PIMCO Schools Morgan Stanley

Rumor has it that PIMCO is considering a name change to PIMpCO after the bitchslapping they doled out to Morgan Stanley last month.

Morgan Stanley's Edward Glenn Hadden is limping away from the inflation-based street fight with the pension giant, and it got ugly. Pay attention, kids. This is what happens when two market behemoths lock horns on opposite sides of a trade.

PIMCO expected higher long-term inflation, so they began buying TIPS - Treasury securities which increase in value as inflation increases. Hadden and Morgan Stanley took the opposite view and began shorting TIPS, and recommending clients do the same. Whenever a Morgan Stanley client called in to buy TIPS, Hadden took the other side of the trade and made it clear he would continue to do so until the trade paid off.

It worked in the early stages of the trade, but Hadden pressed the position too long. It is being reported that he made it clear to fellow TIPS participants that it was senseless to go long TIPS because Morgan Stanley was going to keep shorting them and they'd never go anywhere. But PIMCO called his bluff.

At first, the Morgan Stanley trade worked. Mr. Hadden made it clear to investors that Morgan Stanley was going to stick with its positions, and even add to them, traders say. When investors asked to buy 30-year TIPS, Morgan Stanley offered to sell investors even more of these bonds, these traders say. Morgan Stanley also recommended clients bet against 30-year TIPS, arguing it was the best move for those wishing to wager against bonds, according to a hedge-fund manager who received the pitch.

Some say Morgan Stanley's tactics were aimed at making it clear to traders that it was folly to buy 30-year TIPS because the firm was going to keep selling them. It was the equivalent of telling rivals around a poker table they should fold because you're holding a great hand.

When PIMCO caught wind that MS was aggressively short TIPS, PIMCO went into a buying frenzy on the open market. Hadden took the bait and increased his short position a like amount. Eventually Hadden got squeezed by the increased demand for TIPS, he needed to cover the short, and everyone else in the TIPS market knew it too. The blood was in the water and the feeding frenzy was about to begin.

Everyone knew he'd have to buy a huge lot of TIPS at the June 23 auction, so other traders bid them way up - making it even costlier to cover the short. PIMCO joined the party and managed to scoop up a couple billion dollars worth of TIPS at the auction, adding to Hadden's misery. Several market participants even sent congratulatory emails to PIMCO.

At the end of the day, PIMCO made about $50 million in profit, and Morgan Stanley's loss is estimated in the tens of millions. Ouch. Looks like Hadden, recently poached from Goldman Sachs, has some 'splaining to do.

The lesson here is this: if you're going to try to bully a guy out of the pot, you'd better make sure he doesn't have a bigger stack (and a better hand) than you.