Morgan Stanley shares bounce back

Investors aren't sweating the Morgan Stanley case, for now.

The investment bank's stock sank early Wednesday on reports that it was facing a probe of its dealings in subprime-related debt. The Securities and Exchange Commission sued Goldman Sachs (GS) last month over its handling of a similar deal, known as a collateralized debt obligation, and investors have since been on the lookout for the next bank to face a federal investigation of bubble-era shenanigans.

The thought that Morgan Stanley (MS) might be the next to face the music seemed likely, given a jump this morning in the cost of insuring against a default on the firm's debt. The annual price of buying protection on Morgan bonds rose 8% in morning trading to $206,000 per $10 million of five-year debt, according to CMA.

But the firm's assertion that it hasn't been contacted by the Justice Department seems to have won the day. By the end of the day, Morgan Stanley shares were down just 2% and its credit default swap spreads were actually a bit narrower than they were at the end of the day Tuesday, indicating that there is less of a perceived risk for Chairman John Mack (right) and company.

With the stock trading near book value and everyone expecting additional scrutiny of questionable trades, it will take more than a mere report of a probe to move the needle. "We think downside potential is relatively limited from current levels," Citi analyst Keith Horowitz wrote Wednesday morning. He rates Morgan Stanley hold.

That makes sense, for the moment. But given the backlash against the banks and the extent of bubble-era envelope-pushing on Wall Street, "hold onto your seats" might be the more apt rating for the big banks.