into account the contract terms (including maturity) as well as multiple inputs, including, where applicable, commodity prices, equity prices, interest rate yield curves, credit curves, correlation, creditworthiness of the counterparty, option volatility and currency rates. Where appropriate, valuation adjustments are made to account for various factors such as liquidity risk (bid-ask adjustments), credit quality and model uncertainty. Credit valuation adjustments are applied to both cash instruments and OTC derivatives. For cash instruments, the impact of changes in the Company’s own credit spreads is considered when measuring the fair value of liabilities and the impact of changes in the counterparty’s credit spreads is considered when measuring the fair value of assets. For OTC derivatives, the impact of changes in both the Company’s and the counterparty’s credit standing is considered when measuring fair value. In determining the expected exposure, the Company considers collateral held and legally enforceable master netting agreements that mitigate the Company’s exposure to each counterparty. All valuation adjustments are subject to judgment, are applied on a consistent basis and are based upon observable inputs where available. The Company generally subjects all valuations and models to a review process initially and on a periodic basis thereafter.

Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that the Company believes market participants would use in pricing the asset or liability at the measurement date.

See Note 2 for a description of valuation techniques applied to the major categories of financial instruments measured at fair value.

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis. Certain of the Company’s assets are measured at fair value on a non-recurring basis. The Company incurs impairment charges for any write downs of these assets to fair value. A continued downturn in market conditions could result in impairment charges in future periods.

For assets and liabilities measured at fair value on a non-recurring basis, fair value is determined by using various valuation approaches. The same hierarchy as described above, which maximizes the use of observable inputs and minimizes the use of unobservable inputs, by generally requiring that the observable inputs be used when available, is used in measuring fair value for these items.

For further information on financial assets and liabilities that are measured at fair value on a recurring and non-recurring basis, see Note 2.

Hedge Accounting.

The Company applies hedge accounting under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) using various derivative financial instruments and non-U.S. dollar-denominated debt used to hedge interest rate and foreign exchange risk arising from assets and liabilities not held at fair value as part of asset liability management. These derivative financial instruments are included within Financial instruments owned—Derivative and other contracts or Financial instruments sold, not yet purchased—Derivative and other contracts in the condensed consolidated statements of financial condition.


		12

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The Company’s hedges are designated and qualify for accounting purposes as one of the following types of hedges: hedges of changes in fair value of assets and liabilities due to the risk being hedged (fair value hedges), hedges of the variability of future cash flows from floating rate assets and liabilities due to the risk being hedged (cash flow hedges) and hedges of net investments in foreign operations whose functional currency is different from the reporting currency of the parent company (net investment hedges).

For further information on derivative instruments and hedging activities, see Note 7.

Condensed Consolidated Statements of Cash Flows.

For purposes of the condensed consolidated statements of cash flows, cash and cash equivalents consist of Cash and due from banks and Interest bearing deposits with banks, which are highly liquid investments with original maturities of three months or less and readily convertible to known amounts of cash. The Company’s significant non-cash activities include assumed liabilities, in connection with business acquisitions, of $22 million in the quarter ended March 31, 2008.

Securitization Activities.

The Company engages in securitization activities related to commercial and residential mortgage loans, corporate bonds and loans, U.S. agency collateralized mortgage obligations and other types of financial assets (see Note 4). Generally, such transfers of financial assets are accounted for as sales when the Company has relinquished control over the transferred assets. The gain or loss on sale of such financial assets depends, in part, on the previous carrying amount of the assets involved in the transfer allocated between the assets sold and the retained interests based upon their respective fair values at the date of sale. Transfers that are not accounted for as sales are treated as secured financings (“failed sales”).

Earnings per Common Share.

Basic earnings per common share (“EPS”) is computed by dividing income available to Morgan Stanley common shareholders by the weighted average number of common shares outstanding for the period. Income available to Morgan Stanley common shareholders represents net income applicable to Morgan Stanley reduced by preferred stock dividends, amortization of discounts on preferred stock issued and allocations of earnings to participating securities. Common shares outstanding include common stock and vested restricted stock unit awards where recipients have satisfied either the explicit vesting terms or retirement-eligible requirements. Diluted EPS reflects the assumed conversion of all dilutive securities.

Effective October 13, 2008, as a result of the adjustment to Equity Units sold to a wholly owned subsidiary of China Investment Corporation Ltd. (“CIC”) (see Note 10), the Company calculates earnings per common share in accordance with the Emerging Issues Task Force (“EITF”) No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share” (“EITF 03-6”). EITF 03-6 addresses the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company along with common shareholders according to a predetermined formula. The two-class method requires the Company to present earnings per common share as if all of the earnings for the period are distributed to Morgan Stanley common shareholders and any participating securities, regardless of whether any actual dividends or distributions are made. The amount allocated to the participating securities is based upon the contractual terms of their respective contract and is reflected as a reduction to “Net income applicable to Morgan Stanley common shareholders” for


		13

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

both the Company’s basic and diluted earnings per share calculations (see Note 11). The two-class method does not impact the Company’s actual net income applicable to Morgan Stanley or other financial results. Unless contractually required by the terms of the participating securities, no losses are allocated to participating securities for purposes of the earnings per share calculation under the two-class method.

In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method as described in SFAS No. 128, “Earnings per Share.” Under the guidance in FSP EITF 03-6-1, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 became effective for the Company on January 1, 2009. All prior-period earnings per share data presented have been adjusted retrospectively. The adoption of FSP EITF 03-6-1 reduced basic earnings per share by $0.08 and $0.01 for the quarter ended March 31, 2008 and the one month period ended December 31, 2008, respectively, and reduced diluted earnings per share by $0.06 and $0.01 for the quarter ended March 31, 2008 and the one month period ended December 31, 2008, respectively.

Deferred Compensation Arrangements.

Deferred Compensation Plans. The Company also maintains various deferred compensation plans for the benefit of certain employees that provide a return to the participating employees based upon the performance of various referenced investments. The Company often invests directly, as a principal, in such referenced investments related to its obligations to perform under the deferred compensation plans. Changes in value of such investments made by the Company are recorded primarily in Principal transactions—Investments. Expenses associated with the related deferred compensation plans are recorded in Compensation and benefits.

Accounting Developments.

Dividends on Share-Based Payment Awards. In June 2007, the EITF reached consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards” (“EITF No. 06-11”). EITF No. 06-11 requires that the tax benefit related to dividend equivalents paid on restricted stock units that are expected to vest be recorded as an increase to additional paid-in capital. The Company adopted EITF No. 06-11 prospectively effective December 1, 2008. The Company previously accounted for this tax benefit as a reduction to its income tax provision. The adoption of EITF No. 06-11 did not have a material impact on the Company’s condensed consolidated financial statements.

Transfers of Financial Assets and Repurchase Financing Transactions. In February 2008, the FASB issued FSP FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP FAS No. 140-3”). The objective of FSP FAS No. 140-3 is to provide implementation guidance on accounting for a transfer of a financial asset and repurchase financing. Under the guidance in FSP FAS No. 140-3, there is a presumption that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (i.e., a linked transaction) for purposes of evaluation under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS No. 140”). If certain criteria are met, however, the initial transfer and repurchase financing shall not be evaluated as a linked transaction and shall be evaluated separately under SFAS No. 140. The adoption of FSP FAS 140-3 on December 1, 2008 did not have a material impact on the Company’s condensed consolidated financial statements.


		14

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Determination of the Useful Life of Intangible Assets. In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 removes the requirement of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”) for an entity to consider, when determining the useful life of an acquired intangible asset, whether the intangible asset can be renewed without substantial cost or material modifications to the existing terms and conditions associated with the intangible asset. FSP FAS 142-3 replaces the previous useful-life assessment criteria with a requirement that an entity shall consider its own experience in renewing similar arrangements. If the entity has no relevant experience, it would consider market participant assumptions regarding renewal. The adoption of FSP FAS 142-3 on January 1, 2009 did not have a material impact on the Company’s condensed consolidated financial statements.

Instruments Indexed to an Entity’s Own Stock. In June 2008, the FASB ratified the consensus reached by the EITF on Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF No. 07-5”). EITF No. 07-5 provides guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock. EITF No. 07-5 applies to any freestanding financial instrument or embedded feature that has all of the characteristics of a derivative or freestanding instrument that is potentially settled in an entity’s own stock (with the exception of share-based payment awards within the scope of SFAS 123(R)). To meet the definition of “indexed to own stock,” an instrument’s contingent exercise provisions must not be based on (a) an observable market, other than the market for the issuer’s stock (if applicable), or (b) an observable index, other than an index calculated or measured solely by reference to the issuer’s own operations, and the variables that could affect the settlement amount must be inputs to the fair value of a “fixed-for-fixed” forward or option on equity shares. The adoption of EITF No. 07-5 on January 1, 2009 did not change the classification or measurement of the Company’s financial instruments.

Transfers of Financial Assets and Extinguishments of Liabilities and Consolidation of Variable Interest Entities. In September 2008, the FASB issued for comment revisions to SFAS No. 140 and FASB Interpretation No. 46, as revised (“FIN 46R”), “Consolidation of Variable Interest Entities.” The changes proposed include a removal of the scope exemption from FIN 46R for QSPEs, a revision of the current risks and rewards-based FIN 46R consolidation model to a qualitative model based on control and a requirement that consolidation of VIEs be reevaluated on an ongoing basis. Although the revised standards have not yet been finalized, these changes may have a significant impact on the Company’s condensed consolidated financial statements as the Company may be required to consolidate QSPEs to which the Company has previously sold assets. In addition, the Company may also be required to consolidate other VIEs that are not currently consolidated based on an analysis under the current FIN 46R consolidation model. The proposed revisions, as currently drafted, would be effective for fiscal years that begin after November 15, 2009.

Disclosures about Postretirement Benefit Plan Assets. In December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (FSP FAS 132(R)-1). FSP FAS 132(R)-1 amends SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”, to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. The disclosures about plan assets required by this FSP shall be provided for fiscal years ending after December 15, 2009.

Guidance and Disclosures on Fair Value Measurements. In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”(“FSP FAS 157-4”) and FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1).”


		15

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

FSP FAS 157-4 provides additional application guidance in determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms what SFAS No. 157 states is the objective of fair value measurement—to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. The Company plans to adopt FSP FAS 157-4 in the second quarter of 2009 and does not expect such adoption to have a material impact on the Company’s condensed consolidated financial statements.

FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” and APB Opinion No. 28, “Interim Financial Reporting” by requiring an entity to provide qualitative and quantitative information on a quarterly basis about fair value estimates for any financial instruments not measured on the balance sheet at fair value. The Company plans to adopt the disclosure requirements of FSP FAS 107-1 and APB 28-1 in the second quarter of 2009.

2. Fair Value Disclosures.

Fair Value Measurements.

A description of the valuation techniques applied to the Company’s major categories of assets and liabilities measured at fair value on a recurring basis follows.

Financial Instruments Owned and Financial Instruments Sold, Not Yet Purchased

U.S. Government and Agency Securities

•

U.S. Government Securities. U.S. government securities are valued using quoted market prices. Valuation adjustments are not applied. Accordingly, U.S. government securities are categorized in Level 1 of the fair value hierarchy.

•

U.S. Agency Securities. U.S. agency securities are comprised of two main categories consisting of agency issued debt and mortgage pass-throughs. Non-callable agency issued debt securities are generally valued using quoted market prices. Callable agency issued debt securities are valued by benchmarking model-derived prices to quoted market prices and trade data for identical or comparable securities. Mortgage pass-throughs include To-be-announced (“TBA”) securities and mortgage pass-through pools. TBA securities are generally valued using quoted market prices or are benchmarked thereto. Fair value of mortgage pass-through pools are model driven with respect to spreads of the comparable TBA security. Actively traded non-callable agency issued debt securities and TBA securities are categorized in Level 1 of the fair value hierarchy. Callable agency issued debt securities and mortgage pass-through certificates are generally categorized in Level 2 of the fair value hierarchy.

Other Sovereign Government Obligations

•

Foreign sovereign government obligations are valued using quoted prices in active markets when available. To the extent quoted prices are not available, fair value is determined based on a valuation model that has as inputs interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the bond in terms of issuer, maturity and seniority. These bonds are generally categorized in Levels 1 or 2 of the fair value hierarchy.


		16

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Corporate and Other Debt

•

Corporate Bonds. The fair value of corporate bonds is estimated using recently executed transactions, market price quotations (where observable), bond spreads or credit default swap spreads adjusted for any basis difference between cash and derivative instruments. The spread data used are for the same maturity as the bond. If the spread data does not reference the issuer, then data that reference a comparable issuer are used. When observable price quotations are not available, fair value is determined based on cash flow models with yield curves, bond or single name credit default swap spreads and recovery rates based on collateral values as significant inputs. Corporate bonds are generally categorized in Level 2 of the fair value hierarchy; in instances where prices, spreads or any of the other aforementioned key inputs are unobservable, they are categorized in Level 3 of the hierarchy.

•

Corporate Loans and Lending Commitments. The fair value of corporate loans is estimated using recently executed transactions, market price quotations (where observable) and market observable loan credit default swap spread levels adjusted for any basis difference between cash and derivative instruments, along with proprietary valuation models and default recovery analysis where such transactions and quotations are unobservable. The fair value of contingent corporate lending commitments is estimated by using executed transactions on comparable loans and the anticipated market price based on pricing indications from syndicate banks and customers. The valuation of these commitments also takes into account certain fee income. Corporate loans and lending commitments are generally categorized in Level 2 of the fair value hierarchy; in instances where prices or significant spread inputs are unobservable, they are categorized in Level 3 of the hierarchy.

•

Municipal Bonds. The fair value of municipal bonds is estimated using recently executed transactions, market price quotations and pricing models that factor in, where applicable, interest rates, bond or credit default swap spreads and volatility. These bonds are generally categorized in Level 2 of the fair value hierarchy.

•

Mortgage Loans. Mortgage loans are valued using prices based on trade data for identical or comparable instruments. Where observable prices are not available, the Company estimates fair value based on benchmarking to prices and rates observed in the primary market for similar loan or borrower types, or based on the present value of expected future cash flows using its best estimates of the key assumptions, including forecasted credit losses, prepayment rates, forward yield curves and discount rates commensurate with the risks involved. Due to the subjectivity involved in comparability assessment related to mortgage loan vintage, geographical concentration, prepayment speed and projected loss assumptions, the majority of loans are classified in Level 3 of the fair value hierarchy.

•

Commercial Mortgage-Backed Securities (“CMBS”), Residential Mortgage-Backed Securities (“RMBS”), and other Asset-Backed Securities (“ABS”). CMBS, RMBS and other ABS may be valued based on external price or spread data. When position-specific external price data are not observable, the valuation is based on prices of comparable bonds. Valuation levels of CMBS and RMBS indices are used as an additional data point for benchmarking purposes or to price outright index positions. CMBS, RMBS and other ABS are categorized in Level 3 if external prices or spread inputs are unobservable or if the comparability assessment involves significant subjectivity related to property type differences, cash flows, performance and other inputs; otherwise, they are categorized in Level 2 of the fair value hierarchy.

•

Auction Rate Securities (“ARS”). The Company primarily holds investments in Student Loan Auction Rate Securities (“SLARS”) and Municipal Auction Rate Securities (“MARS”) with interest rates that are reset through periodic auctions. SLARS are ABS backed by pools of student loans. MARS are municipal bonds often wrapped by municipal bond insurance. ARS were historically traded and valued as floating


		17

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

rate notes, priced at par due to the auction mechanism. Beginning in fiscal 2008, uncertainties in the credit markets have resulted in auctions failing for certain types of ARS. Once the auctions failed, ARS could no longer be valued using observations of auction market prices. Accordingly, the fair value of ARS is determined using independent external market data where available and an internally developed methodology to discount for the lack of liquidity and non-performance risk in the current market environment.

The key drivers that impact the valuation of SLARS are the underlying collateral types, amount of leverage in each structure, credit rating and liquidity considerations. The key drivers that impact the valuation of MARS are independent external market data, the maximum rate, quality of underlying issuers/insurers and evidence of issuer calls. MARS are generally categorized in Level 2 as the valuation technique relies on observable external data. SLARS are generally categorized in Level 3 of the fair value hierarchy.

•

Retained Interests in Securitization Transactions. Fair value for retained interests in securitized financial assets (in the form of one or more tranches of the securitization) is determined using observable prices or, in cases where observable prices are not available for certain retained interests, the Company estimates fair value based on the present value of expected future cash flows using its best estimates of the key assumptions, including forecasted credit losses, prepayment rates, forward yield curves and discount rates commensurate with the risks involved. When observable prices are available, retained interests are categorized in Level 2 of the fair value hierarchy. In the absence of observable prices, retained interests are categorized in Level 3 of the fair value hierarchy.

Corporate Equities

•

Exchange-Traded Equity Securities. Exchange-traded equity securities are generally valued based on quoted prices from the exchange. To the extent these securities are actively traded, valuation adjustments are not applied and they are categorized in Level 1 of the fair value hierarchy.

Derivative and Other Contracts

•

Listed Derivative Contracts. Listed derivatives that are actively traded are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy. Listed derivatives that are not actively traded are valued using the same approaches as those applied to OTC derivatives; they are generally categorized in Level 2 of the fair value hierarchy.

•

OTC Derivative Contracts. OTC derivative contracts include forward, swap and option contracts related to interest rates, foreign currencies, credit standing of reference entities, equity prices or commodity prices.

Depending on the product and the terms of the transaction, the fair value of OTC derivative products can be either observed or modeled using a series of techniques, and model inputs from comparable benchmarks, including closed-form analytic formula, such as the Black-Scholes option-pricing model, and simulation models or a combination thereof. Many pricing models do not entail material subjectivity because the methodologies employed do not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets, as is the case for generic interest rate swaps, certain option contracts and certain credit default swaps. In the case of more established derivative products, the pricing models used by the Company are widely accepted by the financial services industry. A substantial majority of OTC derivative products valued by the Company using pricing models fall into this category and are categorized within Level 2 of the fair value hierarchy.


		18

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Other derivative products include complex products that have become illiquid, require more judgment in the implementation of the valuation technique applied due to the complexity of the valuation assumptions and the reduced observability of inputs. This includes derivative interests in certain mortgage-related collateralized debt obligation (“CDO”) securities, basket credit default swaps, CDO-squared positions and certain types of ABS credit default swaps where direct trading activity or quotes are unobservable. These instruments involve significant unobservable inputs and are categorized in Level 3 of the fair value hierarchy.

Derivative interests in complex mortgage-related CDOs and credit default swaps, for which observability of external price data is extremely limited, are valued based on an evaluation of the market and model input parameters sourced from similar positions as indicated by primary and secondary market activity. Each position is evaluated independently taking into consideration the underlying collateral performance and pricing, behavior of the tranche under various cumulative loss and prepayment scenarios, deal structures (e.g., non-amortizing reference obligations, call features) and liquidity. While these factors may be supported by historical and actual external observations, the determination of their value as it relates to specific positions nevertheless requires significant judgment.

For basket credit default swaps and CDO-squared positions, the correlation input between reference credits is unobservable for each specific swap and is benchmarked to standardized proxy baskets for which correlation data are available. The other model inputs such as credit spread, interest rates and recovery rates are observable. In instances where the correlation input is deemed to be significant, these instruments are categorized in Level 3 of the fair value hierarchy.

The Company trades various derivative structures with commodity underlyings. Depending on the type of structure, the model inputs generally include interest rate yield curves, commodity underlier curves, implied volatility of the underlying commodities and, in some cases, the implied correlation between these inputs. The fair value of these products is estimated using executed trades and broker and consensus data to provide values for the aforementioned inputs. Where these inputs are unobservable, relationships to observable commodities and data points, based on historic and/or implied observations, are employed as a technique to estimate the model input values. Commodity derivatives are generally categorized in Level 2 of the fair value hierarchy; in instances where significant inputs are unobservable, they are categorized in Level 3 of the fair value hierarchy.

For further information on derivative instruments and hedging activities, see Note 7.

Investments

•

Investments in Private Equity and Real Estate. The Company’s investments in private equity and real estate take the form of direct private equity investments and investments in private equity and real estate funds. Initially, the transaction price is generally considered by the Company as the exit price and is the Company’s best estimate of fair value. Thereafter, valuation is based on an assessment of each underlying investment, considering rounds of financing and third-party transactions, expected cash flows and market-based information, including comparable company transactions, trading multiples and changes in market outlook, among other factors. These nonpublic investments are included in Level 3 of the fair value hierarchy because, due to infrequent trading, exit prices tend to be unobservable and reliance is placed on the above methods.

Physical Commodities

•

The Company trades various physical commodities, including crude oil and refined products, natural gas, base and precious metals and agricultural products. Fair value for physical commodities is determined using observable inputs, including broker quotations and published indices. Physical commodities are categorized in Level 2 of the fair value hierarchy.


		19

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Deposits

•

Time Deposits. The fair value of certificates of deposit is estimated using third-party quotations. These deposits are categorized in Level 2 of the fair value hierarchy.

Commercial Paper and Other Short-term Borrowings/Long-Term Borrowings

•

Structured Notes. The Company issues structured notes that have coupons or repayment terms linked to the performance of debt or equity securities, indices, currencies or commodities. Fair value of structured notes is estimated using valuation models for the derivative and debt portions of the notes. These models incorporate observable inputs referencing identical or comparable securities, including prices that the notes are linked to, interest rate yield curves, option volatility, and currency, commodity or equity rates. The impact of the Company’s own credit spreads is also included based on the Company’s observed secondary bond market spreads. Most structured notes are categorized in Level 2 of the fair value hierarchy.

The following fair value hierarchy tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2009, December 31, 2008 and November 30, 2008. See Note 1 for a discussion of the Company’s policies regarding this fair value hierarchy.


		20

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of March 31, 2009


	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Counterparty and Cash Collateral Netting			Balance at March 31, 2009
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	11,357	$	15,623	$	17	$	—		$	26,997
Other sovereign government obligations		19,733		4,164		2		—			23,899
Corporate and other debt(1)		78		51,121		31,488		—			82,687
Corporate equities		30,012		3,302		946		—			34,260
Derivative and other contracts(2)		2,995		147,166		25,966		(96,978	)		79,149
Investments		407		241		8,834		—			9,482
Physical commodities		—		2,484		—		—			2,484

Total financial instruments owned		64,582		224,101		67,253		(96,978	)		258,958
Securities received as collateral		6,651		434		3		—			7,088
Intangible assets(3)		—		—		159		—			159

Liabilities
Commercial paper and other short-term borrowings	$	—	$	1,074	$	—	$	—		$	1,074
Deposits		—		10,677		—		—			10,677
Financial instruments sold, not yet purchased:
U.S. government and agency securities		5,846		2,008		—		—			7,854
Other sovereign government obligations		10,421		445		—		—			10,866
Corporate and other debt		20		6,862		1,950		—			8,832
Corporate equities		17,898		473		74		—			18,445
Derivative and other contracts(2)		6,944		90,013		9,445		(52,314	)		54,088

Total financial instruments sold, not yet purchased		41,129		99,801		11,469		(52,314	)		100,085
Obligation to return securities received as collateral		6,651		434		3		—			7,088
Other secured financings(1)		17		6,234		4,264		—			10,515
Long-term borrowings		—		25,587		5,671		—			31,258

(1)

Approximately $6.5 billion of assets is included in Corporate and other debt and approximately $5.2 billion of related liabilities is included in Other secured financings related to consolidated VIEs or non-consolidated VIEs (in the cases where the assets were transferred by the Company to the VIE and the transfers were accounted for as secured financings). The Company cannot unilaterally remove the assets from the VIEs; these assets are not generally available to the Company. The related liabilities issued by these VIEs are non-recourse to the Company. Approximately $6.0 billion of these assets and approximately $3.7 billion of these liabilities are included in Level 3 of the fair value hierarchy. See Note 4 for additional information on consolidated and non-consolidated VIEs, including retained interests in these entities that the Company holds.

(2)

For positions with the same counterparty that cross over the levels of the fair value hierarchy, both counterparty netting and cash collateral netting are included in the column titled “Counterparty and Cash Collateral Netting.” For contracts with the same counterparty, counterparty netting among positions classified within the same level is included within that level. For further information on derivative instruments and hedging activities, see Note 7.

(3)	Amount represents mortgage servicing rights (“MSRs”) accounted for at fair value. See Note 4 for further information on MSRs.


		21

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of December 31, 2008


	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Counterparty and Cash Collateral Netting			Balance at December 31, 2008
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	10,150	$	17,735	$	127	$	—		$	28,012
Other sovereign government obligations		16,118		4,965		1		—			21,084
Corporate and other debt(1)		99		52,277		34,918		—			87,294
Corporate equities		37,807		3,538		976		—			42,321
Derivative and other contracts(2)		1,069		156,224		37,711		(105,586	)		89,418
Investments		417		270		9,698		—			10,385
Physical commodities		—		2,126		—		—			2,126

Total financial instruments owned		65,660		237,135		83,431		(105,586	)		280,640
Securities received as collateral		4,623		578		30		—			5,231
Intangible assets(3)		—		—		184		—			184

Liabilities
Commercial paper and other short-term borrowings	$	—	$	1,246	$	—	$	—		$	1,246
Deposits		—		9,993		—		—			9,993
Financial instruments sold, not yet purchased:
U.S. government and agency securities		11,133		769		—		—			11,902
Other sovereign government obligations		7,303		2,208		—		—			9,511
Corporate and other debt		17		6,102		3,808		—			9,927
Corporate equities		15,064		1,749		27		—			16,840
Derivative and other contracts(2)		3,886		118,432		14,329		(68,093	)		68,554
Physical commodities		—		33		—		—			33

Total financial instruments sold, not yet purchased		37,403		129,293		18,164		(68,093	)		116,767
Obligation to return securities received as collateral		4,623		578		30		—			5,231
Other secured financings(1)		—		6,391		6,148		—			12,539
Long-term borrowings		—		25,293		5,473		—			30,766

(1)

Approximately $8.9 billion of assets is included in Corporate and other debt and approximately $7.9 billion of related liabilities is included in Other secured financings related to consolidated VIEs or non-consolidated VIEs (in the cases where the assets were transferred by the Company to the VIE and the transfers were accounted for as secured financings). The Company cannot unilaterally remove the assets from the VIEs; these assets are not generally available to the Company. The related liabilities issued by these VIEs are non-recourse to the Company. Approximately $8.1 billion of these assets and approximately $5.9 billion of these liabilities are included in Level 3 of the fair value hierarchy. See Note 4 for additional information on consolidated and non-consolidated VIEs, including retained interests in these entities that the Company holds.

(2)

(3)	Amount represents mortgage servicing rights (“MSRs”) accounted for at fair value. See Note 4 for further information on MSRs.


		22

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of November 30, 2008


	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Counterparty and Cash Collateral Netting			Balance at November 30, 2008
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	5,930	$	14,115	$	206	$	—		$	20,251
Other sovereign government obligations		9,148		10,920		3		—			20,071
Corporate and other debt(1)		47		53,977		34,460		—			88,484
Corporate equities		32,519		3,748		907		—			37,174
Derivative and other contracts(2)		2,478		150,033		40,852		(93,597	)		99,766
Investments		536		330		9,732		—			10,598
Physical commodities		2		2,202		—		—			2,204

Total financial instruments owned		50,660		235,325		86,160		(93,597	)		278,548
Securities received as collateral		4,402		800		15		—			5,217
Intangible assets(3)		—		—		220		—			220

Liabilities
Commercial paper and other short-term borrowings	$	—	$	1,412	$	—	$	—		$	1,412
Deposits		—		6,008		—		—			6,008
Financial instruments sold, not yet purchased:
U.S. government and agency securities		9,474		682		—		—			10,156
Other sovereign government obligations		5,140		4,220		—		—			9,360
Corporate and other debt		18		5,400		3,943		—			9,361
Corporate equities		16,418		108		21		—			16,547
Derivative and other contracts(2)		5,509		115,621		13,228		(60,837	)		73,521

Total financial instruments sold, not yet purchased		36,559		126,031		17,192		(60,837	)		118,945
Obligation to return securities received as collateral		4,402		800		15		—			5,217
Other secured financings(1)		—		6,780		5,747		—			12,527
Long-term borrowings		—		23,413		5,417		—			28,830

(1)

Approximately $9.0 billion of assets is included in Corporate and other debt and approximately $7.2 billion of related liabilities is included in Other secured financings related to consolidated VIEs or non-consolidated VIEs (in the cases where the assets were transferred by the Company to the VIE and the transfers were accounted for as secured financings). The Company cannot unilaterally remove the assets from the VIEs; these assets are not generally available to the Company. The related liabilities issued by these VIEs are non-recourse to the Company. Approximately $7.7 billion of these assets and approximately $5.0 billion of these liabilities are included in Level 3 of the fair value hierarchy. See Note 4 for additional information on consolidated and non-consolidated VIEs, including retained interests in these entities that the Company holds.

(2)

(3)	Amount represents mortgage servicing rights (“MSRs”) accounted for at fair value. See Note 4 for further information on MSRs.


		23

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following tables present additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters ended March 31, 2009 and March 31, 2008 and the one month period ended December 31, 2008. Level 3 instruments may be offset with instruments classified in Level 1 and Level 2. As a result, the realized and unrealized gains or (losses) for assets and liabilities within the Level 3 category presented in the tables below do not reflect the related realized and unrealized gains or (losses) on hedging instruments that have been classified by the Company within the Level 1 and/or Level 2 categories. Additionally, both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains or (losses) during the period for assets and liabilities within the Level 3 category presented in the tables below may include changes in fair value during the period that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

The following tables reflect gains or (losses) for all assets and liabilities categorized as Level 3 for the quarters ended March 31, 2009 and March 31, 2008 and the one month period ended December 31, 2008, respectively. For assets and liabilities that were transferred into Level 3 during the period, gains or (losses) are presented as if the assets or liabilities had been transferred into Level 3 as of the beginning of the period; similarly, for assets and liabilities that were transferred out of Level 3 during the period, gains or (losses) are presented as if the assets or liabilities had been transferred out as of the beginning of the period.

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended March 31, 2009


	Beginning Balance at December 31, 2008		Total Realized and Unrealized Gains or (Losses)(1)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance at March 31, 2009		Unrealized Gains or (Losses) for Level 3 Assets/ Liabilities Outstanding at March 31, 2009(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	127	$	(1	)	$	(86	)	$	(23	)	$	17	$	—
Other sovereign government obligations		1		(1	)		(1	)		3			2		(2	)
Corporate and other debt		34,918		(3,314	)		226			(342	)		31,488		(3,501	)
Corporate equities		976		(95	)		(231	)		296			946		(95	)
Net derivative and other contracts(3)		23,382		2,363			250			(9,474	)		16,521		3,132
Investments		9,698		(1,319	)		510			(55	)		8,834		(1,269	)
Securities received as collateral		30		—			(27	)		—			3		—
Intangible assets		184		(25	)		—			—			159		(25	)

Liabilities
Financial instruments sold, not yet purchased:
Corporate and other debt	$	3,808	$	(20	)	$	647		$	(2,525	)	$	1,950	$	(47	)
Corporate equities		27		20			44			23			74		4
Obligation to return securities received as collateral		30		—			(27	)		—			3		—
Other secured financings		6,148		1,053			(542	)		(289	)		4,264		1,053
Long-term borrowings		5,473		(129	)		83			(14	)		5,671		(129	)

(1)	Total realized and unrealized gains or (losses) are primarily included in Principal transactions—trading in the condensed consolidated statements of income except for $(1,319) million related to Financial instruments owned—investments, which is included in Principal transactions—investments.


		24

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(2)	Amounts represent unrealized gains or (losses) for the quarter ended March 31, 2009 related to assets and liabilities still outstanding at March 31, 2009.

(3)	Net derivative and other contracts represent Financial instruments owned—derivative and other contracts net of Financial instruments sold, not yet purchased—derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 7.

Financial instruments owned—Corporate and other debt. The net losses in Corporate and other debt were primarily driven by certain corporate loans and lending commitments, certain asset-backed securities, including residential and commercial mortgage loans, and certain commercial whole loans.

During the quarter ended March 31, 2009, the Company reclassified approximately $2.3 billion of certain Corporate and other debt from Level 2 to Level 3. The reclassifications were primarily related to asset-backed securities and certain corporate loans. The reclassifications were due to a reduction in market price quotations for these or comparable instruments, or a lack of available broker quotes, such that unobservable inputs had to be utilized for the fair value measurement of these instruments. These unobservable inputs include, depending upon the position, assumptions to establish comparability to bonds, loans or swaps with observable price/spread levels, default recovery rates, forecasted credit losses and prepayment rates.

During the quarter ended March 31, 2009, the Company reclassified approximately $2.7 billion of certain Corporate and other debt from Level 3 to Level 2. These reclassifications primarily related to commercial mortgage-backed securities, subprime CDO and other subprime ABS securities. Their fair value was highly correlated with similar instruments in an observable market and, due to market deterioration, unobservable inputs were no longer deemed significant. In addition, certain corporate loans were reclassified as more liquidity re-entered the market and external prices and spread inputs for these instruments became observable.

Financial instruments owned—Net derivative and other contracts. The net gains in Net derivative and other contracts were primarily driven by widening of credit spreads on underlying reference entities of single name credit default swaps.

During the quarter ended March 31, 2009, the Company reclassified approximately $9.6 billion of certain Derivatives and other contracts from Level 3 to Level 2. These reclassifications of certain Derivatives and other contracts were related to single name mortgage-related credit default swaps and credit default swaps on certain classes of CDOs. The primary reason for the reclassifications is that, due to market deterioration, unobservable inputs, such as correlation, for these derivative contracts were no longer deemed significant to the fair value measurement. In addition, certain corporate tranche-indexed credit default swaps were reclassified due to increased availability of transaction data, broker quotes and/or consensus pricing.

For further information on derivative instruments and hedging activities, see Note 7.

Financial instruments owned—Investments. The net losses from investments were primarily related to investments associated with the Company’s real estate products and private equity portfolio.

Financial instruments sold, not yet purchased—Corporate and other debt. During the quarter, the Company reclassified approximately $2.5 billion of certain Corporate and other debt from Level 3 to Level 2. These reclassifications primarily related to contracts referencing commercial mortgage-backed securities, subprime CDO and other subprime ABS securities. Their fair value was highly correlated with similar instruments in an observable market and, due to market deterioration, unobservable inputs were no longer deemed significant to the fair value measurement.

Other secured financings. The net gains in Other secured financings were primarily due to net gains on liabilities resulting from securitizations recognized on balance sheet. These net gains are offset by net losses in Financial instruments owned—Corporate and other debt.


		25

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months Ended March 31, 2008


	Beginning Balance at December 31, 2007		Total Realized and Unrealized Gains or (Losses)(1)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance at March 31, 2008		Unrealized Gains or (Losses) for Level 3 Assets/ Liabilities Outstanding at March 31, 2008(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	622	$	63		$	(225	)	$	(22	)	$	438	$	33
Other sovereign government obligations		15		(2	)		(2	)		14			25		(3	)
Corporate and other debt		39,707		(3,580	)		1,306			808			38,241		(3,575	)
Corporate equities		1,717		(233	)		(15	)		78			1,547		(63	)
Net derivative and other contracts(3)		5,486		8,561			38			(1,336	)		12,749		7,747
Investments		12,758		(214	)		656			(1,334	)		11,866		(260	)
Securities received as collateral		71		—			(44	)		—			27		—
Intangible assets		3		1			—			—			4		1

Liabilities
Financial instruments sold, not yet purchased:
Corporate and other debt	$	717	$	(585	)	$	(392	)	$	(2	)	$	908	$	(625	)
Corporate equities		175		(116	)		256			(33	)		514		(153	)
Obligation to return securities received as collateral		71		—			(44	)		—			27		—
Other secured financings		6,160		146			1,193			34			7,241		146
Long-term borrowings		5,829		54			18			41			5,834		54

(1)	Total realized and unrealized gains or (losses) are primarily included in Principal transactions—trading in the condensed consolidated statements of income except for $(214) million related to Financial instruments owned—investments, which is included in Principal transactions—investments.

(2)	Amounts represent unrealized gains or (losses) for the quarter ended March 31, 2008 related to assets and liabilities still outstanding at March 31, 2008.

(3)	Net derivative and other contracts represent Financial instruments owned—derivative and other contracts net of Financial instruments sold, not yet purchased—derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 7.

Financial instruments owned—Corporate and other debt. The net losses from Corporate and other debt were primarily driven by certain mortgage-related products and by corporate loans and lending commitments.

During the quarter ended March 31, 2008, the Company reclassified certain Corporate and other debt from Level 2 to Level 3 because certain significant inputs for the fair value measurement became unobservable. These reclassifications included transfers primarily related to corporate loans and lending commitments.


		26

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Financial instruments owned—Net derivative and other contracts. The net gains from Net derivative contracts were primarily driven by certain credit default swaps and other instruments associated with the Company’s credit products.

The Company reclassified certain OTC derivatives from Level 3 to Level 2. These reclassifications included transfers primarily related to corporate tranche-indexed credit default swaps as inputs became observable. The reclassifications were due to increased availability of transaction data and broker quotes.

For further information on derivative instruments and hedging activities, see Note 7.

Financial instruments owned—Investments. The Company reclassified investments from Level 3 to Level 2 because certain significant inputs for the fair value measurement were identified and, therefore, became observable.


		27

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the One Month Ended December 31, 2008


	Beginning Balance at November 30, 2008		Total Realized and Unrealized Gains or (Losses)(1)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance at December 31, 2008		Unrealized Gains or (Losses) for Level 3 Assets/ Liabilities Outstanding at December 31, 2008(2)
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	206	$	(3	)	$	(76	)	$	—		$	127	$	(5	)
Other sovereign government obligations		3		—			(1	)		(1	)		1		—
Corporate and other debt		34,460		(393	)		1,036			(185	)		34,918		(378	)
Corporate equities		907		(11	)		(3	)		83			976		(10	)
Net derivative and other contracts(3)		27,624		(2,040	)		(43	)		(2,159	)		23,382		(1,879	)
Investments		9,732		(169	)		149			(14	)		9,698		(158	)
Securities received as collateral		15		—			15			—			30		—
Intangible assets		220		(36	)		—			—			184		(36	)

Liabilities
Financial instruments sold, not yet purchased:
Corporate and other debt	$	3,943	$	(43	)	$	(140	)	$	(38	)	$	3,808	$	(63	)
Corporate equities		21		(20	)		(20	)		6			27		1
Obligation to return securities received as collateral		15		—			15			—			30		—
Other secured financings		5,747		(219	)		34			148			6,148		(219	)
Long-term borrowings		5,417		(52	)		4			—			5,473		(51	)

(1)	Total realized and unrealized gains or (losses) are primarily included in Principal transactions—trading in the condensed consolidated statements of income except for $(169) million related to Financial instruments owned—investments, which is included in Principal transactions—investments.

(2)	Amounts represent unrealized gains or (losses) for the one month period ended December 31, 2008 related to assets and liabilities still outstanding at December 31, 2008.

(3)	Net derivative and other contracts represent Financial instruments owned—derivative and other contracts net of Financial instruments sold, not yet purchased—derivative and other contracts. For further information on derivative instruments and hedging activities, see Note 7.

Financial instruments owned—Net derivative and other contracts. The net losses in Net derivative and other contracts were primarily driven by tightening of credit spreads on underlying reference entities of certain basket credit default swaps, single name credit default swaps and corporate tranche-indexed credit default swaps.

The Company reclassified certain Net derivative contracts from Level 3 to Level 2. The reclassifications were primarily related to corporate tranche-indexed credit default swaps. The reclassifications were due to an increase in transaction data, available broker quotes and/or available consensus pricing, such that significant inputs for the fair value measurement were observable.

For further information on derivative instruments and hedging activities, see Note 7.


		28

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis.

Certain assets were measured at fair value on a non-recurring basis and are not included in the tables above. These assets may include certain loans, certain equity method investments, certain premises and equipment, certain intangible assets and certain real estate investments.

The following table presents, by caption on the condensed consolidated statement of financial position, the fair value hierarchy for those assets measured at fair value on a non-recurring basis for which the Company recognized an impairment charge for the quarter ended March 31, 2009.


	Carrying Value at March 31, 2009		Fair Value Measurements Using:						Total (Losses) for the Three Months Ended March 31, 2009(1)
	Carrying Value at March 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total (Losses) for the Three Months Ended March 31, 2009(1)
	(dollars in millions)
Receivables—Other loans(2)	$	386	$	—	$	—	$	386	$	(98	)
Other investments(3)		163		—		—		163		(44	)
Premises, equipment and software costs(4)		8		—		—		8		(5	)
Intangible assets(5)		21		—		—		21		(6	)
Other assets(6)		226		—		—		226		(125	)

Total	$	804	$	—	$	—	$	804	$	(278	)

(1)	Impairment losses are recorded within Other expenses in the condensed consolidated statement of income except for impairment losses related to Receivables—Other loans and Other investments, which are included in Other revenues.

(2)

Loans held for investment with a carrying amount of $484 million were written down to their fair value of $386 million, resulting in an impairment charge of $98 million, calculated based upon the fair value of the collateral. The fair value of the collateral was determined using internal expected recovery models.

(3)	Equity method investments with a carrying amount of $207 million were written down to their fair value of $163 million, resulting in an impairment charge of $44 million. Impairment losses recorded were determined primarily using discounted cash flow models.

(4)	Equipment with a carrying value of $13 million was written down to their fair value of $8 million, resulting in an impairment charge of $5 million.

(5)	Intangible assets other than goodwill with a carrying amount of $27 million were written down to fair value of $21 million, resulting in an impairment charge of $6 million, recorded within the Asset Management business segment (see Note 5).

(6)

Buildings and property with a carrying amount of $351 million were written down to their fair value of $226 million, resulting in an impairment charge of $125 million. Fair values were generally determined using discounted cash flow models or third-party appraisals and valuations. This charge relates to the Asset Management business segment.

There were no liabilities measured at fair value on a non-recurring basis during the quarter ended March 31, 2009. In addition, there were no assets or liabilities measured at fair value on a non-recurring basis for which the Company recognized an impairment charge during the one month period ended December 31, 2008 and the quarter ended March 31, 2008.


		29

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Fair Value Option.

The following tables present net gains or (losses) due to changes in fair value for items measured at fair value pursuant to the fair value option election for the quarters ended March 31, 2009 and March 31, 2008 and the one month period ended December 31, 2008.


	Principal Transactions: Trading			Net Interest Revenue			Gains (Losses) Included in Net Revenues
	(dollars in millions)
Three Months Ended March 31, 2009
Commercial paper and other short-term borrowings	$	84		$	—		$	84
Deposits		(87	)		(92	)		(179	)
Long-term borrowings		(1,405	)		(140	)		(1,545	)

Three Months Ended March 31, 2008
Commercial paper and other short-term borrowings	$	(74	)	$	(4	)	$	(78	)
Deposits		4			(24	)		(20	)
Long-term borrowings		2,104			(168	)		1,936

One Month Ended December 31, 2008
Commercial paper and other short-term borrowings	$	(81	)	$	—		$	(81	)
Deposits		(120	)		(26	)		(146	)
Long-term borrowings		(1,597	)		(52	)		(1,649	)

In addition to the amounts in the above table, as discussed in Note 1, all of the instruments within Financial instruments owned or Financial instruments sold, not yet purchased are measured at fair value, either through the election of SFAS No. 159 or as required by other accounting pronouncements.

Borrowings and Deposits.

For the quarter ended March 31, 2009 and the one month period ended December 31, 2008, the estimated changes in the fair value of the Company’s short-term and long-term borrowings, including structured notes and junior subordinated debentures, for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were losses of approximately $1,636 million and $241 million, respectively. These losses were attributable to the tightening of the Company’s credit spreads and were determined based upon observations of the Company’s secondary bond market spreads. The remainder of changes in fair value of the short-term and long-term borrowings during the quarter ended March 31, 2009 and the one month period ended December 31, 2008 is attributable to changes in foreign currency exchange rates and interest rates and movements in the reference price or index for structured notes. For the quarter ended March 31, 2008, the estimated changes in the fair value of the Company’s short-term and long-term borrowings, including structured notes and junior subordinated debentures, for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were gains of approximately $1,891 million. The remainder of changes in fair value of the short-term and long-term borrowings during the quarter ended March 31, 2008 are attributable to changes in foreign currency exchange rates and interest rates and movements in the reference price or index for structured notes. For the quarters ended March 31, 2009 and March 31, 2008 and the one month period ended December 31, 2008, the estimated changes in the fair value of deposits for which the fair value option was elected that were attributable to changes in instrument-specific credit risk were immaterial. As of March 31, 2009, December 31, 2008 and November 30, 2008, the aggregate contractual principal amount of short-term and long-term debt instruments and deposits for which the fair value option was elected exceeded the


		30

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

fair value of such instruments by approximately $4.6 billion, $5.7 billion and $7.5 billion, respectively. These amounts do not include structured notes where the repayment of the initial principal amount fluctuates based on changes in the reference price or index.

Contingent Lending Commitments.

The estimated changes in the fair value of contingent lending commitments, included in Financial instruments sold, not yet purchased, for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were immaterial in the quarter ended March 31, 2009 and the one month period ended December 31, 2008. For the quarter ended March 31, 2008, the estimated changes in the fair value of contingent lending commitments for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were losses of approximately $156 million. See discussion below regarding changes in instrument-specific credit spreads related to loan assets.

Loans.

As of March 31, 2009, December 31, 2008 and November 30, 2008, the aggregate contractual principal amount of loans for which the fair value option was elected exceeded the fair value of such loans by approximately $30.7 billion, $31.0 billion and $30.5 billion, respectively. The aggregate fair value of loans that were 90 or more days past due as of March 31, 2009, December 31, 2008 and November 30, 2008 was $1.2 billion, $2.0 billion and $2.0 billion, respectively. The aggregate contractual principal amount of such loans 90 or more days past due exceeded their fair value by approximately $18.8 billion, $19.8 billion and $19.8 billion at March 31, 2009, December 31, 2008 and November 30, 2008, respectively. The majority of this difference between principal and fair value amounts emanates from the Company’s distressed debt trading business, which purchases distressed debt at amounts well below par.

For the quarters ended March 31, 2009 and March 31, 2008 and the one month period ended December 31, 2008, changes in the fair value of loans for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were losses of $349 million, $2,366 million and $498 million, respectively. Instrument-specific credit losses were determined by excluding the non-credit components of gains and losses, such as those due to changes in interest rates.

3.	Collateralized Transactions.

Securities purchased under agreements to resell (“reverse repurchase agreements”) and Securities sold under agreements to repurchase (“repurchase agreements”), principally government and agency securities, are carried at the amounts at which the securities subsequently will be resold or reacquired as specified in the respective agreements; such amounts include accrued interest. Reverse repurchase agreements and repurchase agreements are presented on a net-by-counterparty basis, when appropriate. The Company’s policy is generally to take possession of securities purchased under agreements to resell. Securities borrowed and Securities loaned are carried at the amounts of cash collateral advanced and received in connection with the transactions. Other secured financings include the liabilities related to transfers of financial assets that are accounted for as financings rather than sales, consolidated variable interest entities where the Company is deemed to be the primary beneficiary, and certain equity-referenced securities and loans where in all instances these liabilities are payable solely from the cash flows of the related assets accounted for as Financial instruments owned (see Note 4).

The Company pledges its financial instruments owned to collateralize repurchase agreements and other securities financings. Pledged financial instruments that can be sold or repledged by the secured party are identified as Financial instruments owned (pledged to various parties) in the condensed consolidated statements of financial


		31

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

condition. The carrying value and classification of financial instruments owned by the Company that have been loaned or pledged to counterparties where those counterparties do not have the right to sell or repledge the collateral were as follows:


	At March 31, 2009		At December 31, 2008		At November 30, 2008
	(dollars in millions)
Financial instruments owned:
U.S. government and agency securities	$	8,915	$	9,134	$	7,701
Other sovereign government obligations		3,308		2,570		626
Corporate and other debt		12,529		21,850		33,037
Corporate equities		3,543		4,388		5,726

Total	$	28,295	$	37,942	$	47,090

The Company enters into reverse repurchase agreements, repurchase agreements, securities borrowed and securities loaned transactions to, among other things, acquire securities to cover short positions and settle other securities obligations, to accommodate customers’ needs and to finance the Company’s inventory positions. The Company also engages in securities financing transactions for customers through margin lending. Under these agreements and transactions, the Company either receives or provides collateral, including U.S. government and agency securities, other sovereign government obligations, corporate and other debt, and corporate equities. The Company receives collateral in the form of securities in connection with reverse repurchase agreements, securities borrowed and derivative transactions, and customer margin loans. In many cases, the Company is permitted to sell or repledge these securities held as collateral and use the securities to secure repurchase agreements, to enter into securities lending and derivative transactions or for delivery to counterparties to cover short positions. At March 31, 2009, December 31, 2008 and November 30, 2008, the fair value of financial instruments received as collateral where the Company is permitted to sell or repledge the securities was $283 billion, $290 billion and $294 billion, respectively, and the fair value of the portion that had been sold or repledged was $191 billion, $214 billion and $227 billion, respectively.

The Company additionally receives securities as collateral in connection with certain securities for securities transactions in which the Company is the lender. In instances where the Company is permitted to sell or repledge these securities, the Company reports the fair value of the collateral received and the related obligation to return the collateral in the condensed consolidated statements of financial condition. At March 31, 2009, December 31, 2008 and November 30, 2008, $7 billion, $5 billion and $5 billion, respectively, were reported as Securities received as collateral and an Obligation to return securities received as collateral in the condensed consolidated statements of financial condition. Collateral received in connection with these transactions that was subsequently repledged was approximately $6 billion, $4 billion and $5 billion at March 31, 2009, December 31, 2008 and November 30, 2008, respectively.

The Company manages credit exposure arising from reverse repurchase agreements, repurchase agreements, securities borrowed and securities loaned transactions by, in appropriate circumstances, entering into master netting agreements and collateral arrangements with counterparties that provide the Company, in the event of a customer default, the right to liquidate collateral and the right to offset a counterparty’s rights and obligations. The Company also monitors the fair value of the underlying securities as compared with the related receivable or payable, including accrued interest, and, as necessary, requests additional collateral to ensure such transactions are adequately collateralized. Where deemed appropriate, the Company’s agreements with third parties specify its rights to request additional collateral. Customer receivables generated from margin lending activity are


		32

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

collateralized by customer-owned securities held by the Company. For these transactions, adherence to the Company’s collateral policies significantly limits the Company’s credit exposure in the event of customer default. The Company may request additional margin collateral from customers, if appropriate, and, if necessary, may sell securities that have not been paid for or purchase securities sold but not delivered from customers.

At March 31, 2009, December 31, 2008 and November 30, 2008, cash and securities deposited with clearing organizations or segregated under federal and other regulations or requirements were as follows:


	March 31, 2009		December 31, 2008		November 30, 2008
	(dollars in millions)
Cash	$	23,094	$	24,039	$	25,446
Securities(1)		21,860		38,670		33,642

Total	$	44,954	$	62,709	$	59,088

(1)

Securities deposited with clearing organizations or segregated under federal and other regulations or requirements are included in Federal funds sold and securities purchased under agreements to resell in the condensed consolidated statements of financial condition.

4.	Securitization Activities and Variable Interest Entities.

Securitization Activities and Qualifying Special Purpose Entities.

Securitization Activities. In a securitization transaction, the Company transfers assets (generally commercial or residential mortgage loans or U.S. agency securities) to a special purpose entity (an “SPE”), sells to investors most of the beneficial interests, such as notes or certificates, issued by the SPE and in many cases retains other beneficial interests. In many securitization transactions involving commercial mortgage loans, the Company transfers a portion of the assets transferred to the SPE with unrelated parties transferring the remaining assets.

The purchase of the transferred assets by the SPE is financed through the sale of these interests. In some of these transactions, primarily involving residential mortgage loans in the U.S. and Europe and commercial mortgage loans in Europe, the Company serves as servicer for some or all of the transferred loans. In many securitizations, particularly involving residential mortgage loans, the Company also enters into derivative transactions, primarily interest rate swaps or interest rate caps, with the SPE.

In most of these transactions, the SPE meets the criteria to be a QSPE as provided by SFAS No. 140. The Company does not consolidate QSPEs if they meet certain criteria regarding the types of assets and derivatives they may hold, the activities in which they may engage and the range of discretion they may exercise in connection with the assets they hold. The determination of whether an SPE meets the criteria to be a QSPE requires considerable judgment, particularly in evaluating whether the permitted activities of the SPE are significantly limited and in determining whether derivatives held by the SPE are passive and not excessive.

The primary risk retained by the Company in connection with these transactions generally is limited to the beneficial interests issued by the SPE that are owned by the Company, with the risk highest on the most subordinate class of beneficial interests. These beneficial interests generally are included in Financial instruments owned—Corporate and other debt and are measured at fair value. The Company does not provide additional support in these transactions through contractual facilities, such as liquidity facilities, guarantees, or similar derivatives.

Although not obligated, the Company generally makes a market in the securities issued by SPEs in these transactions. In these market-making transactions, the Company offers to buy these securities from and sell these securities to investors. Securities purchased through these market-making activities are not included as retained interests. These beneficial interests generally are included in Financial instruments owned—Corporate and other debt securities and are measured at fair value.


		33

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The Company enters into derivatives, generally interest rate swaps and interest rate caps with a senior payment priority in many securitization transactions. The risks associated with these and similar derivatives with SPEs are essentially the same as similar derivatives with non-SPE counterparties and are managed as part of the Company’s overall exposure.

For further information on derivative instruments and hedging activities, see Note 7.

QSPEs. The following tables present information as of March 31, 2009 and December 31, 2008 regarding QSPEs to which the Company acting as principal, has transferred assets and received sales treatment, and QSPEs sponsored by the Company to which the Company has not transferred assets (dollars in millions):


	At March 31, 2009
	Residential Mortgage Loans		Commercial Mortgage Loans		U.S. Agency Collateralized Mortgage Obligations		Other
QSPE assets (unpaid principal balance)(1)	$	63,487	$	112,013	$	27,902	$	2,564
Retained interests (fair value):
Investment grade	$	344	$	354	$	11	$	—
Non-investment grade		74		171		—		—

Total retained interests (fair value)	$	418	$	525	$	11	$	—

Interests purchased in the secondary market (fair value):
Investment grade	$	81	$	187	$	—	$	17
Non-investment grade		38		5		—		12

Total interests purchased in the secondary market (fair value)	$	119	$	192	$	—	$	29

Derivatives (fair value)	$	397	$	503	$	—	$	1,197
Assets serviced (unpaid principal balance)		22,281		7,764		—		—

(1)	Amount includes $57.3 billion of assets transferred to the QSPEs by unrelated transferors.


	At December 31, 2008
	Residential Mortgage Loans		Commercial Mortgage Loans		U.S. Agency Collateralized Mortgage Obligations		Other
QSPE assets (unpaid principal balance)(1)	$	65,344	$	112,557	$	28,380	$	2,684
Retained interests (fair value):
Investment grade	$	500	$	482	$	102	$	—
Non-investment grade		33		100		—		—

Total retained interests (fair value)	$	533	$	582	$	102	$	—

Interests purchased in the secondary market (fair value):
Investment grade	$	42	$	156	$	8	$	23
Non-investment grade		49		14		—		12

Total interests purchased in the secondary market (fair value)	$	91	$	170	$	8	$	35

Derivatives (fair value)	$	488	$	515	$	—	$	1,156
Assets serviced (unpaid principal balance)		23,211		8,196		—		—

(1)	Amount includes $57.8 billion of assets transferred to the QSPEs by unrelated transferors.


		34

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Transferred assets are carried at fair value prior to securitization, and any changes in fair value are recognized in the condensed consolidated statements of income. The Company may act as underwriter of the beneficial interests issued by securitization vehicles. Underwriting net revenues are recognized in connection with these transactions. The Company may retain interests in the securitized financial assets as one or more tranches of the securitization. These retained interests are included in the condensed consolidated statements of financial condition at fair value. Any changes in the fair value of such retained interests are recognized in the condensed consolidated statements of income. Net gains at the time of securitization were not material during the quarter ended March 31, 2009 and the one month period ended December 31, 2008.

During the quarters ended March 31, 2009 and March 31, 2008, the Company received proceeds from new securitization transactions of $332 million and $3.8 billion, respectively. The Company did not receive any proceeds from new securitization transactions during the one month period ended December 31, 2008. During the quarters ended March 31, 2009 and March 31, 2008 and the one month period ended December 31, 2008, the Company received proceeds from cash flows from retained interests in securitization transactions of $236 million, $1.1 billion and $153 million, respectively.

The Company provides representations and warranties that certain assets transferred in securitization transactions conform to specific guidelines (see Note 8).

Mortgage Servicing Rights. The Company may retain servicing rights to certain mortgage loans that are sold through its securitization activities. These transactions create an asset referred to as MSRs, which totaled approximately $159 million, $184 million and $220 million as of March 31, 2009, December 31, 2008 and November 30, 2008, respectively, and are included within Intangible assets and carried at fair value in the condensed consolidated statements of financial condition.

SPE Mortgage Servicing Activities. The Company services residential mortgage loans in the U.S. and Europe and commercial mortgage loans in Europe owned by SPEs, including SPEs sponsored by the Company and SPEs not sponsored by the Company. Most of these SPEs meet the requirements for QSPEs. The Company generally holds retained interests in Company-sponsored QSPEs. In some cases, as part of its market making activities, the Company may own some beneficial interests issued by both Company-sponsored and non-Company sponsored SPEs.

The Company provides no credit support as part of its servicing activities. The Company is required to make servicing advances to the extent that it believes that such advances will be reimbursed. Reimbursement of servicing advances is a senior obligation of the SPE, senior to the most senior beneficial interests outstanding. Outstanding advances are included in Other assets and are recorded at cost. Advances as of March 31, 2009 and December 31, 2008 totaled approximately $2.5 billion and $2.4 billion, respectively, net of reserves of approximately $9 million and $10 million, respectively.

The following table presents information about the Company’s mortgage servicing activities for SPEs to which the Company transferred loans as of March 31, 2009 and December 31, 2008 (dollars in millions):


	At March 31, 2009
	Residential Mortgage QSPEs			Residential Mortgage Failed Sales			Commercial Mortgage QSPEs		Commercial Mortgage Consolidated SPEs
Assets serviced (unpaid principal balance)	$	22,281		$	858		$	7,764	$	2,310
Amounts past due 90 days or greater (unpaid principal balance)(1)	$	7,860		$	334		$	3	$	—
Percentage of amounts past due 90 days or greater		35.3	%		38.9	%		—		—
Credit losses	$	554		$	23		$	—	$	—

(1)	Includes loans that are at least 90 days contractually delinquent, loans for which the borrower has filed for bankruptcy, loans in foreclosure and real estate owned.


		35

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)


	At December 31, 2008
	Residential Mortgage QSPEs			Residential Mortgage Failed Sales			Commercial Mortgage QSPEs		Commercial Mortgage Consolidated SPEs
Assets serviced (unpaid principal balance)	$	23,211		$	890		$	8,196	$	2,349
Amounts past due 90 days or greater (unpaid principal balance)(1)	$	7,586		$	308		$	—	$	—
Percentage of amounts past due 90 days or greater		32.7	%		34.6	%		—		—
Credit losses	$	181		$	11		$	—	$	—

(1)	Includes loans that are at least 90 days contractually delinquent, loans for which the borrower has filed for bankruptcy, loans in foreclosure and real estate owned.

The Company also serviced residential and commercial mortgage loans for SPEs sponsored by unrelated parties with unpaid principal balances totaling $24 billion and $25 billion as of March 31, 2009 and December 31, 2008, respectively.

Variable Interest Entities. FIN 46R applies to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. QSPEs currently are not subject to the requirements of FIN 46R. The primary beneficiary of a VIE is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns or both, as a result of holding variable interests. The Company consolidates entities of which it is the primary beneficiary.

The Company is involved with various entities in the normal course of business that may be deemed to be VIEs. The Company’s variable interests in VIEs include debt and equity interests, commitments, guarantees and derivative instruments. The Company’s involvement with VIEs arises primarily from:

•

Interests purchased in connection with market making and retained interests held as a result of securitization activities.

•

Guarantees issued and residual interests retained in connection with municipal bond securitizations.

•

Loans and investments made to VIEs that hold debt, equity, real estate or other assets.

•

Derivatives entered into with variable interest entities.

•

Structuring of credit-linked notes (“CLNs”) or other asset-repackaged notes designed to meet the investment objectives of clients.

•

Other structured transactions designed to provide tax-efficient yields to the Company or its clients.

The Company determines whether it is the primary beneficiary of a VIE upon its initial involvement with the VIE. This determination is based upon an analysis of the design of the VIE, including the VIE’s structure and activities and the variable interests owned by the Company.

The Company reassesses whether it is the primary beneficiary of a VIE upon the occurrence of certain reconsideration events. If the Company’s initial assessment results in a determination that it is not the primary beneficiary of a VIE, then the Company reassesses this determination upon the occurrence of:

•

Changes to the VIE’s governing documents or contractual arrangements in a manner that reallocates the obligation to absorb the expected losses or the right to receive the expected residual returns of the VIE between the current primary beneficiary and the other variable interest holders, including the Company.

•

Acquisition by the Company of additional variable interests in the VIE.


		36

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

If the Company’s initial assessment results in a determination that it is the primary beneficiary, then the Company reassesses this determination upon the occurrence of:

•

A sale or disposition by the Company of all or part of its variable interests in the VIE to parties unrelated to the Company.

•

The issuance of new variable interests by the VIE to parties unrelated to the Company.

Except for consolidated VIEs included in other structured financings in the tables below, the Company accounts for the assets held by the entities primarily in Financial instruments owned and the liabilities of the entities as Other secured financings in the condensed consolidated statements of financial condition. The Company includes assets held by consolidated VIEs included in other structured financings primarily in Receivables, Premises, equipment and software costs and Other assets and the liabilities primarily as Other liabilities and accrued expenses and Payables in the condensed consolidated statements of financial condition. Except for consolidated VIEs included in other structured financings, the assets and liabilities are measured at fair value, with changes in fair value reflected in earnings.

The assets owned by many consolidated VIEs cannot be removed unilaterally by the Company and are not generally available to the Company. The related liabilities issued by many consolidated VIEs are non-recourse to the Company. In certain other consolidated VIEs, the Company has the unilateral right to remove assets or provides additional recourse through derivatives such as total return swaps, guarantees or other forms of involvement.

The following tables present information as of March 31, 2009 and December 31, 2008 about VIEs which the Company consolidates (dollars in millions):


	At March 31, 2009
	Mortgage and Asset-backed Securitizations		Credit and Real Estate		Commodities Financing		Other Structured Financings		Total
VIE assets that the Company consolidates	$	3,255	$	3,358	$	773	$	1,020	$	8,406
VIE liabilities		1,739		826		693		230		3,488
Maximum exposure to loss:
Debt and equity interests	$	1,552	$	2,544	$	—	$	944	$	5,040
Derivatives and other contracts		461		3,230		1,141		—		4,832
Commitments and guarantees		—		—		—		332		332

Total maximum exposure to loss	$	2,013	$	5,774	$	1,141	$	1,276	$	10,204


		37

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)


	At December 31, 2008
	Mortgage and Asset-backed Securitizations		Credit and Real Estate		Commodities Financing		Other Structured Financings		Total
VIE assets that the Company consolidates	$	4,307	$	4,121	$	809	$	1,664	$	10,901
VIE liabilities		2,473		1,505		766		801		5,545
Maximum exposure to loss:
Debt and equity interests	$	1,834	$	2,605	$	—	$	882	$	5,321
Derivatives and other contracts		517		2,757		1,307		—		4,581
Commitments and guarantees		—		—		—		330		330

Total maximum exposure to loss	$	2,351	$	5,362	$	1,307	$	1,212	$	10,232

The following tables present information about non-consolidated VIEs in which the Company had significant variable interests or served as the sponsor and had any variable interest as of March 31, 2009 and December 31, 2008 (dollars in millions):


	At March 31, 2009
	Mortgage and Asset-backed Securitizations		Credit and Real Estate		Municipal Tender Option Bond Trusts		Other Structured Financings		Total
VIE assets that the Company does not consolidate	$	1,507	$	16,103	$	813	$	5,542	$	23,965
Maximum exposure to loss:
Debt and equity interests	$	62	$	3,732	$	172	$	897	$	4,863
Derivatives and other contracts		—		5,160		—		—		5,160
Commitments and guarantees		—		—		227		504		731

Total maximum exposure to loss	$	62	$	8,892	$	399	$	1,401	$	10,754

Carrying value of exposure to loss:
Debt and equity interests	$	62	$	3,732	$	172	$	720	$	4,686
Derivatives and other contracts		—		2,311		—		—		2,311
Commitments and guarantees		—		—		—		27		27

Total carrying value of exposure to loss	$	62	$	6,043	$	172	$	747	$	7,024


	At December 31, 2008
	Mortgage and Asset-backed Securitizations		Credit and Real Estate		Municipal Tender Option Bond Trusts		Other Structured Financings		Total
VIE assets that the Company does not consolidate	$	1,629	$	18,456	$	2,173	$	8,068	$	30,326
Maximum exposure to loss:
Debt and equity interests	$	38	$	4,420	$	1,145	$	880	$	6,483
Derivatives and other contracts		—		5,156		—		—		5,156
Commitments and guarantees		—		—		320		564		884

Total maximum exposure to loss	$	38	$	9,576	$	1,465	$	1,444	$	12,523

Carrying value of exposure to loss:
Debt and equity interests	$	38	$	4,420	$	1,145	$	703	$	6,306
Derivatives and other contracts		—		2,488		—		—		2,488
Commitments and guarantees		—		—		—		36		36

Total carrying value of exposure to loss	$	38	$	6,908	$	1,145	$	739	$	8,830


		38

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The Company’s maximum exposure to loss often differs from the carrying value of the VIE’s assets. The maximum exposure to loss is dependent on the nature of the Company’s variable interest in the VIEs and is limited to the notional amounts of certain liquidity facilities, other credit support, total return swaps, written put options, and the fair value of certain other derivatives and investments the Company has made in the VIEs. Liabilities issued by VIEs generally are non-recourse to the Company. Where notional amounts are utilized in quantifying maximum exposure related to derivatives, such amounts do not reflect fair value writedowns already recorded by the Company.

The Company’s maximum exposure to loss does not include the offsetting benefit of any financial instruments that the Company may utilize to hedge these risks associated with the Company’s variable interests.

Municipal Tender Option Bond Trusts. In a municipal tender option bond transaction, the Company, on behalf of a client, transfers a municipal bond to a trust. The trust issues short-term securities which the Company as the remarketing agent sells to investors. The client retains a residual interest. The short-term securities are supported by a liquidity facility pursuant to which the investors may put their short-term interests. In some programs, the Company provides this liquidity facility; in most programs, a third-party provider will provide such liquidity facility. The Company may purchase short-term securities in its role either as remarketing agent or liquidity provider. The client can generally terminate the transaction at any time. The liquidity provider can generally terminate the transaction upon the occurrence of certain events. When the transaction is terminated, the municipal bond is generally sold or returned to the client. Any losses suffered by the liquidity provider upon the sale of the bond are the responsibility of the client. This obligation generally is collateralized. In prior periods, the Company established trusts in connection with its proprietary trading activities and consolidated those trusts. As of March 31, 2009 and December 31, 2008, no proprietary trusts were outstanding.

Credit Protection Purchased Through CLNs. In a CLN transaction, the Company transfers assets (generally high quality securities or money market investments) to an SPE, enters into a derivative transaction in which the SPE writes protection on an unrelated reference asset or group of assets through a credit default swap, a total return swap or similar instrument, and sells to investors the securities issued by the SPE. In some transactions, the Company may also enter into interest rate or currency swaps with the SPE. Upon the occurrence of a credit event related to the reference asset, the SPE will sell the collateral securities in order to make the payment to the Company. The Company is generally exposed to price changes on the collateral securities in the event of a credit event and subsequent sale. These transactions are designed to transfer the credit risk on the reference asset to investors. In some transactions, the assets and liabilities of the SPE are recognized in the Company’s condensed consolidated financial statements. In other transactions, the transfer of the collateral securities is accounted for as a sale of assets and the SPE is not consolidated. The structure of the transaction determines the accounting treatment.

The derivatives in CLN transactions consist of total return swaps, credit default swaps or similar contracts in which the Company has purchased protection on a reference asset or group of assets. Payments by the SPE are collateralized. The risks associated with these and similar derivatives with SPEs are essentially the same as similar derivatives with non-SPE counterparties and are managed as part of the Company’s overall exposure.

Other Structured Financings. The Company primarily invests in equity interests issued by entities that develop and own low income communities (including low income housing projects) and entities that construct and own facilities that will generate energy from renewable resources. The equity interests entitle the Company to its share of tax credits and tax losses generated by these projects. In addition, the Company has issued guarantees to investors in certain low-income housing funds. The guarantees are designed to return an


		39

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

investor’s contribution to a fund and the investor’s share of tax losses and tax credits expected to be generated by the fund. The Company is also involved with entities designed to provide tax-efficient yields to the Company or its clients.

Collateralized Loan and Debt Obligations. A collateralized loan obligation (“CLO”) or a CDO is a SPE that purchases a pool of assets, consisting of corporate loans, corporate bonds, asset-backed securities or synthetic exposures on similar assets through derivatives and issues multiple tranches of debt and equity securities to investors. In the Asset Management business segment, the Company manages CLOs with assets of $2.1 billion as of both March 31, 2009 and December 31, 2008 and receives a management fee for these services. Except for the management fee, the Company’s maximum exposure to loss on these managed CLOs is immaterial as of March 31, 2009 and December 31, 2008. The Company’s maximum exposure to other CLOs and CDOs is $3.3 billion and $3.4 billion as of March 31, 2009 and December 31, 2008, respectively, excluding the exposure to the assets transferred to Ascension, a wholly owned subsidiary of the Company (see Note 9).

Asset Management Investment Funds. The tables above do not include certain investments made by the Company held by entities qualifying for accounting purposes as investment companies.

Failed Sales.

In order to be treated as a sale of assets for accounting purposes, a transfer of financial assets must meet all of the criteria provided in SFAS No. 140. If the transfer fails to meet these criteria, that transfer is treated as a failed sale. In such case, the Company continues to recognize the assets in Financial instruments owned and the Company recognizes the associated liabilities in Other secured financings in the condensed consolidated statements of financial condition.

The assets transferred to many unconsolidated VIEs in transactions accounted for as failed sales cannot be removed unilaterally by the Company and are not generally available to the Company. The related liabilities issued by many unconsolidated VIEs are non-recourse to the Company. In certain other failed sale transactions, the Company has the unilateral right to remove assets or provides additional recourse through derivatives such as total return swaps, guarantees or other forms of involvement.


		40

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following tables present information about transfers of assets treated by the Company as secured financings as of March 31, 2009 and December 31, 2008 (dollars in millions):


	At March 31, 2009
	Residential Mortgage Loans		Commercial Mortgage Loans		Credit-Linked Notes		Other
Assets
Unpaid principal amount	$	420	$	2,391	$	1,190	$	1,862
Fair value		198		2,018		924		1,684

Other secured financings
Unpaid principal amount		239		2,265		1,119		1,847
Fair value		149		1,941		916		1,683


	At December 31, 2008
	Residential Mortgage Loans		Commercial Mortgage Loans		Credit-Linked Notes		Other
Assets
Unpaid principal amount	$	439	$	2,573	$	1,333	$	2,028
Fair value		227		2,245		1,144		1,814

Other secured financings
Unpaid principal amount		258		2,512		1,293		2,008
Fair value		175		2,208		1,134		1,810

5.	Goodwill and Net Intangible Assets.

The Company tests goodwill for impairment on an annual basis and on an interim basis when certain events or circumstances exist. The Company tests for impairment at the reporting unit level, which are generally one level below its business segments. Goodwill impairment is determined by comparing the estimated fair value of a reporting unit with its respective book value. If the estimated fair value exceeds the book value, goodwill at the reporting unit level is not deemed to be impaired. If the estimated fair value is below book value, however, further analysis is required to determine the amount of the impairment. The estimated fair values of the reporting units are generally determined utilizing methodologies that incorporate price-to-book, price-to-earnings and assets under management multiples of certain comparable companies.

The Company completed its annual goodwill impairment testing as of June 1, 2008 and June 1, 2007, which did not result in any goodwill impairment. Due to continued deterioration in the financial markets, the Company performed interim impairment tests of goodwill in the one month period ended December 31, 2008 and in the first quarter of 2009, which did not result in impairment.


		41

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Changes in the carrying amount of the Company’s goodwill and intangible assets for the one month period ended December 31, 2008 and the quarter ended March 31, 2009 were as follows:


	Institutional Securities			Global Wealth Management Group		Asset Management		Total
	(dollars in millions)
*Goodwill:*
Balance at November 30, 2008	$	800		$	272	$	1,171	$	2,243
Foreign currency translation adjustments and other		13			—		—		13

Balance at December 31, 2008		813			272		1,171		2,256
Foreign currency translation adjustments and other		(14	)		—		—		(14	)
Goodwill disposed of during the period		(16	)		—		—		(16	)

Balance at March 31, 2009	$	783		$	272	$	1,171	$	2,226


	Institutional Securities			Asset Management			Total
	(dollars in millions)
*Intangible Assets:*
Amortizable intangible assets at November 30, 2008	$	334		$	393		$	727
Foreign currency translation adjustments and other		3			—			3
Amortization expense		(4	)		(4	)		(8	)

Amortizable intangible assets at December 31, 2008		333			389			722
Mortgage servicing rights (see Note 4)		184			—			184

Balance of intangible assets at December 31, 2008	$	517		$	389		$	906

Amortizable intangible assets at December 31, 2008	$	333		$	389		$	722
Foreign currency translation adjustments and other		(2	)		(3	)		(5	)
Intangible assets dispose d of during the period		(1	)		—			(1	)
Amortization expense		(8	)		(12	)		(20	)
Impairment losses		—			(6	)		(6	)

Amortizable intangible assets at March 31, 2009		322			368			690
Mortgage servicing rights (see Note 4)		159			—			159

Balance of intangible assets at March 31, 2009	$	481		$	368		$	849

6.	Long-Term Borrowings.

The Company’s long-term borrowings included the following components:


	At March 31, 2009		At December 31, 2008		At November 30, 2008
	(dollars in millions)
Senior debt	$	167,473	$	165,181	$	148,959
Subordinated debt		4,199		4,342		4,212
Junior subordinated debentures		10,436		10,312		10,266

Total	$	182,108	$	179,835	$	163,437

During the quarter ended March 31, 2009 and the one month period ended December 31, 2008, the Company issued notes with a carrying value aggregating approximately $17 billion and $12 billion, respectively. The


		42

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

amount for the quarter ended March 31, 2009 included non-U.S. dollar currency notes aggregating approximately $1 billion. During the quarter ended March 31, 2009 and the one month period ended December 31, 2008, $14.4 billion and $5.7 billion of notes were repaid, respectively.

The weighted average maturity of the Company’s long-term borrowings, based upon stated maturity dates, was approximately 5.8 years and 6.3 years as of March 31, 2009 and December 31, 2008, respectively.

As of March 31, 2009, certain of the Company’s subsidiaries were in default under third party real estate financings that are generally non-recourse (subject to limited guarantees) due to a breach of certain non-monetary covenants. Limited waivers of those covenants have been obtained from the lenders for the period effective March 31, 2009 and continuing through May 31, 2009.

Federal Deposit Insurance Corporation (“FDIC”) Temporary Liquidity Guarantee Program (“TLGP”).

As of March 31, 2009, the Company had commercial paper and long-term debt outstanding of $1.0 billion and $23.7 billion, respectively, under the TLGP. As of December 31, 2008, the Company had commercial paper and long-term debt outstanding of $6.4 billion and $9.8 billion, respectively, under the TLGP. These borrowings are senior unsecured debt obligations of the Company and guaranteed by the FDIC under the TLGP. The FDIC has concluded that the guarantee is backed by the full faith and credit of the U.S. government.

7.	Derivative Instruments and Hedging Activities.

The Company trades, makes markets and takes proprietary positions globally in listed futures, OTC swaps, forwards, options and other derivatives referencing, among other things, interest rates, currencies, investment grade and non-investment grade corporate credits, loans, bonds, U.S. and other sovereign securities, emerging market bonds and loans, credit indices, asset-backed security indices, property indices, mortgage-related and other asset-backed securities and real estate loan products. The Company uses these instruments for trading, as well as for asset and liability management.

The Company manages its trading positions by employing a variety of risk mitigation strategies. These strategies include diversification of risk exposures and hedging. Hedging activities consist of the purchase or sale of positions in related securities and financial instruments, including a variety of derivative products (e.g., futures, forwards, swaps and options). The Company manages the market risk associated with its trading activities on a Company-wide basis, on a worldwide trading division level and on an individual product basis.

The Company incurs credit risk as a dealer in OTC derivatives. Credit risk with respect to derivative instruments arises from the failure of a counterparty to perform according to the terms of the contract. The Company’s exposure to credit risk at any point in time is represented by the fair value of the derivative contracts reported as assets. The fair value of a derivative represents the amount at which the derivative could be exchanged in an orderly transaction between market participants, and is further described in Notes 1 and 2 to the condensed consolidated financial statements.

In connection with its derivative activities, the Company may enter into master netting agreements and collateral arrangements with counterparties. These agreements provide the Company with the ability to offset a counterparty’s rights and obligations, request additional collateral when necessary or liquidate the collateral in the event of counterparty default.


		43

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The table below presents a summary by counterparty credit rating and remaining contract maturity of the fair value of OTC derivatives in a gain position at March 31, 2009. Fair value is presented in the final column net of collateral received (principally cash and U.S. government and agency securities):

OTC Derivative Products—Financial Instruments Owned (1)


	Years to Maturity								Cross-Maturity and Cash Collateral Netting(3)			Net Exposure Post-Cash Collateral		Net Exposure Post- Collateral
Credit Rating(2)	Less than 1		1-3		3-5		Over 5		Cross-Maturity and Cash Collateral Netting(3)			Net Exposure Post-Cash Collateral		Net Exposure Post- Collateral
	(dollars in millions)
AAA	$	1,632	$	2,973	$	5,899	$	15,478	$	(11,364	)	$	14,618	$	13,931
AA		9,414		14,799		12,273		33,627		(56,980	)		13,133		11,898
A		9,269		8,577		9,868		20,057		(30,658	)		17,113		14,115
BBB		5,185		4,820		3,512		8,591		(10,297	)		11,811		9,925
Non-investment grade		5,793		5,743		4,792		9,457		(8,660	)		17,125		13,758

Total	$	31,293	$	36,912	$	36,344	$	87,210	$	(117,959	)	$	73,800	$	63,627

(1)	Fair values shown represent the Company’s net exposure to counterparties related to the Company’s OTC derivative products. The table does not include listed derivatives and the effect of any related hedges utilized by the Company.

(2)	Obligor credit ratings are determined by the Credit Risk Management Department using methodologies generally consistent with those employed by external rating agencies.

(3)

Amounts represent the netting of receivable balances with payable balances for the same counterparty across maturity categories. Receivable and payable balances with the same counterparty in the same maturity category are netted within such maturity category, where appropriate. Cash collateral received is netted on a counterparty basis, provided legal right of offset exists.

Hedge Accounting.

The Company applies hedge accounting under SFAS No. 133 using various derivative financial instruments and non-U.S. dollar-denominated debt used to hedge interest rate and foreign exchange risk arising from assets and liabilities not held at fair value as part of asset liability management.

For all hedges where hedge accounting is being applied, effectiveness testing and other procedures to ensure the ongoing validity of the hedges are performed at least monthly.

Fair Value Hedges—Interest Rate Risk. The Company’s designated fair value hedges consisted primarily of interest rate swaps designated as fair value hedges of changes in the benchmark interest rate of fixed rate borrowings, including both certificates of deposit and senior long-term borrowings. The Company uses regression analysis to perform an ongoing prospective and retrospective assessment of the effectiveness of these hedging relationships (i.e., the Company applies the “long-haul” method of hedge accounting). A hedging relationship is deemed effective if the fair values of the hedging instrument (derivative) and the hedged item


		44

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(debt liability) change inversely within a range of 80% to 125%. The Company considers the impact of valuation adjustments related to the Company’s own credit spreads and counterparty credit spreads to determine whether they would cause the hedging relationship to be ineffective.

For qualifying fair value hedges of benchmark interest rates, the changes in the fair value of the derivative and the changes in the fair value of the hedged liability provide offset of one another and, together with any resulting ineffectiveness, are recorded in Interest expense. When a derivative is de-designated as a hedge, any basis adjustment remaining on the hedged liability is amortized to Interest expense over the remaining life of the liability using the effective interest method.

Cash Flow Hedges. The Company applies cash flow hedge accounting to interest rate swaps designated as hedges of the variability of future cash flows from floating rate liabilities due to the benchmark interest rate. The Company uses regression analysis to perform an ongoing prospective and retrospective assessment of the effectiveness of these hedging relationships. Changes in fair value of these interest rate swaps are recorded within Accumulated other comprehensive income (loss) in Shareholders’ equity, net of tax effects, to the extent they are effective. Amounts recorded to Accumulated other comprehensive income (loss) are then reclassified to Interest expense as interest on the hedged borrowings is recognized. Any ineffective portion of the change in fair value of these instruments is recorded in Interest expense. The amount of loss recorded in Accumulated other comprehensive income (loss) and reclassified to interest expense was immaterial for the quarter ended March 31, 2009.

In 2005, the Company de-designated interest rate swaps used to hedge variable rate long-term borrowings associated with a sold business and no longer accounts for them as cash flow hedges. Amounts in Accumulated other comprehensive income (loss) related to these interest rate swaps continue to be reclassified to Interest expense since the related borrowings remain outstanding.

Net Investment Hedges. The Company utilizes forward foreign exchange contracts and non-U.S. dollar denominated debt to manage the currency exposure relating to its net investments in non-U.S. dollar functional currency operations. No hedge ineffectiveness is recognized in earnings since the notional amounts of the hedging instruments equal the portion of the investments being hedged, and, where forward contracts are used, the currencies being exchanged are the functional currencies of the parent and investee; where debt instruments are used as hedges, they are denominated in the functional currency of the investee. The gain or loss from revaluing hedges of net investments in foreign operations at the spot rate is deferred and reported within Accumulated other comprehensive income (loss) in Shareholders’ equity, net of tax effects. The forward points on the hedging instruments are recorded in Interest and dividend revenues.


		45

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following table summarizes the fair value of derivative instruments designated as accounting hedges under SFAS No. 133, and the fair value of derivative instruments not designated as accounting hedges by type of derivative contract on a gross basis as of March 31, 2009. Fair values of derivative contracts in an asset position are included in Financial instruments owned—derivative and other contracts. Fair values of derivative contracts in a liability position are reflected in Financial instruments sold, not yet purchased—derivative and other contracts.


	Assets at March 31, 2009					Liabilities at March 31, 2009
	Fair Value			Notional		Fair Value			Notional
	(dollars in millions)
Derivatives designated as accounting hedges:
Interest rate contracts	$	6,569		$	67,397	$	99		$	3,008
Foreign exchange contracts		138			3,600		107			5,881

Total derivatives designated as accounting hedges		6,707			70,997		206			8,889

Debt instruments designated as net investment hedges(1)		—			—		3,824			3,824

Total derivatives and non-derivatives designated as accounting hedges		6,707			70,997		4,030			12,713

Derivatives not designated as accounting hedges (2):
Interest rate contracts		824,223			14,109,036		795,542			14,148,490
Credit contracts		448,708			3,197,224		415,221			3,080,401
Foreign exchange contracts		75,515			1,052,183		74,089			1,002,351
Equity contracts		71,250			509,917		72,731			536,775
Commodity contracts		108,640			861,790		106,317			668,405
Other		957			17,952		2,168			20,453

Total derivatives not designated as accounting hedges		1,529,293			19,748,102		1,466,068			19,456,875

Total derivatives	$	1,536,000		$	19,819,099	$	1,466,274		$	19,465,764
Cash collateral netting		(84,275	)		—		(39,610	)		—
Counterparty netting		(1,372,576	)		—		(1,372,576	)		—

Total derivatives	$	79,149		$	19,819,099	$	54,088		$	19,465,764

(1)	The notional amount for foreign currency debt instruments designated as net investment hedges represents the principal amount at current exchange rates.

(2)

Notional amounts include net notionals related to long and short futures contracts of $251 billion and $637 billion, respectively. The variation margin on these futures contracts (excluded from the table above) of $1,859 million and $89 million is included in Receivables—Brokers, dealers and clearing organizations and Payables—Brokers, dealers and clearing organizations, respectively, on the condensed consolidated statement of financial position.


		46

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following tables summarize the gains or losses reported on derivative instruments designated and qualifying as accounting hedges for the quarter ended March 31, 2009.

Derivatives Designated as Fair Value Hedges.


Product Type	Classification of Gains or (Losses)	Amount of Gains or (Losses) Recognized in Income on Derivatives		Amount of Gains or (Losses) Recognized in Income on Borrowings
	(dollars in millions)
Interest rate contracts(1)	Interest expense	$	(2,759)	$	2,690

Total		$	(2,759)	$	2,690

(1)	A loss of $69 million was recognized in income related to hedge ineffectiveness.

Derivatives Designated as Net Investment Hedges.


Product Type	Amount of Gains or (Losses) Recognized in OCI (effective portion)(2)
	(dollars in millions)
Foreign exchange contracts(1)	$	230
Debt instruments		103

Total	$	333

(1)	A gain of $9 million was recognized in income related to amounts excluded from hedge effectiveness testing.

(2)	No gains or (losses) were reclassified from Other comprehensive income (“OCI”) into income during the quarter ended March 31, 2009.

Derivatives Designated as Cash Flow Hedges.

The amount of losses recognized in OCI (effective portion) and the amount of losses reclassified from OCI into income on interest rate contracts was not material for the quarter ended March 31, 2009.


		47

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The table below summarizes gains or losses on derivative instruments not designated as accounting hedges for the quarter ended March 31, 2009:


Product Type	Amount of Gains or (Losses) Recognized in Income for the Three Months Ended March 31, 2009 (1)(2)
	(dollars in millions)
Interest rate contracts	$	(1,888	)
Credit contracts		2,557
Foreign exchange contracts		2,415
Equity contracts		(1,240	)
Commodity contracts		752
Other contracts		482

Total derivative instruments	$	3,078

(1)	Gains or (losses) on derivative contracts not designated as hedges are primarily included in Principal transactions—trading.

(2)	Gains or (losses) associated with derivative contracts that have physically settled are excluded from the table above. Gains or (losses) on these contracts are reflected with the associated cash instruments, which are also included in Principal transactions—trading.

The Company also has certain embedded derivatives that have been bifurcated from the related structured borrowings under SFAS No. 133. Such derivatives are classified in Long-term borrowings and had a net fair value of $293 million and a notional of $4,157 million. The Company recognized gains of $45 million related to changes in the fair value of its bifurcated embedded derivatives for the quarter ended March 31, 2009.

As of March 31, 2009, December 31, 2008 and November 30, 2008, the amount of payables in respect of cash collateral received that was netted against derivative assets was $84.3 billion, $88.5 billion and $76.0 billion, respectively. The amount of receivables in respect of cash collateral paid that was netted against derivative liabilities was $39.6 billion, $51.0 billion and $43.2 billion, respectively. Cash collateral receivables and payables of $1.0 billion and $58 million, respectively, as of March 31, 2009, $1.3 billion and $92 million, respectively, as of December 31, 2008, and $1.7 billion and $4 million, respectively, as of November 30, 2008, were not offset against certain contracts that did not meet the SFAS No. 133 definition of a derivative.

Credit-Risk-Related Contingencies.

In connection with certain OTC trading agreements, the Company may be required to provide additional collateral to certain counterparties in the event of a credit ratings downgrade. As of March 31, 2009, the aggregate fair value of derivative contracts that contain credit-risk-related contingent features that are in a net liability position totaled $30,402 million for which the Company has posted collateral of $24,074 million in the normal course of business. The amount of additional collateral that could be called by counterparties under the terms of collateral agreements in the event of a one-notch downgrade of the Company’s long-term credit rating was approximately $949 million. An additional amount of approximately $1,197 million could be called in the event of a two-notch downgrade. Of these amounts, $1,445 million relates to bilateral arrangements between the Company and other parties where upon the downgrade of one party, the downgraded party must deliver incremental collateral to the other party. These bilateral downgrade arrangements are a risk management tool used extensively by the Company as credit exposures are reduced if counterparties are downgraded.


		48

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Credit Derivatives.

The Company enters into credit derivatives, principally through credit default swaps, under which it provides counterparties protection against the risk of default on a set of debt obligations issued by a specified reference entity or entities. A majority of the Company’s counterparties are banks, broker-dealers, insurance and other financial institutions, and monoline insurers. The table below summarizes certain information regarding protection sold through credit default swaps and credit-linked notes as of March 31, 2009:

Protection Sold

Maximum Potential Payout/Notional

Fair Value
(Asset)/
Liability(1)

Years to Maturity

Credit Ratings of the Reference Obligation

Less than 1

1-3

3-5

Over 5

Total

(dollars in millions)