Oct. 10 (Bloomberg) -- Morgan Stanley's stock and bonds dropped for a fifth day after Moody's Investors Service said it may reduce the U.S. investment bank's credit rating on concern the financial crisis threatens earnings and investor confidence.

Morgan Stanley fell 22 percent in New York Stock Exchange composite trading to the lowest level since 1996. The shares have lost almost 60 percent this week. Senior unsecured debt that matures in April 2018 fell to 61 cents on the dollar from 63 cents yesterday. Shares of Goldman Sachs Group Inc., which had its credit rating outlook changed to negative, fell 12.4 percent.

The possible downgrade adds to pressure on Chief Executive Officer John Mack, 63, as he seeks to assure shareholders, creditors and clients about the firm's health. The bankruptcy of Lehman Brothers Holdings Inc. and emergency sales of Merrill Lynch & Co. and Bear Stearns Cos. sparked concern that firms like Morgan Stanley that depend on debt markets will run out of funding.

``An extended downturn in global capital market activity will reduce Morgan Stanley's revenue and profit potential in 2009, and perhaps beyond this period,'' Moody's said in an e- mailed statement. ``Investor, counterparty and customer confidence is critical to the funding and profit generation of the firm, especially in a hostile market environment.''

Moody's put Morgan Stanley's A1 long-term rating on review for a possible downgrade and lowered its outlook for Goldman Sachs Group Inc.'s Aa3 long-term rating to negative.

The U.S. government probably won't let Morgan Stanley and larger rival Goldman Sachs go bankrupt, because Lehman's failure roiled debt markets so severely, said Benjamin Wallace, an analyst at Grimes & Co. at Westborough, Massachusetts, which manages about $700 million.

Lesson Learned

``The government learned its lesson with Lehman,'' said Wallace. ``You need them to potentially come in and invest in these companies.''

U.S. President George W. Bush said earlier today the government will ``aggressively'' use a ``wide range of tools'' to help stabilize markets and resolve the financial crisis. Treasury Secretary Henry Paulson is working to put into place a Congress- approved $700 billion rescue plan and the government may buy stakes in several banks.

Morgan Stanley dropped $2.77 to $9.68 at 4 p.m. in New York Stock Exchange composite trading, after sinking to $6.71. Goldman fell $12.55 to $88.80 after dropping as low as $74.

Egan-Jones Ratings Co. said Morgan Stanley probably needs to raise $60 billion in new equity to reassure customers and investors, up from a $30 billion estimate yesterday. The investment bank has about $900 billion of assets. Mark Lake, a Morgan Stanley spokesman, declined to comment.

Snowball Effect

``The analogy is a snowball rolling down a mountain; the mass needed to stop that negative momentum increases as that snowball picks up speed and size,'' Egan-Jones's Sean Egan said in a phone interview today. ``Perception trumps reality. They need a massive injection to stop the slide and hopefully they don't commit the Bear Stearns or Lehman mistake.''

Morgan Stanley and Goldman Sachs declined this week as a short-selling ban expired and concern grew about their earnings prospects. The New York-based firms have transformed themselves into bank holding companies and raised money from outside investors to help weather the credit market turmoil that toppled Lehman Brothers.

Morgan Stanley's stock has ``been under extraordinary pressure as of late, for no apparent fundamental reason, as we estimate liquidity, the balance sheet, and long-term earnings prospects are sound,'' David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, wrote in a note today. ``However, as we've seen with Bear Stearns and Lehman, once the fear virus has infected the story, it is tough to shake.''

Mitsubishi UFJ

The Morgan Stanley credit review affects about $200 billion of debt, Moody's said. The ratings company affirmed its Prime-1 grade for Morgan Stanley's short-term debt. The outlook for Goldman affects $175 billion of debt, and the company's short- term ratings were also affirmed at Prime-1.

Moody's in August cut Morgan Stanley's long-term credit rating from Aa3. At A1, the firm now has the fifth-highest investment grade rating.

Morgan Stanley is selling more than 20 percent of itself to Japan's Mitsubishi UFJ Financial Group Inc. for $9 billion. Morgan Stanley's total market value at today's closing price is about $10.3 billion.

``I would be angry if I were a Mitsubishi shareholder and I got the same amount of Morgan Stanley when the stock has been cut in value,'' said Kenneth Crawford, a senior portfolio manager at Argent Capital Management in St. Louis, Missouri.

`Incredible Scenarios'

Morgan Stanley and Mitsubishi UFJ have moved to quash speculation that their agreement would collapse. The deal will close Oct. 14 ``as planned,'' Mitsubishi UFJ spokesman Takashi Takeuchi said today in an interview. Mitsubishi UFJ agreed to pay $6 billion for preferred stock and $3 billion for common stock at a value of $25.25 apiece, or 50 percent more than yesterday's closing price of $12.45.

There have been no discussions on changing the terms of the transaction, according to a person familiar with the situation at Morgan Stanley. Executives at the firm are expecting Mitsubishi may demand a bigger stake, CNBC reported, citing senior officials at the U.S. company. Another option is for the U.S. Treasury to buy part of Morgan Stanley, CNBC said.

Crawford said he sold his Morgan Stanley stock last month after Lehman went bankrupt and American International Group Inc. was forced to rely on government support to fund itself.

``After Lehman was allowed to go bust and then AIG couldn't come up with the liquidity they needed, all of a sudden it seemed more likely that incredible scenarios could be more credible,'' he said.

Controls

Closing the investment from Mitsubishi UFJ will be ``critical'' for Morgan Stanley to keep its current credit ratings, Moody's said.

``Morgan Stanley's recent performance has been relatively solid, it has acted to solidify its capital base, it has maintained a good liquidity profile, and it has benefited from a level of systemic support that is factored into the rating,'' Moody's said in its release.

For Morgan Stanley and Goldman, becoming bank holding companies regulated by the Federal Reserve may ``limit profit opportunities,'' while at the same time lower risks, Moody's said.

``Based on the fact that they're allegedly commercial banks now and are moving that way, I think they're likely to get protection,'' said Grimes & Co.'s Wallace. ``Whatever solution they come up with for the banking industry as a whole will apply to them, because they're no longer special.''

Goldman has raised $10 billion, including $5 billion from billionaire investor Warren Buffett. The company, led by Chief Executive Officer Lloyd Blankfein, has recorded $4.9 billion of credit market losses since August last year, compared with $15.7 billion at Morgan Stanley.

``Goldman's commitment to controls is noteworthy,'' said Moody's analyst Peter Nerby in the statement.

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net.

Last Updated: October 10, 2008 17:00 EDT