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Morgan, Merrill and Lehman Cut By S&P

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Downgrades leave investors wondering who's next.

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Just when you thought the news for investment banks couldn't get worse, Standard & Poor's cut the credit ratings Monday of market stalwarts Morgan Stanley (MS), Lehman Brothers (LEH) and Merrill Lynch (MER). Per Bloomberg:

Morgan Stanley, the second-biggest U.S. securities firm by market value, was cut to A+ from AA-, S&P said today in a report. Merrill Lynch, the third-biggest, was cut to A from A+, as was Lehman Brothers, the fourth-biggest. The "actions reflect prospects of continued weakness in the investment banking business and the potential for more write-offs, though not of the magnitude of those of the past few quarters,'' Tanya Azarchs, an S&P analyst, said today in a statement.

This is a negative for these companies, as well as the rest of the group. Here's why:

The Bloomberg article points out that analyst Brad Hintz said, "The ratings downgrades may make it harder for the banks to sell derivatives such as credit-default swaps that are tied to bonds or loans." While this issue is unlikely to be the death knell of any of the aforementioned companies, it could nonetheless affect business and by extension share price.

The downgrades may also turn off some would-be or fence-sitting retail and institutional investors, keeping them out of the stock. Furthermore -- and this is purely speculative --management at these firms may be starting to sense that swinging public opinion in their favor, at least in the near term, is unlikely. If that's the case, expect to see one or more take asset write-downs (in effect, write-downs of everything except the kitchen sink) and, for all intents and purposes, scrap the year. Bad news this year could make next year's numbers appear as pure as the driven snow.

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But don't think this is going to be the final shoe to drop for big players in the financial industry. According to CNBC, "The rating agency also said it may downgrade Wachovia (WB) and revised outlooks to negative on Bank of America (BAC) and JPMorgan Chase (JPM)."

Morgan Stanley was down $1.13 a share, or 2.55%, on the news. Merrill was off $1.30 a share, or almost 3%, and Lehman was off almost $3, or a little more than 8%, in regular trading. Morgan Stanley and Merrill were down a fraction in after-hours action. Lehman was up a smidge.

No positions in stocks mentioned.

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