"The financial crisis of 2008 caused the industry to fundamentally re-evaluate the way it manages liquidity," Lake said. "We have taken the lessons we learned from that period and applied them to our liquidity-management program to protect both our franchise and our clients going forward."
Lake wouldn't say what practices the firm has changed.
Hedge funds are mostly private, unregulated and unrated investment pools that often try to increase trading returns by supplementing their own capital with stock and cash borrowed from Wall Street's prime-brokerage divisions.
Prime-Brokerage Revenue
The world's 10 largest investment banks garnered about $10 billion in revenue from prime brokerage in 2010, almost as much as they made trading stocks, according to London-based research firm Coalition Development Ltd. The top 25 hedge-fund managers earned $22.1 billion in 2010, according to AR magazine.
Prior to the crisis, prime brokerage was one of Morgan Stanley's most profitable businesses, generating at least $2 billion of revenue a year, according to Brad Hintz, a former Morgan Stanley treasurer who now follows the firm as an analyst at Sanford C. Bernstein & Co. in New York. The bank doesn't disclose how much revenue it gets from the business.
Any requirement that prime brokers keep more cash on hand to survive a hedge-fund run may cut into the profitability of the business. That's because cash and Treasury securities that can be liquidated easily in a squeeze are less profitable to hold than loans and bonds that pay higher interest rates. Also, prime brokers may have to issue more long-term debt, which would force them to pay higher interest rates, said Richard Lindsey, a former prime-brokerage chief at Bear Stearns Cos.
'Infinitely Lived Borrowing'
"The safest way to fund something is to take out long-term debt or, even better, equity, which is essentially infinitely lived borrowing," said Lindsey, now principal of Callcott Group LLC in New York, which advises pension funds and endowments on portfolio risks. "The problem of course is that those are the most expensive forms of financing."
In July 2008, Morgan Stanley said in a regulatory filing that its policies were designed "to ensure adequate funding over a wide range of market environments." The firm's "contingency" plan anticipated a "potential, prolonged liquidity contraction over a one-year time period," according to the filing. Resources included a $5 billion credit line from a group of banks that could be used in an emergency.
At the end of August, Morgan Stanley had $179 billion of liquidity, filings show. The firm had $2 billion of Fed loans outstanding on Aug. 31, according to data compiled by Bloomberg.
As of Sept. 29, its liquidity had shrunk 44 percent to $99.8 billion, according to internal reports released by the crisis commission. By then, the firm had $107.3 billion of Fed loans outstanding, the Bloomberg data show.
'Adverse Funding Flows'