Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 2007

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-11758

Morgan Stanley

(Exact Name of Registrant as Specified in its Charter)


Delaware		36-3145972
(State of Incorporation)		(I.R.S. Employer Identification No.)

1585 Broadway New York, NY		10036
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code: (212) 761-4000

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large Accelerated Filer x		Accelerated Filer ¨		Non-Accelerated Filer ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of September 30, 2007, there were 1,061,228,375 shares of the Registrant’s Common Stock, par value $.01 per share, outstanding.

MORGAN STANLEY

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended August 31, 2007


		Page
Part I—Financial Information
Item 1.	Financial Statements (unaudited)
	Condensed Consolidated Statements of Financial Condition—August 31, 2007 and November 30, 2006	1
	Condensed Consolidated Statements of Income—Three and Nine Months Ended August 31, 2007 and 2006	3
	Condensed Consolidated Statements of Comprehensive Income—Three and Nine Months Ended August 31, 2007 and 2006	4
	Condensed Consolidated Statements of Cash Flows—Nine Months Ended August 31, 2007 and 2006	5
	Notes to Condensed Consolidated Financial Statements	6
	Report of Independent Registered Public Accounting Firm	48
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	49
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	85
Item 4.	Controls and Procedures	93

Part II—Other Information
Item 1.	Legal Proceedings	94
Item 1A.	Risk Factors	95
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	95
Item 6.	Exhibits	96


		i

AVAILABLE INFORMATION

Morgan Stanley files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). You may read and copy any document we file with the SEC at the SEC’s public reference room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including Morgan Stanley) file electronically with the SEC. Morgan Stanley’s electronic SEC filings are available to the public at the SEC’s internet site, www.sec.gov.

Morgan Stanley’s internet site is www.morganstanley.com. You can access Morgan Stanley’s Investor Relations webpage at www.morganstanley.com/about/ir. Morgan Stanley makes available free of charge, on or through our Investor Relations webpage, its proxy statements, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Morgan Stanley also makes available, through its Investor Relations webpage, via a link to the SEC’s internet site, statements of beneficial ownership of Morgan Stanley’s equity securities filed by its directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

Morgan Stanley has a Corporate Governance webpage. You can access information about Morgan Stanley’s corporate governance at www.morganstanley.com/about/company/governance. Morgan Stanley posts the following on its Corporate Governance webpage:

•

Composite Certificate of Incorporation;

•

Bylaws;

•

Charters for our Audit Committee, Compensation, Management Development and Succession Committee and Nominating and Governance Committee;

•

Corporate Governance Policies;

•

Policy Regarding Communication with the Board of Directors;

•

Policy Regarding Director Candidates Recommended by Shareholders;

•

Policy Regarding Corporate Political Contributions;

•

Policy Regarding Shareholder Rights Plan;

•

Code of Ethics and Business Conduct; and

•

Integrity Hotline.

Morgan Stanley’s Code of Ethics and Business Conduct applies to all directors, officers and employees, including its Chief Executive Officer, its Chief Financial Officer and its Controller and Principal Accounting Officer. Morgan Stanley will post any amendments to the Code of Ethics and Business Conduct and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange, Inc. (“NYSE”) on its internet site. You can request a copy of these documents, excluding exhibits, at no cost, by contacting Investor Relations, 1585 Broadway, New York, NY 10036 (212-761-4000). The information on Morgan Stanley’s internet site is not incorporated by reference into this report.


		ii

Item 1.

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in millions, except share data)


	August 31, 2007		November 30, 2006
	(unaudited)
Assets
Cash and cash equivalents	$	36,588	$	20,606
Cash and securities deposited with clearing organizations or segregated under federal and other regulations or requirements (including securities at fair value of $13,865 at August 31, 2007 and $8,648 at November 30, 2006)		43,229		29,565
Financial instruments owned (approximately $155 billion and $125 billion were pledged to various parties at August 31, 2007 and November 30, 2006, respectively):
U.S. government and agency securities		40,333		39,352
Other sovereign government obligations		34,822		27,305
Corporate and other debt		159,971		158,864
Corporate equities		102,846		86,058
Derivative contracts		62,488		55,443
Investments		12,921		4,725
Physical commodities		2,704		3,031

Total financial instruments owned		416,085		374,778
Securities received as collateral		92,212		64,588
Collateralized agreements:
Securities purchased under agreements to resell		176,910		175,787
Securities borrowed		257,032		299,631
Receivables:
Consumer loans (net of allowances of $831 at November 30, 2006)		—		22,915
Customers		89,080		82,923
Brokers, dealers and clearing organizations		20,911		7,633
Other loans		16,127		11,908
Fees, interest and other		9,307		8,937
Other investments		12,722		3,232
Office facilities and other equipment, at cost (net of accumulated depreciation of $3,516 at August 31, 2007 and $3,645 at November 30, 2006)		4,193		4,086
Goodwill		2,554		2,792
Intangible assets (net of accumulated amortization of $159 at August 31, 2007 and $109 at November 30, 2006)		897		651
Other assets		7,284		11,160

Total assets	$	1,185,131	$	1,121,192


		1

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—(Continued)

(dollars in millions, except share data)


	August 31, 2007			November 30, 2006
	(unaudited)
Liabilities and Shareholders’ Equity
Commercial paper and other short-term borrowings	$	30,845		$	29,092
Deposits		23,268			28,343
Financial instruments sold, not yet purchased:
U.S. government and agency securities		19,480			26,168
Other sovereign government obligations		26,791			28,961
Corporate and other debt		9,796			10,336
Corporate equities		57,483			59,399
Derivative contracts		62,088			57,491
Physical commodities		459			764

Total financial instruments sold, not yet purchased		176,097			183,119
Obligation to return securities received as collateral		92,212			64,588
Collateralized financings:
Securities sold under agreements to repurchase		253,989			267,566
Securities loaned		145,145			150,257
Other secured financings		37,340			45,556
Payables:
Customers		171,316			134,907
Brokers, dealers and clearing organizations		10,812			7,635
Interest and dividends		5,177			4,746
Other liabilities and accrued expenses		28,466			24,975
Long-term borrowings		175,214			144,978

		1,149,881			1,085,762

Capital Units		—			66

Commitments and contingencies
Shareholders’ equity:
Preferred stock		1,100			1,100
Common stock, $0.01 par value;
Shares authorized: 3,500,000,000 at August 31, 2007 and November 30, 2006;
Shares issued: 1,211,701,552 at August 31, 2007 and November 30, 2006;
Shares outstanding: 1,062,450,986 at August 31, 2007 and 1,048,877,006 at November 30, 2006		12			12
Paid-in capital		1,471			2,213
Retained earnings		42,043			41,422
Employee stock trust		5,738			4,315
Accumulated other comprehensive loss		(95	)		(35	)
Common stock held in treasury, at cost, $0.01 par value;
149,250,566 shares at August 31, 2007 and 162,824,546 shares at November 30, 2006		(9,281	)		(9,348	)
Common stock issued to employee trust		(5,738	)		(4,315	)

Total shareholders’ equity		35,250			35,364

Total liabilities and shareholders’ equity	$	1,185,131		$	1,121,192

See Notes to Condensed Consolidated Financial Statements.


		2

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(dollars in millions, except share and per share data)


	Three Months Ended August 31,						Nine Months Ended August 31,
	2007			2006			2007			2006
	(unaudited)						(unaudited)
Revenues:
Investment banking	$	1,659		$	1,138		$	4,799		$	3,252
Principal transactions:
Trading		1,381			2,843			10,377			9,488
Investments		558			300			2,442			1,229
Commissions		1,264			880			3,392			2,794
Asset management, distribution and administration fees		1,701			1,312			4,776			3,901
Interest and dividends		14,405			12,021			43,976			31,483
Other		262			119			855			367

Total revenues		21,230			18,613			70,617			52,514
Interest expense		13,272			11,549			42,141			30,524

Net revenues		7,958			7,064			28,476			21,990

Non-interest expenses:
Compensation and benefits		3,596			3,085			13,365			10,682
Occupancy and equipment		279			233			818			658
Brokerage, clearing and exchange fees		459			339			1,186			971
Information processing and communications		302			274			865			805
Marketing and business development		190			147			542			422
Professional services		507			459			1,436			1,281
Other		360			283			1,019			716

Total non-interest expenses		5,693			4,820			19,231			15,535

Income from continuing operations before (losses) gains from unconsolidated investees and income taxes		2,265			2,244			9,245			6,455
(Losses) gains from unconsolidated investees		(19	)		20			(65	)		25
Provision for income taxes		772			676			3,029			2,127

Income from continuing operations		1,474			1,588			6,151			4,353
Discontinued operations:
Gain from discontinued operations		111			399			1,024			1,435
Provision for income taxes		(42	)		(136	)		(378	)		(522	)

Gain on discontinued operations		69			263			646			913

Net income	$	1,543		$	1,851		$	6,797		$	5,266

Preferred stock dividend requirements	$	17		$	—		$	50		$	—

Earnings applicable to common shareholders	$	1,526		$	1,851		$	6,747		$	5,266

Earnings per basic common share:
Income from continuing operations	$	1.45		$	1.57		$	6.08		$	4.29
Gain on discontinued operations		0.07			0.26			0.65			0.90

Earnings per basic common share	$	1.52		$	1.83		$	6.73		$	5.19

Earnings per diluted common share:
Income from continuing operations	$	1.38		$	1.50		$	5.79		$	4.12
Gain on discontinued operations		0.06			0.25			0.61			0.87

Earnings per diluted common share	$	1.44		$	1.75		$	6.40		$	4.99

Average common shares outstanding:
Basic		1,002,330,181			1,010,468,365			1,002,687,312			1,014,846,804

Diluted		1,057,495,875			1,055,664,392			1,053,683,836			1,055,811,711

See Notes to Condensed Consolidated Financial Statements.


		3

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in millions)


	Three Months Ended August 31,						Nine Months Ended August 31,
	2007			2006			2007			2006
	(unaudited)						(unaudited)
Net income	$	1,543		$	1,851		$	6,797		$	5,266
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments		97			22			—			152
Net change in cash flow hedges		4			(10	)		15			70
Unrealized losses on securities available for sale		(77	)		—			(77	)		—
Minimum pension liability adjustment		—			—			2			—

Comprehensive income	$	1,567		$	1,863		$	6,737		$	5,488

See Notes to Condensed Consolidated Financial Statements.


		4

MORGAN STANLEY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)


	Nine Months Ended August 31,
	2007			2006
	(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	6,797		$	5,266
Adjustments to reconcile net income to net cash used for operating activities:
Losses (gains) from unconsolidated investees		65			(25	)
Compensation payable in common stock and options		2,132			1,742
Depreciation and amortization		478			538
Provision for consumer loan losses		472			517
Gain on sale of Quilter Holdings Ltd.		(168	)		—
Aircraft-related charges		—			125
Changes in assets and liabilities:
Cash and securities deposited with clearing organizations or segregated under federal and other regulations or requirements		(13,661	)		(3,856	)
Financial instruments owned, net of financial instruments sold, not yet purchased		(42,669	)		(67,756	)
Securities borrowed		42,599			(38,783	)
Securities loaned		(5,112	)		18,544
Receivables and other assets		(23,204	)		(11,019	)
Payables and other liabilities		44,864			37,938
Securities purchased under agreements to resell		(1,123	)		2,542
Securities sold under agreements to repurchase		(14,212	)		9,678

Net cash (used for) operating activities		(2,742	)		(44,549	)

CASH FLOWS FROM INVESTING ACTIVITIES
Net proceeds from (payments for):
Office facilities and aircraft under operating leases		(1,228	)		1,327
Business acquisitions, net of cash acquired		(1,169	)		(1,676	)
Sale of Quilter Holdings Ltd.		476			—
Net principal disbursed on consumer loans		(4,776	)		(10,145	)
Sales of consumer loans		5,301			10,698
Purchases of securities available for sale		(13,194	)		—
Sales of securities available for sale		4,216			—

Net cash (used for) provided by investing activities		(10,374	)		204

CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from (payments for):
Short-term borrowings		4,624			(5,122	)
Derivatives financing activities		298			1,002
Other secured financings		(14,663	)		14,408
Deposits		15,188			6,512
Tax benefits associated with stock-based awards		242			60
Net proceeds from:
Issuance of preferred stock		—			1,097
Issuance of common stock		784			390
Issuance of long-term borrowings		54,426			33,263
Payments for:
Repayments of long-term borrowings		(21,970	)		(14,888	)
Redemption of Capital Units		(66	)		—
Repurchases of common stock		(3,237	)		(2,381	)
Cash distribution in connection with the Discover Spin-off		(5,615	)		—
Cash dividends		(913	)		(864	)

Net cash provided by financing activities		29,098			33,477

Net increase (decrease) in cash and cash equivalents		15,982			(10,868	)
Cash and cash equivalents, at beginning of period		20,606			29,414

Cash and cash equivalents, at end of period	$	36,588		$	18,546

See Notes to Condensed Consolidated Financial Statements.


		5

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.	Introduction and Basis of Presentation.

The Company. Morgan Stanley (the “Company”) is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Global Wealth Management Group and Asset Management.

A summary of the activities of each of the Company’s business segments is as follows:

Institutional Securities includes capital raising; financial advisory services, including advice on mergers and acquisitions, restructurings, real estate and project finance; corporate lending; sales, trading, financing and market-making activities in equity securities and related products and fixed income securities and related products, including foreign exchange and commodities; benchmark indices and risk management analytics; research; and investment activities.

Global Wealth Management Group provides brokerage and investment advisory services covering various investment alternatives; financial and wealth planning services; annuity and other insurance products; credit and other lending products; banking and cash management services; retirement services; and trust and fiduciary services.

Asset Management provides global asset management products and services in equity, fixed income and alternative investments, which includes private equity, infrastructure, real estate, fund of funds and hedge funds, to institutional and retail clients through proprietary and third party retail distribution channels, intermediaries and the Company’s institutional distribution channel. Asset Management also engages in investment activities.

Discontinued Operations.

Discover. On June 30, 2007, the Company completed the spin-off (the “Discover Spin-off”) of Discover Financial Services (“DFS”). The results of DFS prior to the Discover Spin-off are reported as discontinued operations for all periods presented.

Quilter Holdings Ltd. The results of Quilter Holdings Ltd. (“Quilter”) are reported as discontinued operations for all periods presented through its sale on February 28, 2007. The results of Quilter were formerly included in the Global Wealth Management Group business segment.

Aircraft Leasing. The results of the Company’s aircraft leasing business are reported as discontinued operations for all periods presented through its sale on March 24, 2006. The results of the Company’s aircraft leasing business were formerly included in the Institutional Securities business segment.

See Note 15 for additional information on discontinued operations.

Basis of Financial Information. The condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which require the Company to make estimates and assumptions regarding the valuations of certain financial instruments, the outcome of litigation and tax matters, incentive-based compensation accruals and other matters that affect the condensed consolidated financial statements and related disclosures. The Company believes that the estimates utilized in the preparation of the condensed consolidated financial statements are prudent and reasonable. Actual results could differ materially from these estimates.

In connection with the Company’s application of Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” in fiscal 2006,


		6

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

the Company adjusted its opening retained earnings for fiscal 2006 and its financial results for the first two quarters of fiscal 2006. See Note 24 to the consolidated financial statements for the fiscal year ended November 30, 2006, included in the Company’s Current Report on Form 8-K dated April 10, 2007 (the “Form 8-K”).

All material intercompany balances and transactions have been eliminated.

The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Form 8-K. The condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for the fair statement of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire year.

Reclassifications.

Deferred Compensation plans. The Company maintains various deferred compensation plans for the benefit of certain employees. Beginning December 1, 2006, increases or decreases in assets or earnings associated with such plans are reflected in net revenues, and increases or decreases in liabilities associated with such plans are reflected in compensation expense. Previously, the increases or decreases in assets and liabilities associated with these plans were both recorded in net revenues. The amount of the reclassification that was recorded within net revenues was $172 million and $358 million for the quarter and nine month period ended August 31, 2006.

Investments and Loans. During the second quarter of fiscal 2007, the Company reclassified investments that are accounted for at fair value from Other assets to Financial instruments owned—Investments in the condensed consolidated statement of financial condition. Gains and losses associated with these investments are reflected in Principal transactions—investments in the condensed consolidated statements of income.

During the second quarter of fiscal 2007, the Company reclassified investments that are not accounted for at fair value (such as investments accounted for under the equity or cost method) from Other assets to Other investments. Gains and losses associated with these investments are primarily reflected in (Losses) gains from unconsolidated investees.

During the second quarter of fiscal 2007, the Company reclassified certain structured loan products and other loans that are accounted for on an accrual basis to Receivables—Other loans. Previously, these amounts were included in Financial instruments owned—Corporate and other debt, Receivables—Customers and Receivables—Fees, interest and other. In addition, certain mortgage lending products accounted for at fair value that were previously included in Consumer loans have been reclassified to Financial instruments owned—Corporate and other debt.

These reclassifications were primarily made in order to enhance the presentation of financial instruments on the Company’s condensed consolidated statement of financial condition in connection with the Company’s adoption of Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”).

Segments. Beginning in the second quarter of fiscal 2007, the Company’s real estate investing business is included within the results of the Asset Management business segment. Previously, this business was included in the Institutional Securities business segment. Real estate advisory activities and certain passive limited


		7

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

partnership interests remain within Institutional Securities. Income before taxes associated with the real estate investing activities that were transferred to the Asset Management business segment was $46 million and $102 million for the quarter and nine months ended August 31, 2006. In addition, activities associated with certain shareholder recordkeeping services are included within the Global Wealth Management Group business segment. Previously, these activities were included within the Asset Management business segment. These changes were made in order to reflect the manner in which these segments are currently managed.

For all of the above reclassifications, prior periods have been adjusted to conform to the current year’s presentation.

Consolidation. The condensed consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and other entities in which the Company has a controlling financial interest.

For entities where (1) the total equity investment at risk is sufficient to enable the entity to finance its activities independently, and (2) the equity holders bear the economic residual risks of the entity and have the right to make decisions about the entity’s activities, the Company consolidates those entities it controls through a majority voting interest or otherwise. For entities that do not meet these criteria, commonly known as variable interest entities (“VIE”), the Company consolidates those entities where the Company absorbs a majority of the expected losses or a majority of the expected residual returns, or both, of such entities.

Notwithstanding the above, certain securitization vehicles, commonly known as qualifying special purpose entities, are not consolidated by the Company if they meet certain criteria regarding the types of assets and derivatives they may hold, the types of sales they may engage in, and the range of discretion they may exercise in connection with the assets they hold.

For investments in entities in which the Company does not have a controlling financial interest, but has significant influence over operating and financial decisions, the Company generally applies the equity method of accounting, except in instances where the Company has elected to fair value certain investments that had previously been accounted for under the equity method (see Note 18).

Equity and partnership interests held by entities qualifying for accounting purposes as investment companies are carried at fair value.

The Company’s U.S. and international subsidiaries include Morgan Stanley & Co. Incorporated (“MS&Co.”), Morgan Stanley & Co. International plc (“MSIP”), Morgan Stanley Japan Securities Co., Ltd. (“MSJS”) and Morgan Stanley Investment Advisors Inc. On April 1, 2007, the Company merged Morgan Stanley DW Inc. (“MSDWI”) into MS&Co. Upon completion of the merger, the surviving entity, MS&Co., became the Company’s principal U.S. broker-dealer.

Income Statement Presentation. The Company, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. In connection with the delivery of the various products and services to clients, the Company manages its revenues and related expenses in the aggregate. As such, when assessing the performance of its businesses, the Company considers its principal trading, investment banking, commissions and interest and dividend income, along with the associated interest expense, as one integrated activity for each of the Company’s separate businesses.


		8

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The Company’s cost infrastructure supporting its businesses varies by activity. In some cases, these costs are directly attributable to one line of business, and, in other cases, such costs relate to multiple businesses. As such, when assessing the performance of its businesses, the Company does not consider these costs separately, but rather assesses performance in the aggregate along with the related revenues.

Therefore, the Company’s pricing structure considers various items, including the level of expenses incurred directly and indirectly to support the cost infrastructure, the risk it incurs in connection with a transaction, the overall client relationship and the availability in the market for the particular product and/or service. Accordingly, the Company does not manage or capture the costs associated with the products or services sold or its general and administrative costs by revenue line, in total or by product.

Revenue Recognition.

Investment Banking. Underwriting revenues and fees for mergers, acquisitions and advisory assignments are recorded when services for the transactions are determined to be completed, generally as set forth under the terms of the engagement. Transaction-related expenses, primarily consisting of legal, travel and other costs directly associated with the transaction, are deferred and recognized in the same period as the related investment banking transaction revenue. Underwriting revenues are presented net of related expenses. Non-reimbursed expenses associated with advisory transactions are recorded within Non-interest expenses.

Commissions. The Company generates commissions from executing and clearing customer transactions on stock, options and futures markets. Commission revenues are recorded in the accounts on trade date.

Asset Management, Distribution and Administration Fees. Asset management, distribution and administration fees are recognized over the relevant contract period, generally quarterly or annually. In certain management fee arrangements, the Company is entitled to receive performance-based fees (also referred to as incentive fees) when the return on assets under management exceeds certain benchmark returns or other performance targets. In such arrangements, performance fee revenue is accrued (or reversed) quarterly based on measuring account/fund performance to date versus the performance benchmark stated in the investment management agreement.

Financial Instruments. The Company’s financial instruments owned and financial instruments sold, not yet purchased are recorded at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

In connection with the Company’s adoption of SFAS No. 157 effective December 1, 2006, the Company categorizes its assets and liabilities that are accounted for at fair value in the condensed consolidated statements of financial condition into a fair value hierarchy as defined by SFAS No. 157. The fair value hierarchy is directly related to the amount of subjectivity associated with the inputs utilized to determine the fair value of these assets and liabilities. See Note 18 for further information about the fair value hierarchy and the Company’s assets and liabilities that are accounted for at fair value.

As a result of the Company’s adoption of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), on December 1, 2006, the Company elected the fair value option for certain instruments. Such instruments included loans and other financial instruments held by subsidiaries that are not registered broker-dealers as defined in the AICPA Audit and Accounting Guide, Brokers and Dealers in Securities, or that are not held by investment companies as defined in the AICPA Audit and Accounting Guide, Investment Companies. A substantial portion of these positions, as well as the financial instruments included within Other secured financings, had been accounted for by the Company at fair value prior to the adoption of SFAS No. 159. Changes in the fair value of these positions are included within Principal transactions—trading revenues in the Company’s condensed consolidated statements of income.

Financial Instruments Used for Trading. Financial instruments owned and Financial instruments sold, not yet purchased, which include cash and derivative products, are recorded at fair value in the condensed consolidated statements of financial condition, and gains and losses are reflected net in Principal transactions—trading


		9

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

revenues in the condensed consolidated statements of income. Interest income and expense and dividend income are recorded within the condensed consolidated statements of income depending on the nature of the instrument and related market conventions.

The fair value of the Company’s financial instruments are generally based on or derived from bid prices or parameters for Financial instruments owned and ask prices or parameters for Financial instruments sold, not yet purchased.

A substantial percentage of the fair value of the Company’s financial instruments used for trading is based on observable market prices, observable market parameters, or is derived from such prices or parameters. The availability of observable market prices and pricing parameters can vary from product to product. Where available, observable market prices and pricing parameters in a product (or a related product) may be used to derive a price without requiring significant judgment. In certain markets, such as for products that are less actively traded, observable market prices or market parameters are not available, and fair value is determined using techniques appropriate for each particular product. These techniques can, at times, involve a significant degree of judgment.

In the case of financial instruments transacted on recognized exchanges, the observable prices represent quotations for completed transactions from the exchange on which the financial instrument is principally traded. Also as a result of the adoption of SFAS No. 157 on December 1, 2006, the Company no longer utilizes block discounts in cases where it has large holdings of unrestricted financial instruments with quoted prices that are readily and regularly available in an active market.

In the case of over-the-counter (“OTC”) derivative contracts, fair value is derived primarily using pricing models, which may require multiple market input parameters. Where appropriate, valuation adjustments are made to account for various factors, including credit quality and market liquidity. These adjustments are applied on a consistent basis and are based upon observable market data where available. The Company also uses pricing models to manage the risks introduced by OTC derivatives. Depending on the product and the terms of the transaction, the fair value of OTC derivative products can be modeled using a series of techniques, including closed-form analytic formulae, such as the Black-Scholes option pricing model, simulation models or a combination thereof, applied consistently. In the case of more established derivative products, the pricing models used by the Company are widely accepted by the financial services industry. Pricing models take into account the contract terms, including the maturity, as well as market parameters such as interest rates, volatility and the creditworthiness of the counterparty. As a result of the Company’s adoption of SFAS No. 157, the impact of the Company’s own credit spreads are also considered when measuring the fair value of liabilities, including OTC derivative contracts.

Prior to the adoption of SFAS No. 157, the Company followed the provisions of Emerging Issues Task Force (“EITF”) Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (“EITF Issue No. 02-3”). See also Note 18. Under EITF Issue No. 02-3, in the absence of observable market prices or parameters in an active market, observable prices or parameters of other comparable current market transactions, or other observable data supporting a fair value based on a pricing model at the inception of a contract, revenue recognition at the inception of an OTC derivative financial instrument was not permitted. Such revenue was recognized in income at the earlier of when there was market value observability or at the end of the contract period. In the absence of observable market prices or parameters in an active market, observable prices or parameters of other comparable current market transactions, or other observable data supporting a fair value based on a pricing model at the inception of a contract, fair value was based on the transaction price. With the adoption of SFAS No. 157, the Company is no longer applying the revenue recognition criteria of EITF Issue No. 02-3.


		10

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Purchases and sales of financial instruments and related expenses are recorded on trade date. The fair value of OTC financial instruments, including derivative contracts related to financial instruments and commodities, are presented in the accompanying condensed consolidated statements of financial condition on a net-by-counterparty basis, when appropriate.

The Company nets cash collateral paid or received against its derivatives inventory under credit support annexes, which the Company views as conditional contracts, pursuant to legally enforceable master netting agreements.

Investment Activities. Substantially all equity and debt investments purchased in connection with private equity and other investment activities are recorded at fair value and are included within Financial instruments owned—Investments in the condensed consolidated statements of financial condition, and gains and losses are primarily reflected in Principal transactions—investment revenues. The carrying value of such investments reflects expected exit values based upon appropriate valuation techniques applied on a consistent basis. Such techniques employ various market, income and cost approaches to determine fair value at the measurement date. The Company’s partnership interests are included within Financial instruments owned—Investments in the condensed consolidated statements of financial condition and are recorded at fair value, which considers the fair value of the underlying partnership’s net assets.

Financial Instruments Used for Asset and Liability Management. The Company applies hedge accounting to various derivative financial instruments used to hedge interest rate, foreign exchange and credit risk arising from assets, liabilities and forecasted transactions. These instruments are included within Financial instruments owned—Derivative contracts or Financial instruments sold, not yet purchased—Derivative contracts within the condensed consolidated statements of financial condition.

These hedges are designated and qualify for accounting purposes as one of the following types of hedges: hedges of changes in fair value of assets and liabilities due to the risk being hedged (fair value hedges), hedges of the variability of future cash flows from forecasted transactions and floating rate assets and liabilities due to the risk being hedged (cash flow hedges) and hedges of net investments in foreign operations whose functional currency is different from the reporting currency of the parent company (net investment hedges).

For all hedges where hedge accounting is being applied, effectiveness testing and other procedures to ensure the ongoing validity of the hedges are performed at least monthly. The impact of hedge ineffectiveness on the condensed consolidated statements of income, primarily related to fair value hedges, was a gain of $67 million and $133 million for the quarter and nine month period ended August 31, 2007, respectively. The amount excluded from the assessment of hedge effectiveness was immaterial. If a derivative is de-designated as a hedge, it is thereafter accounted for as a financial instrument used for trading.

Fair Value Hedges—Interest Rate Risk.

In the first quarter of fiscal 2007, the Company began using regression analysis to perform an ongoing prospective and retrospective assessment of the effectiveness of these hedging relationships (i.e., the Company applied the “long-haul” method of hedge accounting). A hedging relationship is deemed to be effective if the fair values of the hedging instrument (derivative) and the hedged item (debt liability) change inversely within a range of 80% to 125%.

Previously, the Company’s designated fair value hedges consisted primarily of interest rate swaps designated as fair value hedges of changes in the benchmark interest rate of fixed rate borrowings, including both certificates of deposit and senior long-term borrowings. For these hedges, the Company ensured that the terms of the hedging instruments and hedged items matched and other accounting criteria were met so that the hedges were assumed


		11

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

to have no ineffectiveness (i.e., the Company applied the “shortcut” method of hedge accounting). The Company also used interest rate swaps as fair value hedges of the benchmark interest rate risk of host contracts of equity-linked notes that contained embedded derivatives. For these hedging relationships, regression analysis was used for the prospective and retrospective assessments of hedge effectiveness.

For qualifying fair value hedges of benchmark interest rates, the changes in the fair value of the derivative and the changes in the fair value of the hedged liability provide offset of one another and, together with any resulting ineffectiveness, are recorded in Interest expense. When a derivative is de-designated as a hedge, any basis adjustment remaining on the hedged liability is amortized to Interest expense over the life of the liability using the effective interest method.

Fair Value Hedges—Credit Risk.

The Company has designated a portion of the credit derivative embedded in a non-recourse structured note liability as a fair value hedge of the credit risk arising from a loan receivable to which the structured note liability is specifically linked. Regression analysis is used to perform prospective and retrospective assessments of hedge effectiveness for this hedge relationship. The changes in the fair value of the derivative and the changes in the fair value of the hedged item provide offset of one another and, together with any resulting ineffectiveness, are recorded in Principal transactions—trading revenues.

Cash Flow Hedges.

Before the sale of the aircraft leasing business (see Note 15), the Company applied hedge accounting to interest rate swaps used to hedge variable rate long-term borrowings associated with this business. Changes in the fair value of the swaps were recorded in Accumulated other comprehensive income (loss) in Shareholders’ equity, net of tax effects, and then reclassified to Interest expense as interest on the hedged borrowings was recognized.

In connection with the sale of the aircraft leasing business, the Company de-designated the interest rate swaps associated with this business effective August 31, 2005 and no longer accounts for them as cash flow hedges. Amounts in Accumulated other comprehensive income (loss) related to those interest rate swaps continue to be reclassified to Interest expense since the related borrowings remain outstanding.

Net Investment Hedges.

The Company utilizes forward foreign exchange contracts and non-U.S. dollar-denominated debt to manage the currency exposure relating to its net investments in non-U.S. dollar functional currency operations. No hedge ineffectiveness is recognized in earnings since the notional amounts of the hedging instruments equal the portion of the investments being hedged, and, where forward contracts are used, the currencies being exchanged are the functional currencies of the parent and investee; where debt instruments are used as hedges, they are denominated in the functional currency of the investee. The gain or loss from revaluing hedges of net investments in foreign operations at the spot rate is deferred and reported within Accumulated other comprehensive income (loss) in Shareholders’ equity, net of tax effects. The forward points on the hedging instruments are recorded in Interest and dividend revenues.

Securitization Activities. The Company engages in securitization activities related to commercial and residential mortgage loans, corporate bonds and loans, U.S. agency collateralized mortgage obligations and other types of financial assets (see Note 3). The Company may retain interests in the securitized financial assets as one or more tranches of the securitization. The exposure to credit losses from securitized loans is limited to the Company’s


		12

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

retained contingent risk, which represents the Company’s retained interest in securitized loans. The gain or loss on the sale of financial assets depends, in part, on the previous carrying amount of the assets involved in the transfer allocated between the assets sold and the retained interests based upon their respective fair values at the date of sale. To determine fair values, observable market prices are used if available. However, observable market prices may not be available for certain retained interests so the Company estimates fair value based on the present value of expected future cash flows using its best estimates of the key assumptions, including forecasted credit losses, payment rates, forward yield curves and discount rates commensurate with the risks involved.

In connection with the adoption of SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140” (“SFAS No. 156”) on December 1, 2006, the Company has elected to fair value mortgage servicing rights (see Note 3).

Securities Available for Sale. In the second quarter of fiscal 2007, the Company purchased certain debt securities that have been classified as “securities available for sale”. Securities available for sale are reported at fair value within Other Investments in the condensed consolidated statement of financial condition with unrealized gains and losses reported in Other Comprehensive Income (net of tax). Realized gains and losses and other-than-temporary impairments associated with securities available for sale are reported in Other revenues in the condensed consolidated statement of income (see Note 19).

Stock-Based Compensation. The Company early adopted SFAS No. 123R, “Share-Based Payment,” using the modified prospective approach as of December 1, 2004. SFAS No. 123R revised the fair value-based method of accounting for share-based payment liabilities, forfeitures and modifications of stock-based awards and clarified guidance in several areas, including measuring fair value, classifying an award as equity or as a liability and attributing compensation cost to service periods.

For stock-based awards issued prior to the adoption of SFAS No. 123R, the Company’s accounting policy for awards granted to retirement-eligible employees is to recognize compensation cost over the service period specified in the award terms. The Company accelerates any unrecognized compensation cost for such awards if and when a retirement-eligible employee leaves the Company.

For fiscal 2005 year-end stock-based compensation awards that were granted to retirement-eligible employees in December 2005, the Company recognized the compensation cost for such awards at the date of grant instead of over the service period specified in the award terms. As a result, the Company recorded non-cash incremental compensation expenses of approximately $378 million in the first quarter of fiscal 2006 for stock-based awards granted to retirement-eligible employees as part of the fiscal 2005 year-end award process and for awards granted to retirement-eligible employees, including new hires, in the first quarter of fiscal 2006. These incremental expenses were included within Compensation and benefits expense and reduced income before taxes within the Institutional Securities ($270 million), Global Wealth Management Group ($80 million) and Asset Management ($28 million) business segments.

Consolidated Statements of Cash Flows. For purposes of these statements, cash and cash equivalents consist of cash and highly liquid investments not held for resale with maturities, when purchased, of three months or less. In connection with business acquisitions, the Company assumed liabilities of $7,704 million and $30 million in the nine months ended August 31, 2007 and August 31, 2006, respectively. In connection with the Discover Spin-off, net assets of approximately $5,558 million were distributed to shareholders (see Note 15).


		13

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

2.	Goodwill and Net Intangible Assets.

The Company completed its annual goodwill impairment testing, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” as of December 1, 2006 and 2005. During the quarter ended August 31, 2007, the Company changed the date of its annual goodwill impairment testing to June 1 in order to move the impairment testing outside of the Company’s normal year-end reporting process to a date when resources are less constrained. The Company believes that the resulting change in accounting principle related to the annual testing date will not delay, accelerate, or avoid an impairment charge. Goodwill impairment tests performed as of June 1, 2007 and December 1, 2006 and 2005 concluded that no impairment charges were required as of those dates. The Company determined that the change in accounting principle related to the annual testing date is preferable under the circumstances and does not result in adjustments to the Company’s financial statements when applied retrospectively.

Changes in the carrying amount of the Company’s goodwill and intangible assets for the nine month period ended August 31, 2007 were as follows:


	Institutional Securities			Global Wealth Management Group			Asset Management			Discover			Total
	(dollars in millions)
*Goodwill:*
Balance as of November 30, 2006	$	701		$	589		$	968		$	534		$	2,792
Translation adjustments		—			9			—			2			11
Goodwill acquired during the period and other(1)		415			3			132			—			550
Goodwill disposed during the period(2)		(8	)		(255	)		—			(536	)		(799	)

Balance as of August 31, 2007	$	1,108		$	346		$	1,100		$	—		$	2,554


	Institutional Securities			Global Wealth Management Group			Asset Management			Discover			Total
	(dollars in millions)
*Intangible assets(3):*
Balance as of November 30, 2006	$	447		$	—		$	3		$	201		$	651
Intangible assets acquired during the period and other(1)		341			—			205			5			551
Intangible assets disposed during the period(2)		(39	)		—			—			(200	)		(239	)
Amortization expense and other(4)		(51	)		—			(9	)		(6	)		(66	)

Balance as of August 31, 2007	$	698		$	—		$	199		$	—		$	897

(1)

Institutional Securities activity primarily represents goodwill and intangible assets acquired in connection with the Company’s acquisitions of Saxon Capital, Inc. and CityMortgage Bank. Asset Management activity represents goodwill and intangible assets acquired in connection with the Company’s acquisitions of FrontPoint Partners, Brookville Capital Management and Affinity Asset Management.

(2)	Global Wealth Management Group activity primarily represents goodwill disposed of in connection with the Company’s sale of Quilter. Discover activity represents goodwill and intangible assets disposed of in connection with the Discover Spin-off (see Note 15).

(3)	Effective December 1, 2006, mortgage servicing rights have been included in net intangible assets. Amounts as of November 30, 2006 have been reclassified to conform with the current presentation. See Note 3 for further information on the Company’s mortgage servicing rights.

(4)	Amortization expense for Discover is included in discontinued operations.


		14

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

3.	Collateralized and Securitization Transactions.

Securities purchased under agreements to resell (“reverse repurchase agreements”) and Securities sold under agreements to repurchase (“repurchase agreements”), principally government and agency securities, are carried at the amounts at which the securities subsequently will be resold or reacquired as specified in the respective agreements; such amounts include accrued interest. Reverse repurchase agreements and repurchase agreements are presented on a net-by-counterparty basis, when appropriate. The Company’s policy is to take possession of securities purchased under agreements to resell. Securities borrowed and Securities loaned are carried at the amounts of cash collateral advanced and received in connection with the transactions. Other secured financings include the liabilities related to transfers of financial assets that are accounted for as financings rather than sales, consolidated variable interest entities where the Company is deemed to be the primary beneficiary and certain equity-referenced securities and loans where in all instances these liabilities are payable solely from the cash flows of the related assets accounted for as Financial instruments owned.

The Company pledges its financial instruments owned to collateralize repurchase agreements and other securities financings. Pledged securities that can be sold or repledged by the secured party are identified as Financial instruments owned (pledged to various parties) in the condensed consolidated statements of financial condition. The carrying value and classification of securities owned by the Company that have been loaned or pledged to counterparties where those counterparties do not have the right to sell or repledge the collateral were as follows:


	At August 31, 2007		At November 30, 2006
	(dollars in millions)
Financial instruments owned:
U.S. government and agency securities	$	10,191	$	12,111
Other sovereign government obligations		893		893
Corporate and other debt		44,185		44,237
Corporate equities		3,910		6,662

Total	$	59,179	$	63,903

The Company enters into reverse repurchase agreements, repurchase agreements, securities borrowed and securities loaned transactions to, among other things, acquire securities to cover short positions and settle other securities obligations, to accommodate customers’ needs and to finance the Company’s inventory positions. The Company also engages in securities financing transactions for customers through margin lending. Under these agreements and transactions, the Company either receives or provides collateral, including U.S. government and agency securities, other sovereign government obligations, corporate and other debt, and corporate equities. The Company receives collateral in the form of securities in connection with reverse repurchase agreements, securities borrowed and derivative transactions, and customer margin loans. In many cases, the Company is permitted to sell or repledge these securities held as collateral and use the securities to secure repurchase agreements, to enter into securities lending and derivative transactions or for delivery to counterparties to cover short positions. At August 31, 2007 and November 30, 2006, the fair value of securities received as collateral where the Company is permitted to sell or repledge the securities was $987 billion and $942 billion, respectively, and the fair value of the portion that has been sold or repledged was $771 billion and $780 billion, respectively.

The Company additionally receives securities as collateral in connection with certain securities for securities transactions in which the Company is the lender. In instances where the Company is permitted to sell or repledge these securities, the Company reports the fair value of the collateral received and the related obligation to return


		15

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

the collateral in the condensed consolidated statement of financial condition. At August 31, 2007 and November 30, 2006, $92 billion and $65 billion, respectively, were reported as Securities received as collateral and an Obligation to return securities received as collateral in the condensed consolidated statements of financial condition. Collateral received in connection with these transactions that was subsequently repledged was approximately $80 billion and $45 billion at August 31, 2007 and November 30, 2006, respectively.

The Company manages credit exposure arising from reverse repurchase agreements, repurchase agreements, securities borrowed and securities loaned transactions by, in appropriate circumstances, entering into master netting agreements and collateral arrangements with counterparties that provide the Company, in the event of a customer default, the right to liquidate collateral and the right to offset a counterparty’s rights and obligations. The Company also monitors the fair value of the underlying securities as compared with the related receivable or payable, including accrued interest, and, as necessary, requests additional collateral to ensure such transactions are adequately collateralized. Where deemed appropriate, the Company’s agreements with third parties specify its rights to request additional collateral. Customer receivables generated from margin lending activity are collateralized by customer-owned securities held by the Company. For these transactions, adherence to the Company’s collateral policies significantly limits the Company’s credit exposure in the event of customer default. The Company may request additional margin collateral from customers, if appropriate, and, if necessary, may sell securities that have not been paid for or purchase securities sold, but not delivered from customers.

In connection with its Institutional Securities business, the Company engages in securitization activities related to residential and commercial mortgage loans, U.S. agency collateralized mortgage obligations, corporate bonds and loans, and other types of financial assets. These assets are carried at fair value, and any changes in fair value are recognized in the condensed consolidated statements of income. The Company may act as underwriter of the beneficial interests issued by securitization vehicles. Underwriting net revenues are recognized in connection with these transactions. The Company may retain interests in the securitized financial assets as one or more tranches of the securitization. These retained interests are included in the condensed consolidated statements of financial condition at fair value. Any changes in the fair value of such retained interests are recognized in the condensed consolidated statements of income. Retained interests in securitized financial assets associated with the Institutional Securities business were approximately $6.4 billion at August 31, 2007, the majority of which were related to residential mortgage loan, U.S. agency collateralized mortgage obligation and commercial mortgage loan securitization transactions. Net gains at the time of securitization were $69 million in the nine month period ended August 31, 2007. The assumptions that the Company used to determine the fair value of its retained interests at the time of securitization related to those transactions that occurred during the quarter and nine month period ended August 31, 2007 were not materially different from the assumptions included in the table below.


		16

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following table presents information on the Company’s residential mortgage loan, commercial mortgage loan and U.S. agency collateralized mortgage obligation securitization transactions. Key economic assumptions and the sensitivity of the current fair value of the retained interests to immediate 10% and 20% adverse changes in those assumptions at August 31, 2007 were as follows (dollars in millions):


	Residential Mortgage Loans			Commercial Mortgage Loans			U.S. Agency Collateralized Mortgage Obligations
Investment grade retained interests	$	572		$	1,058		$	1,411
Non-investment grade retained interests		2,518			646			—

Total retained interests (carrying amount/fair value)	$	3,090		$	1,704		$	1,411

Weighted average life (in months)		51			60			74
Credit losses (rate per annum)		0.00 - 8.00	%		0.00 - 5.20	%		—
Impact on fair value of 10% adverse change	$	(264	)	$	(4	)	$	—
Impact on fair value of 20% adverse change	$	(517	)	$	(8	)	$	—
Weighted average discount rate (rate per annum)		11.46	%		7.55	%		5.69	%
Impact on fair value of 10% adverse change	$	(101	)	$	(22	)	$	(40	)
Impact on fair value of 20% adverse change	$	(193	)	$	(44	)	$	(77	)
Prepayment speed assumption(1)(2)		194-7500	PSA		—			152-362	PSA
Impact on fair value of 10% adverse change	$	(190	)	$	—		$	(5	)
Impact on fair value of 20% adverse change	$	(282	)	$	—		$	(10	)

(1)	Amounts for residential mortgage loans exclude positive valuation effects from immediate 10% and 20% changes.

(2)	Commercial mortgage loans typically contain provisions that either prohibit or economically penalize the borrower from prepaying the loan for a specified period of time.

The table above does not include the offsetting benefit of any financial instruments that the Company may utilize to hedge risks inherent in its retained interests. In addition, the sensitivity analysis is hypothetical and should be used with caution. Changes in fair value based on a 10% or 20% variation in an assumption generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interests is calculated independent of changes in any other assumption; in practice, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. In addition, the sensitivity analysis does not consider any corrective action that the Company may take to mitigate the impact of any adverse changes in the key assumptions.

In connection with its Institutional Securities business, during the nine month periods ended August 31, 2007 and 2006, the Company received proceeds from new securitization transactions of $55.9 billion and $52.8 billion, respectively, and cash flows from retained interests in securitization transactions of $4.1 billion and $3.9 billion, respectively.

Mortgage Servicing Rights. In connection with its Institutional Securities business, the Company may retain servicing rights to certain mortgage loans that are sold through its securitization activities. These transactions create an asset referred to as mortgage servicing rights (“MSRs”), which are included within Intangible assets in the condensed consolidated statements of financial condition.

In March 2006, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 156, which requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if


		17

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

practicable. The standard permits an entity to subsequently measure each class of servicing assets or servicing liabilities at fair value and report changes in fair value in the statement of income in the period in which the changes occur. The Company adopted SFAS No. 156 on December 1, 2006 and has elected to fair value MSRs held as of the date of adoption. This election did not have a material impact on the Company’s opening balance of Retained earnings as of December 1, 2006. The Company also elected to fair value MSRs acquired after December 1, 2006.

The following table presents information about the Company’s MSRs, which relate to its mortgage loan business activities (dollars in millions):


	Three Months Ended August 31, 2007			Nine Months Ended August 31, 2007
	(dollars in millions)
Fair value as of the beginning of the period	$	338		$	93
Additions:
Purchases of servicing assets(1)		15			283
Servicing assets that result from transfers of financial assets		251			388

Total Additions		266			671
Subtractions:
Sales/Disposals		(208	)		(317	)
Changes in fair value(2)		(39	)		(90	)

Fair value as of the end of the period	$	357		$	357

Amount of contractually specified(2):
Servicing fees	$	46		$	122
Late fees		7			19
Ancillary fees		—			1

	$	53		$	142

(1)	Includes MSRs obtained in connection with the Company’s acquisition of Saxon Capital, Inc. (see Note 16).

(2)	These amounts are recorded within Other revenues in the Company’s condensed consolidated statements of income.


	Three Months Ended August 31, 2007	Nine Months Ended August 31, 2007
Assumptions Used in Measuring Fair Value:
Weighted average discount rate	16.64%	16.80%
Weighted average prepayment speed assumption	641 PSA	641 PSA

The Company generally utilizes information provided by third parties in order to determine the fair value of its MSRs. The valuation of MSRs consist of projecting servicing cash flows and discounting such cash flows using an appropriate risk-adjusted discount rate. These valuations require estimation of various assumptions, including future servicing fees, credit losses and other related costs, discount rates and mortgage prepayment speeds. The Company also compares the estimated fair values of the MSRs from the valuations with observable trades of similar instruments or portfolios. Due to subsequent changes in economic and market conditions, the actual rates of prepayments, credit losses and the value of collateral may differ significantly from the Company’s original estimates. Such differences could be material. If actual prepayment rates and credit losses were higher than those


		18

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

assumed, the value of the Company’s MSRs could be adversely affected. The Company may hedge a portion of its MSRs through the use of financial instruments, including certain derivative contracts.

4.	Consumer Loans.

Consumer loans (net of allowances of $831 million) totaled $22,915 million at November 30, 2006 and were primarily related to general purpose credit card and consumer installment loans of DFS. The Company completed the Discover Spin-off in June 2007 (see Note 15). See Note 5 of the Form 8-K for information on Consumer loans as of November 30, 2006.

5.	Long-Term Borrowings and Capital Units.

Long-term Borrowings. Long-term borrowings at August 31, 2007 scheduled to mature within one year aggregated $22,984 million.

During the nine month period ended August 31, 2007, the Company issued senior notes with a carrying value at quarter end aggregating $55,551 million, including non-U.S. dollar currency notes aggregating $23,728 million. Maturities in the aggregate of these notes by fiscal year are as follows: 2007, $318 million; 2008, $5,418 million; 2009, $4,774 million; 2010, $9,479 million; 2011, $1,654 million; and thereafter, $33,908 million. In the nine month period ended August 31, 2007, $21,970 million of senior notes were repaid.

The weighted average maturity of the Company’s long-term borrowings, based upon stated maturity dates, was approximately 5.6 years at August 31, 2007.

Capital Units. The Company redeemed all $66 million of the outstanding Capital Units on February 28, 2007.

6.	Shareholders’ Equity.

Regulatory Requirements. On April 1, 2007, the Company merged MSDWI into MS&Co. Upon completion of the merger, the surviving entity, MS&Co., became the Company’s principal U.S. broker-dealer. MS&Co. is a registered broker-dealer and registered futures commission merchant and, accordingly, subject to the minimum net capital requirements of the Securities and Exchange Commission (the “SEC”), the New York Stock Exchange, Inc. and the Commodity Futures Trading Commission. MS&Co. has consistently operated in excess of these requirements. MS&Co.’s net capital totaled $6,446 million at August 31, 2007, which exceeded the amount required by $4,876 million. MSIP, a London-based broker-dealer subsidiary, is subject to the capital requirements of the Financial Services Authority, and MSJS, a Tokyo-based broker-dealer subsidiary, is subject to the capital requirements of the Financial Services Agency. MSIP and MSJS consistently operated in excess of their respective regulatory capital requirements.

Under regulatory capital requirements adopted by the Federal Deposit Insurance Corporation (the “FDIC”) and other bank regulatory agencies, FDIC-insured financial institutions must maintain (a) 3% to 4% of Tier 1 capital, as defined, to average assets (“leverage ratio”), (b) 4% of Tier 1 capital, as defined, to risk-weighted assets (“Tier 1 risk-weighted capital ratio”) and (c) 8% of total capital, as defined, to risk-weighted assets (“total risk-weighted capital ratio”). At August 31, 2007, the leverage ratio, Tier 1 risk-weighted capital ratio and total risk-weighted capital ratio of each of the Company’s FDIC-insured financial institutions exceeded these regulatory minimums.

Certain other U.S. and non-U.S. subsidiaries are subject to various securities, commodities and banking regulations, and capital adequacy requirements promulgated by the regulatory and exchange authorities of the


		19

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(UNAUDITED)

countries in which they operate. These subsidiaries have consistently operated in excess of their local capital adequacy requirements. Morgan Stanley Derivative Products Inc. and Cournot Financial Products LLC, which are triple-A rated derivative products subsidiaries, maintain certain operating restrictions that have been reviewed by various rating agencies.

The Company is a consolidated supervised entity (“CSE”) as defined by the SEC. As such, the Company is subject to group-wide supervision and examination by the SEC and to minimum capital requirements on a consolidated basis. As of August 31, 2007, the Company was in compliance with the CSE capital requirements.

MS&Co. is required to hold tentative net capital in excess of $1 billion and net capital in excess of $500 million in accordance with the market and credit risk standards of Appendix E of Rule 15c3-1. MS&Co. is also required to notify the SEC in the event that its tentative net capital is less than $5 billion. As of August 31, 2007, MS&Co. had tentative net capital in excess of the minimum and the notification requirements.

Treasury Shares. During the nine month period ended August 31, 2007, the Company purchased approximately $3.2 billion of its common stock (approximately 42 million shares) through publicly announced plans or programs at an average cost of $76.23 per share, which includes the actual price of shares purchased prior to the Discover Spin-off. During the nine month period ended August 31, 2006, the Company purchased approximately $2.4 billion of its common stock through publicly announced plans or programs at an average cost of $61.76 per share.

7.	Earnings per Common Share.

Basic earnings per share (“EPS”) is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the assumed conversion of all dilutive securities. The following table presents the calculation of basic and diluted EPS (in millions, except for per share data):


	Three Months Ended August 31,					Nine Months Ended August 31,
	2007			2006		2007			2006
Basic EPS:
Income from continuing operations	$	1,474		$	1,588	$	6,151		$	4,353
Gain on discontinued operations		69			263		646			913
Preferred stock dividend requirements		(17	)		—		(50	)		—

Net income applicable to common shareholders	$	1,526		$	1,851	$	6,747		$	5,266

Weighted average common shares outstanding		1,002			1,010		1,003			1,015

Earnings per basic common share:
Income from continuing operations	$	1.45		$	1.57	$	6.08		$	4.29
Gain on discontinued operations		0.07			0.26		0.65			0.90

Earnings per basic common share	$	1.52		$	1.83	$	6.73		$	5.19

Diluted EPS:
Net income applicable to common shareholders	$	1,526		$	1,851	$	6,747		$	5,266

Weighted average common shares outstanding		1,002			1,010		1,003			1,015
Effect of dilutive securities:
Stock options and restricted stock units		55			46		51			41

Weighted average common shares outstanding and common stock equivalents		1,057			1,056		1,054			1,056

Earnings per diluted common share:
Income from continuing operations	$	1.38		$	1.50	$	5.79		$	4.12
Gain on discontinued operations		0.06			0.25		0.61			0.87

Earnings per diluted common share	$	1.44		$	1.75	$	6.40		$	4.99


		20

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following securities were considered antidilutive and therefore were excluded from the computation of diluted EPS:


	Three Months Ended August 31,		Nine Months Ended August 31,
	2007	2006	2007	2006
	(shares in millions)
Number of antidilutive securities (including stock options and restricted stock units) outstanding at end of period	19	40	19	41

Cash dividends declared per common share were $0.27 and $0.81 for the quarter and nine month periods ended August 31, 2007 and 2006, respectively.

8.	Commitments and Contingencies.

The Company’s commitments as of August 31, 2007 are summarized below by period of expiration. Since commitments may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements:


	Years to Maturity								Total
	Less than 1		1-3		3-5		Over 5		Total
	(dollars in millions)
Letters of credit and other financial guarantees(1)	$	10,739	$	1	$	—	$	—	$	10,740
Investment activities(2)		402		185		3		854		1,444
Investment grade corporate lending commitments(3)		18,759		7,703		22,148		1,770		50,380
Non-investment grade corporate lending commitments(3)		3,812		823		4,425		26,615		35,675
Sales and trading-related commitments(4)		677		1,549		1,090		8,369		11,685
Commitments for secured lending transactions(5)		8,199		3,695		1,248		2,601		15,743
Commitments to purchase mortgage loans(6)		222		—		—		—		222
Commitments to originate mortgage loans(7)		869		—		—		—		869
Commitments to extend credit for mortgage lending(8)		3,985		—		—		—		3,985
Commitments to municipal bond trusts(9)		16,020		—		—		—		16,020
Other commitments(10)		1,221		42		4		—		1,267

Total	$	64,905	$	13,998	$	28,918	$	40,209	$	148,030

(1)	This amount represents the Company’s outstanding letters of credit and other financial guarantees, which are primarily used to satisfy various collateral requirements.

(2)	This amount represents commitments associated with the Company’s real estate, private equity and principal investment activities.

(3)

The Company’s investment grade and non-investment grade lending commitments are made in connection with corporate lending and other business activities. Credit ratings for commitments are determined by the Company’s Institutional Credit Department using methodologies generally consistent with those employed by external rating agencies. Obligor credit ratings of BB+ or lower are considered non-investment grade.

(4)	This amount represents commitments associated with the Company’s Institutional Securities sales and trading activities.

(5)

This amount represents lending commitments extended by the Company to companies that are secured by assets of the borrower. Loans made under these arrangements typically are at variable rates and generally provide for over-collateralization based upon the creditworthiness of the borrower. This amount also includes commitments to asset-backed commercial paper conduits of $1,974 million, which primarily have maturities of less than 3 years.

(6)	This amount represents the Company’s forward purchase contracts involving mortgage loans.


		21

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(7)	This amount represents residential mortgage loan commitments to individuals.

(8)	This amount represents residential home equity lines of credit.

(9)	This amount represents commitments to municipal bond trusts in connection with the Company’s Institutional Securities business.

(10)	This amount includes commercial loan commitments to small businesses and commitments related to securities-based lending activities in connection with the Company’s Global Wealth Management Group business.

In the ordinary course of business, the Company guarantees the debt and/or certain trading obligations (including obligations associated with derivatives, foreign exchange contracts and the settlement of physical commodities) of certain subsidiaries. These guarantees generally are entity or product specific and are required by investors or trading counterparties. The activities of the subsidiaries covered by these guarantees (including any related debt or trading obligations) are included in the Company’s condensed consolidated financial statements.

At August 31, 2007, the Company had commitments to enter into reverse repurchase and repurchase agreements of approximately $99 billion and $50 billion, respectively.

Legal. In the normal course of business, the Company has been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with its activities as a global diversified financial services institution. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the issuers that would otherwise be the primary defendants in such cases are bankrupt or in financial distress.

The Company is also involved, from time to time, in other reviews, investigations and proceedings (both formal and informal) by governmental and self-regulatory agencies regarding the Company’s business, including, among other matters, accounting and operational matters, certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief. The number of reviews, investigations and proceedings has increased in recent years with regards to many firms in the financial services industry, including the Company.

The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, fine, penalty or other relief, if any, might be. Subject to the foregoing, and except for the pending matter described in the paragraphs below, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of the pending matters will not have a material adverse effect on the condensed consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. Legal reserves have been established in accordance with SFAS No. 5, “Accounting for Contingencies” (“SFAS No. 5”). Once established, reserves are adjusted when there is more information available or when an event occurs requiring a change.

Coleman Litigation. On May 8, 2003, Coleman (Parent) Holdings Inc. (“CPH”) filed a complaint against the Company in the Circuit Court of the Fifteenth Judicial Circuit for Palm Beach County, Florida. The complaint relates to the 1998 merger between The Coleman Company, Inc. (“Coleman”) and Sunbeam, Inc. (“Sunbeam”). The complaint, as amended, alleges that CPH was induced to agree to the transaction with Sunbeam based on certain financial misrepresentations, and it asserts claims against the Company for aiding and abetting fraud, conspiracy and punitive damages. Shortly before trial, which commenced in April 2005, the trial court granted, in part, a motion for entry of a default judgment against the Company and ordered that portions of CPH’s


		22

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

complaint, including those setting forth CPH’s primary allegations against the Company, be read to the jury and deemed established for all purposes in the action. In May 2005, the jury returned a verdict in favor of CPH and awarded CPH $604 million in compensatory damages and $850 million in punitive damages. On June 23, 2005, the trial court issued a final judgment in favor of CPH in the amount of $1,578 million, which included prejudgment interest and excluded certain payments received by CPH in settlement of related claims against others.

On June 27, 2005, the Company filed a notice of appeal with the District Court of Appeal for the Fourth District of Florida (the “Court of Appeal”) and posted a supersedeas bond, which automatically stayed execution of the judgment pending appeal.

On March 21, 2007, the Court of Appeal issued an opinion reversing the trial court’s award for compensatory and punitive damages and remanding the case to the trial court for entry of a judgment for the Company. On June 4, 2007, the Court of Appeal’s March 21, 2007 opinion became final when the Court of Appeal issued an order denying CPH’s motions for rehearing, rehearing en banc and for certification of certain questions for review by the Florida Supreme Court (the “Supreme Court”). On June 11, 2007, the trial court issued an order cancelling the supersedeas bond that the Company had posted. On July 2, 2007 CPH filed a petition with the Supreme Court asking that court to review the Court of Appeal’s decision. On July 25, 2007, the Company filed a brief with the Supreme Court in opposition to CPH’s request that the Supreme Court review the March 21, 2007 decision of the Court of Appeal. The Company is maintaining a reserve for the Coleman litigation. The reserve is presently $360 million, which the Company believes to be a reasonable estimate, under SFAS No. 5, of the low end of the range of its probable exposure in the event the Court of Appeal’s March 21, 2007 opinion is reversed or modified as a result of further appellate proceedings and the case remanded for a new trial. If the trial court’s compensatory and/or punitive awards are ultimately upheld on appeal, in whole or in part, the Company may incur an additional expense equal to the difference between the amount affirmed on appeal (and post-judgment interest thereon) and the amount of the reserve. While the Company cannot predict with certainty the amount of such additional expense, such additional expense could have a material adverse effect on the condensed consolidated financial condition of the Company and/or the Company’s or Institutional Securities’ operating results and cash flows for a particular future period, and the upper end of the range could exceed $1.5 billion.

Income Taxes. For information on contingencies associated with income tax examinations, see Note 17.

9.	Derivative Contracts.

In the normal course of business, the Company enters into a variety of derivative contracts related to financial instruments and commodities. The Company uses these instruments for trading and investment purposes, as well as for asset and liability management. These instruments generally represent future commitments to swap interest payment streams, exchange currencies, or purchase or sell commodities and other financial instruments on specific terms at specified future dates. Many of these products have maturities that do not extend beyond one year, although swaps, options and equity warrants typically have longer maturities. For further discussion of these matters, refer to Note 11 to the consolidated financial statements for the fiscal year ended November 30, 2006, included in the Form 8-K.

Future changes in interest rates, foreign currency exchange rates or the fair values of the financial instruments, commodities or indices underlying these contracts ultimately may result in cash settlements exceeding fair value amounts recognized in the condensed consolidated statements of financial condition. The amounts in the following table represent the fair value of exchange traded and OTC options and other contracts (including interest rate, foreign exchange, and other forward contracts and swaps) for derivatives for trading and investment


		23

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

and for asset and liability management, net of offsetting positions in situations where netting is appropriate. The asset amounts are not reported net of non-cash collateral, which the Company obtains with respect to certain of these transactions to reduce its exposure to credit losses.

Credit risk with respect to derivative instruments arises from the failure of a counterparty to perform according to the terms of the contract. The Company’s exposure to credit risk at any point in time is represented by the fair value of the contracts reported as assets. The Company monitors the creditworthiness of counterparties to these transactions on an ongoing basis and requests additional collateral when deemed necessary.

The Company’s derivatives (both listed and OTC), net of cash collateral, at August 31, 2007 and November 30, 2006 are summarized in the table below, showing the fair value of the related assets and liabilities by product:


	At August 31, 2007				At November 30, 2006
Product Type	Assets		Liabilities		Assets		Liabilities
	(dollars in millions)
Interest rate and currency swaps, interest rate options, credit derivatives and other fixed income securities contracts	$	26,437	$	17,122	$	19,444	$	15,688
Foreign exchange forward contracts and options		5,952		6,775		7,325		7,725
Equity securities contracts (including equity swaps, warrants and options)		18,570		27,604		16,705		23,155
Commodity forwards, options and swaps		11,529		10,587		11,969		10,923

Total	$	62,488	$	62,088	$	55,443	$	57,491

10.

Segment Information.

The Company structures its segments primarily based upon the nature of the financial products and services provided to customers and the Company’s management organization. The Company provides a wide range of financial products and services to its customers in each of its business segments: Institutional Securities, Global Wealth Management Group and Asset Management. For further discussion of the Company’s business segments, see Note 1. Certain reclassifications have been made to prior-period amounts to conform to the current period’s presentation.

Revenues and expenses directly associated with each respective segment are included in determining their operating results. Other revenues and expenses that are not directly attributable to a particular segment are allocated based upon the Company’s allocation methodologies, generally based on each segment’s respective net revenues, non-interest expenses or other relevant measures.

As a result of treating certain intersegment transactions as transactions with external parties, the Company includes an “Intersegment Eliminations” category to reconcile the segment results to the Company’s consolidated results. Income before taxes in Intersegment Eliminations primarily represents the effect of timing differences associated with the revenue and expense recognition of commissions paid by Asset Management to the Global Wealth Management Group associated with sales of certain products and the related compensation costs paid to the Global Wealth Management Group’s global representatives.


		24

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Selected financial information for the Company’s segments is presented below:


Three Months Ended August 31, 2007	Institutional Securities			Global Wealth Management Group		Asset Management			Intersegment Eliminations(4)			Total
	(dollars in millions)
Net revenues excluding net interest	$	4,049		$	1,488	$	1,372		$	(84	)	$	6,825
Net interest		934			195		(8	)		12			1,133

Net revenues	$	4,983		$	1,683	$	1,364		$	(72	)	$	7,958

Income from continuing operations before losses from unconsolidated investees and income taxes	$	1,501		$	287	$	491		$	(14	)	$	2,265
Losses from unconsolidated investees		(19	)		—		—			—			(19	)
Provision for income taxes		483			119		174			(4	)		772

Income from continuing operations(2)	$	999		$	168	$	317		$	(10	)	$	1,474


Three Months Ended August 31, 2006	Institutional Securities(1)			Global Wealth Management Group(1)		Asset Management(1)			Intersegment Eliminations(1)			Total
	(dollars in millions)
Net revenues excluding net interest	$	4,575		$	1,235	$	835		$	(53	)	$	6,592
Net interest		319			136		10			7			472

Net revenues	$	4,894		$	1,371	$	845		$	(46	)	$	7,064

Income from continuing operations before gains from unconsolidated investees and income taxes	$	1,915		$	161	$	155		$	13		$	2,244
Gains from unconsolidated investees		20			—		—			—			20
Provision for income taxes		556			54		61			5			676

Income from continuing operations(2)	$	1,379		$	107	$	94		$	8		$	1,588


Nine Months Ended August 31, 2007	Institutional Securities(1)			Global Wealth Management Group(1)		Asset Management(1)			Intersegment Eliminations(1)(4)			Total
	(dollars in millions)
Net revenues excluding net interest	$	18,243		$	4,346	$	4,260		$	(208	)	$	26,641
Net interest		1,331			490		(19	)		33			1,835

Net revenues	$	19,574		$	4,836	$	4,241		$	(175	)	$	28,476

Income from continuing operations before losses from unconsolidated investees and income taxes	$	7,296		$	777	$	1,173		$	(1	)	$	9,245
Losses from unconsolidated investees		(65	)		—		—			—			(65	)
Provision for income taxes		2,293			308		428			—			3,029

Income from continuing operations(2)	$	4,938		$	469	$	745		$	(1	)	$	6,151


		25

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)


Nine Months Ended August 31, 2006	Institutional Securities(1)		Global Wealth Management Group(1)		Asset Management(1)			Intersegment Eliminations(1)(4)			Total
	(dollars in millions)
Net revenues excluding net interest	$	15,057	$	3,707	$	2,467		$	(200	)	$	21,031
Net interest		578		353		13			15			959

Net revenues	$	15,635	$	4,060	$	2,480		$	(185	)	$	21,990

Income from continuing operations before gains from unconsolidated investees and income taxes	$	5,521	$	339	$	583		$	12		$	6,455
Gains from unconsolidated investees		25		—		—			—			25
Provision for income taxes		1,778		114		230			5			2,127

Income from continuing operations(2)	$	3,768	$	225	$	353		$	7		$	4,353


Net Interest(1)	Institutional Securities		Global Wealth Management Group		Asset Management			Intersegment Eliminations(4)			Total
	(dollars in millions)
Three Months Ended August 31, 2007
Interest and dividends	$	14,141	$	321	$	14		$	(71	)	$	14,405
Interest expense		13,207		126		22			(83	)		13,272

Net interest	$	934	$	195	$	(8	)	$	12		$	1,133

Three Months Ended August 31, 2006
Interest and dividends	$	11,852	$	265	$	21		$	(117	)	$	12,021
Interest expense		11,533		129		11			(124	)		11,549

Net interest	$	319	$	136	$	10		$	7		$	472

Nine Months Ended August 31, 2007
Interest and dividends	$	43,355	$	893	$	57		$	(329	)	$	43,976
Interest expense		42,024		403		76			(362	)		42,141

Net interest	$	1,331	$	490	$	(19	)	$	33		$	1,835

Nine Months Ended August 31, 2006
Interest and dividends	$	31,012	$	711	$	37		$	(277	)	$	31,483
Interest expense		30,434		358		24			(292	)		30,524

Net interest	$	578	$	353	$	13		$	15		$	959


Total Assets(1)(3)	Institutional Securities		Global Wealth Management Group		Asset Management			Discover			Total
	(dollars in millions)
At August 31, 2007	$	1,151,453	$	23,134	$	10,544		$	—		$	1,185,131

At November 30, 2006	$	1,063,985	$	21,232	$	6,908		$	29,067		$	1,121,192

(1)	Certain reclassifications have been made to prior-period amounts to conform to the current period’s presentation.

(2)	See Note 15 for a discussion of discontinued operations.

(3)	Corporate assets have been fully allocated to the Company’s business segments.


		26

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(4)

Included in the results for the quarter and nine months ended August 31, 2007 is a $25 million advisory fee related to the Discover Spin-off that was eliminated in consolidation. The results for the nine months ended August 31, 2006 included a $30 million advisory fee related to the Company’s sale of the aircraft leasing business that was eliminated in consolidation.

The Company operates in both U.S. and non-U.S. markets. The Company’s non-U.S. business activities are principally conducted through European and Asian locations. The following table presents net revenues of the Company’s operations by geographic area:


	Three Months Ended August 31,				Nine Months Ended August 31,
	2007		2006		2007		2006
	(dollars in millions)
Regional revenues(1):
Americas	$	4,172	$	4,528	$	16,374	$	13,909
Europe, Middle East, and Africa		2,439		1,825		8,125		5,780
Asia		1,347		711		3,977		2,301

Total	$	7,958	$	7,064	$	28,476	$	21,990

(1)	Reflects the regional view of the Company’s consolidated net revenues, on a managed basis, based on the following methodology:

Institutional Securities: investment banking—client location, equity capital markets—client location, debt capital markets—revenue recording location, sales & trading—trading desk location. Global Wealth Management Group: global representative location. Asset Management: client location, except for the real estate investing business, which is based on asset location.

11.

Variable Interest Entities.

FASB Interpretation No. 46, as revised (“FIN 46R”), “Consolidation of Variable Interest Entities,” applies to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties (“variable interest entities”). Variable interest entities are required to be consolidated by their primary beneficiaries if they do not effectively disperse risks among parties involved. The primary beneficiary of a VIE is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable interests. The Company is involved with various entities in the normal course of business that may be deemed to be VIEs and may hold interests therein, including debt securities, interest-only strip investments and derivative instruments that may be considered variable interests. Transactions associated with these entities include asset- and mortgage-backed securitizations and structured financings (including collateralized debt, bond or loan obligations and credit-linked notes). The Company engages in these transactions principally to facilitate client needs and as a means of selling financial assets. The Company consolidates entities in which it is deemed to be the primary beneficiary. For those entities deemed to be qualifying special purpose entities (as defined in SFAS No. 140), the Company does not consolidate the entity.

The Company purchases and sells interests in entities that may be deemed to be VIEs in the ordinary course of its business. As a result of these activities, it is possible that such entities may be consolidated and deconsolidated at various points in time. Therefore, the Company’s variable interests described below may not be held by the Company at the end of future quarterly reporting periods.


		27

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

At August 31, 2007, in connection with its Institutional Securities business, the aggregate size of VIEs for which the Company was the primary beneficiary of the entities was approximately $28.5 billion, which is the carrying amount of the consolidated assets that are collateral for the entities’ obligations. The nature and purpose of these entities that the Company consolidated were to issue a series of notes to investors that provides the investors a return based on the holdings of the entities. These transactions were executed to facilitate client investment objectives and as a means of selling financial assets. The Company consolidates those entities where it holds either the entire class or a majority of the class of subordinated notes or has entered into a derivative instrument with the VIE, such that it bears the majority of the expected losses or receives a majority of the expected residual returns of the entities. The Company accounts for the assets held by the entities as Financial instruments owned and the liabilities of the entities as Other secured financings.

The following table presents information about VIEs at August 31, 2007 which the Company consolidates:


	VIE Assets that the Company Consolidates		Maximum Exposure to Loss to Consolidated VIEs(1)
	(dollars in millions)
Mortgage and asset-backed securitizations	$	9,922	$	1,050
Municipal bond trusts		837		836
Credit and real estate		6,832		6,218
Commodities financing		1,690		324
Structured transactions		9,240		8,717

Total	$	28,521	$	17,145

(1)

The Company’s maximum exposure to loss often differs from the carrying value of the VIE’s assets. The maximum exposure to loss is dependent on the nature of the Company’s variable interest in the VIEs and is limited to the notional amounts of certain liquidity facilities, other credit support, total return swaps, written put options, and the fair value of certain other derivatives and investments the Company has made in the VIEs.

At August 31, 2007, also in connection with its Institutional Securities business, the aggregate size of the entities for which the Company holds significant variable interests, which consist of subordinated and other classes of beneficial interests, derivative instruments, limited partnership investments and secondary guarantees, was approximately $41.5 billion. The Company’s variable interests associated with these entities were approximately $20.9 billion consisting primarily of senior beneficial interests, which represent the Company’s maximum exposure to loss at August 31, 2007. The Company may hedge the risks inherent in its variable interest holdings, thereby reducing its exposure to loss. The Company’s maximum exposure to loss does not include the offsetting benefit of any financial instruments that the Company utilizes to hedge these risks.


		28

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following table presents information about entities in which the Company holds significant variable interests at August 31, 2007 but does not consolidate:


	VIE Assets for which the Company Holds Significant Variable Interests But Does Not Consolidate		Maximum Exposure to Loss to Non-consolidated VIEs
	(dollars in millions)
Mortgage and asset-backed securitizations	$	6,297	$	249
Credit and real estate		26,610		18,869
Structured transactions		8,634		1,732

Total	$	41,541	$	20,850

12.

Guarantees.

The Company has certain obligations under certain guarantee arrangements, including contracts and indemnification agreements that contingently require a guarantor to make payments to the guaranteed party based on changes in an underlying measure (such as an interest or foreign exchange rate, security or commodity price, an index or the occurrence or non-occurrence of a specified event) related to an asset, liability or equity security of a guaranteed party. Also included as guarantees are contracts that contingently require the guarantor to make payments to the guaranteed party based on another entity’s failure to perform under an agreement, as well as indirect guarantees of the indebtedness of others. The Company’s use of guarantees is disclosed below by type of guarantee:

Derivative Contracts. Certain derivative contracts meet the accounting definition of a guarantee, including certain written options, contingent forward contracts and credit default swaps. Although the Company’s derivative arrangements do not specifically identify whether the derivative counterparty retains the underlying asset, liability or equity security, the Company has disclosed information regarding all derivative contracts that could meet the accounting definition of a guarantee. The maximum potential payout for certain derivative contracts, such as written interest rate caps and written foreign currency options, cannot be estimated, as increases in interest or foreign exchange rates in the future could possibly be unlimited. Therefore, in order to provide information regarding the maximum potential amount of future payments that the Company could be required to make under certain derivative contracts, the notional amount of the contracts has been disclosed.

The Company records all derivative contracts at fair value. For this reason, the Company does not monitor its risk exposure to such derivative contracts based on derivative notional amounts; rather, the Company manages its risk exposure on a fair value basis. Aggregate market risk limits have been established, and market risk measures are routinely monitored against these limits. The Company also manages its exposure to these derivative contracts through a variety of risk mitigation strategies, including, but not limited to, entering into offsetting economic hedge positions. The Company believes that the notional amounts of the derivative contracts generally overstate its exposure.


		29

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Financial Guarantees to Third Parties. In connection with its corporate lending business and other corporate activities, the Company provides standby letters of credit and other financial guarantees to counterparties. Such arrangements represent obligations to make payments to third parties if the counterparty fails to fulfill its obligation under a borrowing arrangement or other contractual obligation.

Market Value Guarantees. Market value guarantees are issued to guarantee return of principal invested to fund investors associated with certain European equity funds and to guarantee timely payment of a specified return to investors in certain affordable housing tax credit funds. The guarantees associated with certain European equity funds are designed to provide for any shortfall between the market value of the underlying fund assets and invested principal and a stipulated return amount. The guarantees provided to investors in certain affordable housing tax credit funds are designed to return an investor’s contribution to a fund and the investor’s share of tax losses and tax credits expected to be generated by a fund.

Liquidity Facilities. The Company has entered into liquidity facilities with special purpose entities and other counterparties, whereby the Company is required to make certain payments if losses or defaults occur. The Company often may have recourse to the underlying assets held by the special purpose entities in the event payments are required under such liquidity facilities.

The table below summarizes certain information regarding these guarantees at August 31, 2007:


	Maximum Potential Payout/Notional										Carrying Amount		Collateral/ Recourse
	Years to Maturity								Total
Type of Guarantee	Less than 1		1-3		3-5		Over 5		Total
	(dollars in millions)
Notional amount of derivative contracts	$	1,063,254	$	978,674	$	2,311,668	$	1,887,950	$	6,241,546	$	133,468	$	123
Standby letters of credit, sales and trading and other financial guarantees		4,663		617		1,099		4,555		10,934		20		1,951
Market value guarantees		39		113		—		601		753		44		108
Liquidity facilities(1)		17,247		275		—		90		17,612		—		18,580

(1)	Includes commitments to municipal bond trusts.

Indemnities. In the normal course of its business, the Company provides standard indemnities to counterparties for certain contingent exposures and taxes, including U.S. and foreign withholding taxes, on interest and other payments made on derivatives, securities and stock lending transactions, certain annuity products and other financial arrangements. These indemnity payments could be required based on a change in the tax laws or change in interpretation of applicable tax rulings or a change in factual circumstances. Certain contracts contain provisions that enable the Company to terminate the agreement upon the occurrence of such events. The maximum potential amount of future payments that the Company could be required to make under these indemnifications cannot be estimated. The Company has not recorded any contingent liability in the condensed consolidated financial statements for these indemnifications and believes that the occurrence of any events that would trigger payments under these contracts is remote.

Exchange/Clearinghouse Member Guarantees. The Company is a member of various U.S. and non-U.S. exchanges and clearinghouses that trade and clear securities and/or futures contracts. Associated with its membership, the Company may be required to pay a proportionate share of the financial obligations of another member who may default on its obligations to the exchange or the clearinghouse. While the rules governing


		30

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

different exchange or clearinghouse memberships vary, in general the Company’s guarantee obligations would arise only if the exchange or clearinghouse had previously exhausted its resources. In addition, any such guarantee obligation would be apportioned among the other non-defaulting members of the exchange or clearinghouse. Any potential contingent liability under these membership agreements cannot be estimated. The Company has not recorded any contingent liability in the condensed consolidated financial statements for these agreements and believes that any potential requirement to make payments under these agreements is remote.

General Partner Guarantees. As a general partner in certain private equity and real estate partnerships, the Company receives distributions from the partnerships according to the provisions of the partnership agreements. The Company may, from time to time, be required to return all or a portion of such distributions to the limited partners in the event the limited partners do not achieve a certain return as specified in various partnership agreements, subject to certain limitations. The maximum potential amount of future payments that the Company could be required to make under these provisions at August 31, 2007 and November 30, 2006 was $473 million and $320 million, respectively. As of August 31, 2007 and November 30, 2006, the Company’s accrued liability for distributions that the Company has determined is probable it will be required to refund based on the applicable refund criteria specified in the various partnership agreements was $19 million and $25 million, respectively.

Securitized Asset Guarantees. As part of the Company’s Institutional Securities securitization activities, the Company provides representations and warranties that certain securitized assets conform to specified guidelines. The Company may be required to repurchase such assets or indemnify the purchaser against losses if the assets do not meet certain conforming guidelines. Due diligence is performed by the Company to ensure that asset guideline qualifications are met, and, to the extent the Company has acquired such assets to be securitized from other parties, the Company seeks to obtain its own representations and warranties regarding the assets. The maximum potential amount of future payments the Company could be required to make would be equal to the current outstanding balances of all assets subject to such securitization activities. Also, in connection with originations of residential mortgage loans under the Company’s FlexSource^® program, the Company may permit borrowers to pledge marketable securities as collateral instead of requiring cash down payments for the purchase of the underlying residential property. Upon sale of the residential mortgage loans, the Company may provide a surety bond that reimburses the purchasers for shortfalls in the borrowers’ securities accounts up to certain limits if the collateral maintained in the securities accounts (along with the associated real estate collateral) is insufficient to cover losses that purchasers experience as a result of defaults by borrowers on the underlying residential mortgage loans. The Company requires the borrowers to meet daily collateral calls to ensure the marketable securities pledged in lieu of a cash down payment are sufficient. At August 31, 2007 and November 30, 2006, the maximum potential amount of future payments the Company may be required to make under its surety bond was $113 million and $121 million, respectively. The Company has not recorded any contingent liability in the condensed consolidated financial statements for these representations and warranties and reimbursement agreements and believes that the probability of any payments under these arrangements is remote.

Other. The Company may, from time to time, in its role as investment banking advisor be required to provide guarantees in connection with certain European merger and acquisition transactions. If required by the regulating authorities, the Company provides a guarantee that the acquirer in the merger and acquisition transaction has or will have sufficient funds to complete the transaction and would then be required to make the acquisition payments in the event the acquirer’s funds are insufficient at the completion date of the transaction. These arrangements generally cover the time frame from the transaction offer date to its closing date and therefore are generally short term in nature. The maximum potential amount of future payments that the Company could be


		31

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

required to make cannot be estimated. The Company believes the likelihood of any payment by the Company under these arrangements is remote given the level of the Company’s due diligence associated with its role as investment banking advisor.

13.

Investments in Unconsolidated Investees.

The Company invests in unconsolidated investees that own synthetic fuel production plants and in certain structured transactions not integral to the operations of the Company. The Company accounts for these investments under the equity method of accounting.

Losses from these investments were $(19) million and $(65) million for the quarter and nine month period ended August 31, 2007, respectively, compared with gains of $20 million and $25 million for the quarter and nine month period ended August 31, 2006, respectively.

Synthetic Fuel Production Plants. The Company’s share of the operating losses generated by these investments is recorded within (Losses) gains from unconsolidated investees, and the tax credits and the tax benefits associated with these operating losses are recorded within the Provision for income taxes.

The table below provides information regarding the losses from unconsolidated investees, tax credits and tax benefits on the losses:


	Three Months Ended August 31,				Nine Months Ended August 31,
	2007		2006		2007		2006
	(dollars in millions)
Losses from unconsolidated investees	$	43	$	2	$	145	$	174
Tax credits		36		14		158		88
Tax benefits on losses		17		1		57		68

Under the current tax law, synthetic fuels tax credits are granted under Section 45K of the Internal Revenue Code. Synthetic fuels tax credits are available in full only when the price of oil is less than a base price specified by the tax code, as adjusted for inflation (“Base Price”). The Base Price for each calendar year is determined by the Secretary of the Treasury by April 1 of the following year. If the annual average price of a barrel of oil in 2007 or future years exceeds the applicable Base Price, the synthetic fuels tax credits generated by the Company’s synthetic fuel facilities will be phased out, on a ratable basis, over the phase-out range. Based on fiscal year to date and futures prices at August 31, 2007, the Company estimates that there will be a partial phase-out of tax credits earned in fiscal 2007. The impact of this partial phase-out is included within (Losses) gains from unconsolidated investees and the Provision for income taxes for the quarter and nine months ended August 31, 2007.

The Company has entered into derivative contracts designed to reduce its exposure to rising oil prices and the potential phase-out of the synthetic fuels tax credits. Changes in fair value relative to these derivative contracts are included within Principal transactions—trading revenues.

Structured Transactions. Gains from unconsolidated investees associated with investments in certain structured investments were $24 million and $80 million for the quarter and nine month period ended August 31, 2007, respectively, compared with gains of $22 million and $199 million for the quarter and nine month period ended August 31, 2006, respectively.


		32

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

14.

Employee Benefit Plans.

The Company maintains various pension and benefit plans for eligible employees.

The components of the Company’s net periodic benefit expense for its pension and postretirement plans were as follows:


	Three Months Ended August 31,						Nine Months Ended August 31,
	2007			2006			2007			2006
	(dollars in millions)
Service cost, benefits earned during the period	$	29		$	30		$	87		$	91
Interest cost on projected benefit obligation		33			33			100			98
Expected return on plan assets		(31	)		(30	)		(93	)		(89	)
Net amortization and other		10			13			26			36

Net periodic benefit expense	$	41		$	46		$	120		$	136

15.

Discontinued Operations.

Discover. On June 30, 2007, the Company completed the Discover Spin-off. The Company distributed all of the outstanding shares of DFS common stock, par value $0.01 per share, to the Company’s stockholders of record as of June 18, 2007. The Company’s stockholders received one share of DFS common stock for every two shares of the Company’s common stock. Stockholders received cash in lieu of fractional shares for amounts less than one full DFS share. The Company received a tax ruling from the Internal Revenue Service that, based on customary representations and qualifications, the distribution was tax-free to the Company’s stockholders for U.S. federal income tax purposes.

The Discover Spin-off allows the Company to focus its efforts on more closely aligned firm-wide strategic priorities within its Institutional Securities, Global Wealth Management Group and Asset Management business segments.

The results of DFS prior to the Discover Spin-off are included within discontinued operations for all periods presented.


		33

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following is a summary of the assets and liabilities associated with DFS as of November 30, 2006 (dollars in millions):


Assets
Cash and cash equivalents	$	869
Financial instruments owned—U.S. government and agency securities		65
Financial instruments owned—Derivative contracts		33
Consumer loans		22,915
Fees, interest and other		166
Office facilities and other equipment, at cost, net		661
Goodwill and net intangible assets		735
Other assets		3,623

Total	$	29,067

Liabilities and Shareholders’ Equity
Commercial paper and other short-term borrowings	$	3,100
Deposits		13,277
Financial instruments sold, not yet purchased—Derivative contracts		28
Interest and dividends payables		129
Other liabilities and accrued expenses		6,508
Long-term borrowings		250

Total		23,292

Net assets	$	5,775

The net assets that were distributed to shareholders on the date of the Discover Spin-off were $5,558 million, which was recorded as a reduction to the Company’s retained earnings.

Net revenues included in discontinued operations related to DFS were $332 million and $2,392 million in the quarter and nine month period ended August 31, 2007 compared with net revenues of $1,047 million and $3,327 million in the quarter and nine month period ended August 31, 2006. The amounts for the periods ended August 31, 2007 include the results of DFS through June 30, 2007.

The results of discontinued operations include interest expense that was allocated based upon borrowings that were specifically attributable to DFS’s operations through intercompany transactions existing prior to the Discover Spin-off. For the three months ended August 31, 2007 and 2006, the amount of interest expense reclassified to discontinued operations was approximately $14 million and $74 million, respectively. Interest expense reclassified to discontinued operations in the nine months ended August 31, 2007 and 2006 was approximately $159 million and $186 million, respectively.

Quilter. On February 28, 2007, the Company sold Quilter, its standalone U.K. mass affluent business. The results of Quilter are included within discontinued operations for all periods presented through the date of sale. The results for discontinued operations in the quarter ended February 28, 2007 also included a pre-tax gain of $168 million ($109 million after-tax) on disposition.

Aircraft Leasing. On March 24, 2006, the Company sold its aircraft leasing business to Terra Firma, a European private equity group. The results for discontinued operations in the quarter ended February 28, 2006 included a loss of $125 million ($75 million after-tax) related to the impact of the finalization of the sales proceeds and balance sheet adjustments related to the closing.


		34

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Summarized financial information for the Company’s discontinued operations:

The table below provides information regarding amounts included within discontinued operations:


	Three Months Ended August 31,				Nine Months Ended August 31,
	2007		2006		2007		2006
	(dollars in millions)
Pre-tax gain/(loss) on discontinued operations
DFS	$	111	$	394	$	850	$	1,457
Quilter		—		5		174		20
Aircraft leasing		—		—		—		(42	)

	$	111	$	399	$	1,024	$	1,435

16.

Acquisitions and Sale of Minority Interest.

MSCI. On July 31, 2007, the Company announced that it would sell a minority interest in its subsidiary, MSCI Inc. (“MSCI”) in an initial public offering. MSCI is a provider of investment decision support tools to equity, fixed income and multi-asset class investment institutions globally. MSCI is included within the Institutional Securities business segment.

JM Financial. In October 2007, the Company dissolved its India joint ventures with JM Financial. The Company purchased the joint venture’s institutional equities sales, trading and research platform by acquiring JM Financial’s 49% interest and sold the Company’s 49% interest in the joint venture’s investment banking, fixed income and retail operation to JM Financial.

CityMortgage Bank. On December 21, 2006, the Company acquired CityMortgage Bank (“CityMortgage”), a Moscow-based mortgage bank that specializes in originating, servicing and securitizing residential mortgage loans in the Russian Federation. Since the acquisition date, the results of CityMortgage have been included within the Institutional Securities business segment.

Olco Petroleum Group Inc. On December 15, 2006, the Company acquired a 60% equity stake in Olco Petroleum Group Inc. (“Olco”), a petroleum products marketer and distributor based in eastern Canada. Since the acquisition date, the results of Olco have been included within the Institutional Securities business segment.

Saxon Capital, Inc. On December 4, 2006, the Company acquired Saxon Capital, Inc. (“Saxon”), a servicer and originator of residential mortgages. Since the acquisition date, the results of Saxon have been included within the Institutional Securities business segment.

FrontPoint Partners. On December 4, 2006, the Company acquired FrontPoint Partners (“FrontPoint”), a provider of absolute return investment strategies. Since the acquisition date, the results of FrontPoint have been included within the Asset Management business segment.

The proforma impact of each of the above business acquisitions individually and in the aggregate was not material to the condensed consolidated financial statements. In addition, in certain cases the allocations of the purchase prices are preliminary and subject to further adjustment as the valuations of certain intangible assets are still in process.


		35

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

17.

Income Tax Examinations.

The Company is under continuous examination by the Internal Revenue Service (the “IRS”) and other tax authorities in certain countries, such as Japan and the U.K., and states in which the Company has significant business operations, such as New York. The tax years under examination vary by jurisdiction; for example, the current IRS examination covers 1999-2005. The Company regularly assesses the likelihood of additional assessments in each of the taxing jurisdictions resulting from these and subsequent years’ examinations. The Company has established tax reserves that the Company believes are adequate in relation to the potential for additional assessments. Once established, the Company adjusts tax reserves only when more information is available or when an event occurs necessitating a change to the reserves. The Company believes that the resolution of tax matters will not have a material effect on the condensed consolidated financial condition of the Company, although a resolution could have a material impact on the Company’s condensed consolidated statement of income for a particular future period and on the Company’s effective income tax rate for any period in which such resolution occurs.

18.

Fair Value Disclosures.

Effective December 1, 2006 the Company early adopted SFAS No. 157 and SFAS No. 159, which require disclosures about the Company’s assets and liabilities that are measured at fair value. Further information about such assets and liabilities is presented below.

Fair Value Measurements. In September 2006, the FASB issued SFAS No. 157, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In addition, SFAS No. 157 disallows the use of block discounts for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available in an active market, and nullifies select guidance provided by EITF Issue No. 02-3, which prohibited the recognition of trading gains or losses at the inception of a derivative contract, unless the fair value of such derivative is obtained from a quoted market price, or other valuation technique that incorporates observable market data. SFAS No. 157 also requires the Company to consider its own credit spreads when measuring the fair value of liabilities, including derivatives. Effective December 1, 2006, the Company elected early adoption of SFAS No. 157. In accordance with the provisions of SFAS No. 157 related to block discounts and EITF Issue No. 02-3, the Company recorded a cumulative effect adjustment of approximately $80 million after-tax as an increase to the opening balance of Retained earnings as of December 1, 2006, which was primarily related to EITF Issue No. 02-3. The impact of considering the Company’s own credit spreads when measuring the fair value of liabilities, including derivatives, did not have a material impact on fair value measurements at the date of adoption.

The Company’s assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with SFAS No. 157. The levels of the fair value hierarchy are described below:

•

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Financial assets and liabilities utilizing Level 1 inputs include active exchange-traded equity securities, listed derivatives, most U.S. Government and agency securities, and certain other sovereign government obligations.

•

Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Financial assets and liabilities utilizing Level 2 inputs include restricted stock, infrequently-traded corporate and municipal bonds, most over-the-counter derivatives and certain mortgage loans.


		36

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

•

Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. Financial assets and liabilities utilizing Level 3 inputs include real estate funds, private equity investments, certain residential and commercial mortgage loans and complex derivatives, including certain credit default swaps and other instruments associated with the Company’s credit products and securitized products activities, certain foreign exchange options and long dated options on gas and power.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains and losses for assets and liabilities within the Level 3 category presented in the tables below may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

The Company also employs various hedging techniques in order to manage risks associated with certain positions, including those that have been classified within the Level 3 category. Such techniques may include the purchase or sale of financial instruments that are classified within the Level 1 and/or Level 2 categories. As a result, the realized and unrealized gains and losses for assets and liabilities within the Level 3 category presented in the tables below do not reflect the related realized or unrealized gains and losses on hedging instruments that have been classified by the Company within the Level 1 and/or Level 2 categories.


		37

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of August 31, 2007, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of August 31, 2007


	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Counterparty and Cash Collateral Netting			Balance as of August 31, 2007
	(dollars in millions)
Assets
Cash and securities deposited with clearing organizations or segregated under federal and other regulations or requirements(3)	$	13,865	$	—	$	—	$	—		$	13,865
Financial instruments owned:
U.S. government and agency securities		17,454		20,703		2,176		—			40,333
Other sovereign government obligations		27,094		7,655		73		—			34,822
Corporate and other debt		—		116,626		43,345		—			159,971
Corporate equities		100,877		283		1,686		—			102,846
Derivative contracts		3,512		439,608		29,543		(410,175	)		62,488
Investments		877		655		11,389		—			12,921
Physical commodities		—		2,704		—		—			2,704

Total financial instruments owned		149,814		588,234		88,212		(410,175	)		416,085
Other investments(1)(3)		—		7,214		1,635		—			8,849
Intangible assets(2)(3)		—		354		3		—			357

Liabilities
Commercial paper and other short-term borrowings(3)	$	—	$	2,666	$	—	$	—		$	2,666
Deposits(3)		—		3,166		—		—			3,166
Financial instruments sold, not yet purchased:
U.S. government and agency securities		19,467		13		—		—			19,480
Other sovereign government obligations		19,363		7,428		—		—			26,791
Corporate and other debt		1		8,371		1,424		—			9,796
Corporate equities		57,368		79		36		—			57,483
Derivative contracts		5,198		436,766		21,639		(401,515	)		62,088
Physical commodities		—		459		—		—			459

Total financial instruments sold, not yet purchased		101,397		453,116		23,099		(401,515	)		176,097

Other secured financings		—		29,905		7,435		—			37,340
Long-term borrowings(3)		—		30,224		417		—			30,641

(1)	Amount represents securities available for sale (see Note 19).

(2)	Amount represents MSRs accounted for at fair value (see Note 3).

(3)	The difference between the total assets and liabilities as of August 31, 2007 presented in the table above and the related amounts in the condensed consolidated statement of financial condition are primarily related to the following:


		38

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Cash and securities deposited with clearing organizations or segregated under federal and other regulations and requirements—cash and cash equivalents which approximate fair value.

Other investments—investments in unconsolidated subsidiaries that are accounted for under the equity method.

Intangible assets—amortizable intangible assets that are not accounted for at fair value.

Commercial paper and other short-term borrowings, Deposits and Long-term borrowings—instruments that are accounted for at historical amounts.


		39

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following table presents additional information about assets and liabilities measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Nine Months ended August 31, 2007


	Beginning Balance		Total Realized and Unrealized Gains or (Losses) included in Income							Total Unrealized Losses Included in Other Comprehensive Income		Total Realized and Unrealized Gains or (Losses)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance
	Beginning Balance		Principal Transactions: Trading			Principal Transactions: Investments		Other Revenues				Total Realized and Unrealized Gains or (Losses)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	2	$	5		$	—	$	—	—		$	5		$	2,150		$	19		$	2,176
Other sovereign government obligations		162		11			—		—	—			11			654			(754	)		73
Corporate and other debt(1)		33,941		(3,015	)		—		—	—			(3,015	)		8,929			3,490			43,345
Corporate equities		1,040		75			—		—	—			75			328			243			1,686
Net derivative contracts(1)(2)		30		7,155			—		—	—			7,155			(701	)		1,420			7,904
Investments(3)		3,879		—			1,978		11	—			1,989			5,504			17			11,389
Other investments		—		—			—		—	(22	)		(22	)		1,603			54			1,635
Intangible assets		—		—			—		—	—			—			—			3			3
Other assets(4)		2,154		—			—		32	—			32			(2,186	)		—			—

Liabilities
Financial instruments sold, not yet purchased:
Corporate and other debt(1)		185		(716	)		—		—	—			(716	)		200			323			1,424
Corporate equities		9		(9	)		—		—	—			(9	)		14			4			36
Other secured financings		4,724		—			—		—	—			—			2,711			—			7,435
Long-term borrowings		464		(76	)		—		—	—			(76	)		(123	)		—			417

(1)	The net gains from Net derivative contracts and the net losses from Corporate and other debt resulted from market movements primarily associated with credit products and various credit linked instruments, respectively.

The net gains in Level 3 Net derivative contracts were primarily driven by certain credit default swaps and other instruments associated with the Company’s credit products and securitized products activities. The net losses in Level 3 Corporate and other debt were primarily driven by certain asset backed securities, including residential and commercial mortgage loans, and by corporate loans and loan commitments.

These results are only a component of the overall trading strategies of these businesses, and do not take into consideration any related financial instruments that have been classified by the Company within the Level 1 and/or Level 2 categories. For example, the Company recorded offsetting net losses in Level 2 Net derivative contracts, which were primarily associated with the Company’s credit products and securitized products activities.

(2)	Amounts represent Financial instruments owned—derivative contracts net of Financial instruments sold, not yet purchased—derivative contracts.

(3)	The net gains from Financial instruments owned—investments were primarily related to investments associated with the Company’s real estate products and private equity portfolio.

(4)	These assets were disposed of in connection with the Discover Spin-off.


		40

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis for the Three Months ended August 31, 2007


	Beginning Balance		Total Realized and Unrealized Gains or (Losses) included in Income					Total Unrealized Losses Included in Other Comprehensive Income (Loss)			Total Realized and Unrealized Gains or (Losses)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance
	Beginning Balance		Principal Transactions: Trading			Principal Transactions: Investments					Total Realized and Unrealized Gains or (Losses)			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or (Out) of Level 3			Ending Balance
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	63	$	15		$	—	$	—		$	15		$	2,071		$	27		$	2,176
Other sovereign government obligations		24		1			—		—			1			—			48			73
Corporate and other debt(1)		35,264		(1,798	)		—		—			(1,798	)		6,383			3,496			43,345
Corporate equities		1,504		(50	)		—		—			(50	)		(30	)		262			1,686
Net derivative contracts(1)(2)		1,918		5,347			—		—			5,347			(482	)		1,121			7,904
Investments(3)		8,528		—			555		—			555			2,163			143			11,389
Other investments		—		—			—		(22	)		(22	)		1,603			54			1,635
Intangible assets		—		—			—		—			—			—			3			3
Other assets(4)		2,446		—			—		—			—			(2,446	)		—			—

Liabilities
Financial instruments sold, not yet purchased:
Corporate and other debt(1)		89		(613	)		—		—			(613	)		586			136			1,424
Corporate equities		63		1			—		—			1			(25	)		(1	)		36
Other secured financings		8,348		—			—		—			—			(913	)		—			7,435
Long-term borrowings		446		28			—		—			28			(1	)		—			417

(1)	The net gains from Net derivative contracts and the net losses from Corporate and other debt resulted from market movements primarily associated with credit products and various credit linked instruments, respectively.

(2)	Amounts represent Financial instruments owned—derivative contracts net of Financial instruments sold, not yet purchased—derivative contracts.

(3)	The net gains from Financial instruments owned—investments were primarily related to investments associated with the Company’s real estate products and private equity portfolio.

(4)	These assets were disposed of in connection with the Discover Spin-off.


		41

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following table presents the amounts of unrealized gains or (losses) for the three and nine months ended August 31, 2007 relating to those assets and liabilities for which the Company utilized significant Level 3 inputs to determine fair value and that were still held by the Company at August 31, 2007:

Unrealized Gains (Losses) for Level 3 Assets and Liabilities Still Held at August 31, 2007


	Three Months Ended August 31, 2007										Nine Months Ended August 31, 2007
	Principal Transactions: Trading			Principal Transactions: Investments		Other Revenues		Other Comprehensive Income			Principal Transactions: Trading			Principal Transactions: Investments		Other Revenues		Other Comprehensive Income
	(dollars in millions)
Assets
Financial instruments owned:
U.S. government and agency securities	$	1		$	—	$	—	$	—		$	—		$	—		—	$	—
Other sovereign government obligations		—			—		—		—			3			—		—		—
Corporate and other debt		(1,705	)		—		—		—			(1,337	)		—		—		—
Corporate equities		39			—		—		—			362			—		—		—
Investments		—			433		—		—			—			1,549		11		—
Net derivative contracts		5,386			—		—		—			8,503			—		—		—
Other investments		—			—		—		(22	)		—			—		—		(22	)

Liabilities
Financial instruments sold, not yet purchased:
Corporate and other debt	$	(615	)	$	—	$	—	$	—		$	(770	)		—	$	—	$	—
Corporate equities		(3	)		—		—		—			(2	)		—		—		—
Long-term borrowings		27			—		—		—			(76	)		—		—		—


		42

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Fair Value Option. In February 2007, the FASB issued SFAS No. 159, which provides a fair value option election that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities, with changes in fair value recognized in earnings as they occur. SFAS No. 159 permits the fair value option election on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. Effective December 1, 2006, the Company elected early adoption of SFAS No. 159. As a result of the adoption of SFAS No. 159, the Company recorded a cumulative effect adjustment of approximately $166 million ($102 million after-tax) as an increase to the opening balance of Retained earnings as of December 1, 2006.

The following table presents information about the eligible instruments for which the Company elected the fair value option and for which a transition adjustment was recorded as of December 1, 2006:


	Carrying Value of Instrument at December 1, 2006		Transition Adjustment to Retained Earnings Gain/(Loss)			Carrying Value of Instrument at December 1, 2006 (After Adoption of SFAS No. 159)
	(dollars in millions)
Financial instruments owned:
Corporate lending(1)	$	8,587	$	16		$	8,603
Mortgage lending(2)		1,258		7			1,265
Investments(3)		1,305		13			1,318
Commercial paper and other short-term borrowings(4)		946		(1	)		947
Deposits(5)		3,143		1			3,142
Long-term borrowings(4)		14,354		130			14,224

Pretax cumulative effect of adoption of the fair value option				166
Deferred taxes				64

Cumulative effect of adoption of the fair value option			$	102

The transition adjustments were primarily related to the following:

(1)	Loans and loan commitments made in connection with Institutional Securities’ corporate lending activities. The fair value option was elected for these positions as they are generally risk-managed on a fair value basis.

(2)

Certain mortgage lending products which are risk-managed by the Institutional Securities business segment on a fair value basis. The Company did not elect the fair value option for other eligible mortgage lending products that were managed by the Discover business segment prior to the Discover Spin-off.

(3)	Certain investments that had been previously accounted for under the equity method, as well as certain interests in clearinghouses. The fair value option was elected only for positions that are risk-managed on a fair value basis.

(4)

Structured notes and other hybrid long-term debt instruments. The fair value option was elected for these positions as they are risk-managed on a fair value basis. The fair value option was elected for all such instruments issued after December 1, 2006, and a portion of the portfolio of instruments outstanding as of December 1, 2006. The fair value option was not elected for the remaining portion of the portfolio that existed as of December 1, 2006 due to cost-benefit considerations, including the operational effort involved.

(5)

Brokered and callable certificates of deposit issued by certain of the Company’s bank subsidiaries. The fair value option was elected for these positions as they are risk-managed on a fair value basis. The Company did not elect the fair value option for other eligible instruments within Deposits that were managed by the Discover business segment prior to the Discover Spin-off.


		43

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

The following table presents gains and (losses) due to changes in fair value for items measured at fair value pursuant to election of the fair value option for the three and nine months ended August 31, 2007:


Three months ended August 31, 2007	Principal Transactions: Trading		Net Interest Revenue		Gains/ (Losses) Included in the Three Months Ended August 31, 2007(1)
	(dollars in millions)
Commercial paper and other short-term borrowings	(44	)	(6	)	(50	)
Deposits	(2	)	—		(2	)
Long-term borrowings	107		(90	)	17

Nine months ended August 31, 2007	Principal Transactions: Trading		Net Interest Revenue		Gains/ (Losses) Included in the Nine Months Ended August 31, 2007(1)
	(dollars in millions)
Commercial paper and other short-term borrowings	(144	)	(11	)	(155	)
Deposits	(1	)	—		(1	)
Long-term borrowings	83		(268	)	(185	)

(1)

In addition to these amounts, as discussed in Note 1, all of the instruments within Financial instruments owned and Financial instruments sold, not yet purchased, are measured at fair value, either through the election of SFAS No. 159 or as required by other accounting pronouncements. Changes in the fair value of these instruments are recorded in Principal transactions—trading and Principal transactions—investment revenues.

Interest income and expense and dividend income are recorded within the condensed consolidated statements of income depending on the nature of the instrument and related market conventions. When interest and dividends are included as a component of the instruments’ fair value, interest and dividends are included within Principal transactions—trading revenues. Otherwise, they are included within Interest and dividend income or Interest expense.

As of August 31, 2007, the aggregate contractual principal amount of loans and long-term receivables for which the fair value option was elected exceeded the fair value of such loans and long-term receivables by approximately $27,569 million. The aggregate fair value of loans that were 90 or more days past due as of August 31, 2007 was $3,694 million. The aggregate contractual principal amount of such loans exceeded their fair value by approximately $22,419 million.

For the quarter and nine months ended August 31, 2007, the estimated changes in the fair value of the Company’s short-term and long-term borrowings, including structured notes, for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were gains of approximately $390 million. This gain was attributable to the widening of the Company’s credit spreads and was determined based upon observations related to secondary market transactions. As of August 31, 2007, the aggregate contractual principal amount of long-term debt instruments for which the fair value option was elected exceeded the fair value of such instruments by approximately $570 million. The estimated change in the fair value of other liabilities for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were losses of approximately $750 million in the quarter and nine months ended August 31, 2007. This loss was primarily related to leveraged loan contingent commitments and was attributable to the illiquid market conditions that existed late in the quarter. It was generally determined based on the differential between estimated expected client yields at August 31, 2007 and contractual yields.


		44

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

For the quarter and nine months ended August 31, 2007, changes in the fair value of loans and other receivables for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were losses of $1,309 million and $1,093 million, respectively. Instrument-specific credit losses were determined by excluding the non-credit components of gains and losses, such as those due to changes in interest rates.

Hybrid Financial Instruments. In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”), which amends SFAS No. 133 and SFAS No. 140. SFAS No. 155 permits hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation to irrevocably be accounted for at fair value, with changes in fair value recognized in the statement of income. The fair value election may be applied on an instrument-by-instrument basis. SFAS No. 155 also eliminates a restriction on the passive derivative instruments that a qualifying special purpose entity may hold. The Company adopted SFAS No. 155 on December 1, 2006. Since SFAS No. 159 incorporates accounting and disclosure requirements that are similar to SFAS No. 155, the Company decided to apply SFAS No. 159, rather than SFAS No. 155, to its fair value elections for hybrid financial instruments.

19.

Other Investments.

The following table presents the composition of Other investments:


	At August 31, 2007		At November 30, 2006
	(dollars in millions)
Securities available for sale	$	8,849	$	—
Other		3,873		3,232

Total	$	12,722	$	3,232

Securities Available for Sale

In the second quarter of fiscal 2007, the Company purchased certain debt securities that have been classified as “securities available for sale” in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”. The following table presents information about the Company’s securities available for sale:


	At August 31, 2007
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(dollars in millions)
Securities available for sale	$	8,978	$	—	$	(129	)	$	8,849

The Securities available for sale portfolio consists of asset-backed securities related to auto, credit card and mortgage loans.

The Company uses the “first in-first out” method to determine the cost of securities sold. The average yield on the securities available for sale portfolio as of August 31, 2007 was 6.86%.

At August 31, 2007, the Securities available for sale portfolio has been in an unrealized loss position for less than 12 months. In the third quarter of fiscal 2007, the Company recorded an immaterial other-than-temporary impairment on certain mortgage-backed securities.


		45

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Other.

Other investments primarily include investments in unconsolidated investees that are accounted for under the equity method of accounting (see Note 13).

20.

Other Accounting Developments.

In June 2005, the FASB ratified the consensus reached in EITF Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF Issue No. 04-5”). Under the provisions of EITF Issue No. 04-5, a general partner in a limited partnership is presumed to control that limited partnership and, therefore, should include the limited partnership in its consolidated financial statements, regardless of the amount or extent of the general partner’s interest unless a simple majority of the limited partners can vote to dissolve or liquidate the partnership or otherwise remove the general partner without having to show cause or the limited partners have substantive participating rights that can overcome the presumption of control by the general partner. EITF Issue No. 04-5 was effective immediately for all newly formed limited partnerships and existing limited partnerships for which the partnership agreements have been modified. For all other existing limited partnerships for which the partnership agreements have not been modified, the Company adopted EITF Issue No. 04-5 on December 1, 2006. The adoption of EITF Issue No. 04-5 on December 1, 2006 did not have a material impact on the Company’s condensed consolidated financial statements.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an income tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for the Company as of December 1, 2007. The Company is currently evaluating the potential impact of adopting FIN 48.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). Among other items, SFAS No. 158 requires recognition of the overfunded or underfunded status of the Company’s defined benefit and postretirement plans as an asset or liability in the financial statements for the fiscal year ending November 30, 2007. SFAS No. 158 also requires the measurement of defined benefit and postretirement plan assets and obligations as of the end of the fiscal year. SFAS No. 158’s requirement to recognize the funded status in the financial statements is effective for fiscal years ending after December 15, 2006, and its requirement to use the fiscal year-end date as the measurement date is effective for fiscal years ending after December 15, 2008. The Company expects to adopt a fiscal year-end measurement date for its fiscal year ending November 30, 2008. Based on information currently available, the Company expects to record an after-tax charge of approximately $200 million to Shareholders’ equity as of November 30, 2007 upon the adoption of SFAS No. 158. The effect of the measurement date change is not expected to be material.

In April 2007, the FASB issued FSP No. FIN 39-1, “Amendment of FASB Interpretation No. 39”, (“FSP FIN 39-1”). FSP FIN 39-1 amends certain provisions of FIN 39, “Offsetting of Amounts Related to Certain Contracts” and permits companies to offset fair value amounts recognized for cash collateral receivables or payables against fair value amounts recognized for net derivative positions executed with the same counterparty under the same master netting arrangement. FSP FIN 39-1 is effective for fiscal years beginning after


		46

MORGAN STANLEY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

November 15, 2007, with early application permitted. The guidance in this FSP is consistent with the Company’s current accounting practice.

In June 2007, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 07–1, “Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” (“SOP 07-1”). SOP 07-1 provides guidance for determining whether an entity is within the scope of the AICPA “Audit and Accounting Guide Investment Companies” (the “Guide”). SOP 07-1 addresses whether the specialized industry accounting principles of the Guide should be retained by a parent company in consolidation. In addition, SOP 07-1 includes certain disclosure requirements for parent companies and equity method investors in investment companies that retain investment company accounting in the parent company’s consolidated financial statements or the financial statements of an equity method investor. SOP 07-1 is effective for the Company as of December 1, 2008. In May 2007, the FASB issued FASB Staff Position (“FSP”) FIN 46R-7, “Application of FIN 46R to Investment Companies,” which amends FIN 46R to make permanent the temporary deferral of the application of FIN 46R to entities within the scope of the revised audit guide under SOP 07-1. FSP FIN No. 46R-7 is effective upon adoption of SOP 07-1. The Company is currently evaluating the potential impact of adopting SOP 07-1 and FSP FIN 46R-7.

In June 2007, the EITF reached consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF Issue No. 06-11 requires that the tax benefit related to dividend equivalents paid on restricted stock units that are expected to vest be recorded as an increase to additional paid-in capital. The Company currently accounts for this tax benefit as a reduction to its income tax provision. EITF Issue No. 06-11 is to be applied prospectively for tax benefits on dividends declared in fiscal years beginning after December 15, 2007. The Company is currently evaluating the potential impact of adopting EITF Issue No. 06-11.

21.

Subsequent Event.

In October 2007, the Company announced that it was restructuring its residential mortgage business to reflect current market conditions and to position the business for long-term growth. The plan reduces origination capacity to a level appropriate for the existing market. The restructuring will result in a net reduction-in-force of approximately 600 employees. The costs associated with the restructuring are not expected to be material.


		47

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Morgan Stanley:

We have reviewed the accompanying condensed consolidated statement of financial condition of Morgan Stanley and subsidiaries (the “Company”) as of August 31, 2007, and the related condensed consolidated statements of income and comprehensive income for the three-month and nine-month periods ended August 31, 2007 and 2006, and condensed consolidated statements of cash flows for the nine-month periods ended August 31, 2007 and 2006. These interim financial statements are the responsibility of the management of Morgan Stanley.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition of Morgan Stanley and subsidiaries as of November 30, 2006, and the related consolidated statements of income, comprehensive income, cash flows and changes in shareholders’ equity for the fiscal year then ended (not presented herein) included in Morgan Stanley’s Current Report on Form 8-K; and in our report dated February 12, 2007 (April 10, 2007 for the effects of the discontinued operations as described in Note 30 to such financial statements), which report contains an explanatory paragraph relating to the adoption, in fiscal 2005, of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” and effective December 1, 2005, the change in accounting policy for recognition of equity awards granted to retirement-eligible employees and an explanatory paragraph relating to, in fiscal 2006, the application of Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of November 30, 2006 is fairly stated, in all material respects, in relation to the consolidated statement of financial condition from which it has been derived.

As discussed in Note 18 to the condensed consolidated interim financial statements, effective December 1, 2006, the Company adopted SFAS No. 157, “Fair Value Measurement” and SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.”

As discussed in Note 1 to the condensed consolidated interim financial statements, effective June 30, 2007, the Company completed the spin-off of Discover Financial Services.

/s/ Deloitte & Touche LLP

New York, New York

October 9, 2007


		48

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Introduction.

Morgan Stanley (the “Company”) is a global financial services firm that maintains significant market positions in each of its business segments—Institutional Securities, Global Wealth Management Group and Asset Management. The Company, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. A summary of the activities of each of the segments follows:

The discussion of the Company’s results of operations below may contain forward-looking statements. These statements, which reflect management’s beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect the Company’s future results, please see “Forward-Looking Statements” immediately preceding Part I, Item 1, “Competition” and “Regulation” in Part I, Item 1, “Risk Factors” in Part I, Item 1A and “Certain Factors Affecting Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended November 30, 2006 (the “Form 10-K”), “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2007 Quarterly Reports on Form 10-Q and other items throughout the Form 10-K, Forms 10-Q and the Company’s 2007 Current Reports on Form 8-K.

Beginning in the second quarter of fiscal 2007, the Company’s real estate investing business is included within the results of the Asset Management business segment. Previously, this business was included in the Institutional Securities business segment. Real estate advisory activities and certain passive limited partnership interests remain within the Institutional Securities business segment. In addition, activities associated with certain shareholder recordkeeping services are included within the Global Wealth Management Group business segment. Previously, these activities were included within the Asset Management business segment. Prior periods have been adjusted to conform to the current year’s presentation.

The Company’s results of operations for the three and nine month periods ended August 31, 2007 and 2006 are discussed below.

Discontinued Operations.

On June 30, 2007, the Company completed the spin-off (the “Discover Spin-off”) of Discover Financial Services (“DFS”) (see “Other Items—Discontinued Operations—Discover” herein). DFS’s results are included within discontinued operations for all periods presented through the date of the Discover Spin-off’s completion. The results of Quilter Holdings Ltd. (“Quilter”), Global Wealth Management Group’s former mass affluent business in the U.K., are reported as discontinued operations for all periods presented through its sale on February 28, 2007. The results of the Company’s aircraft leasing business, which was sold on March 24, 2006, are also reported as discontinued operations through its date of sale (see “Other Items—Discontinued Operations” herein).


		49

Results of Operations.

Executive Summary.

Financial Information.


	Three Months Ended August 31,						Nine Months Ended August 31,
	2007			2006(1)			2007			2006(1)
Net revenues (dollars in millions):
Institutional Securities	$	4,983		$	4,894		$	19,574		$	15,635
Global Wealth Management Group		1,683			1,371			4,836			4,060
Asset Management		1,364			845			4,241			2,480
Intersegment Eliminations		(72	)		(46	)		(175	)		(185	)

Consolidated net revenues	$	7,958		$	7,064		$	28,476		$	21,990

Income before taxes (dollars in millions)(2):
Institutional Securities	$	1,501		$	1,915		$	7,296		$	5,521
Global Wealth Management Group		287			161			777			339
Asset Management		491			155			1,173			583
Intersegment Eliminations		(14	)		13			(1	)		12

Consolidated income before taxes	$	2,265		$	2,244		$	9,245		$	6,455

Consolidated net income (dollars in millions)	$	1,543		$	1,851		$	6,797		$	5,266

Earnings applicable to common shareholders (dollars in millions)(3)	$	1,526		$	1,851		$	6,747		$	5,266

Earnings per basic common share:
Income from continuing operations	$	1.45		$	1.57		$	6.08		$	4.29
Discontinued operations		0.07			0.26			0.65			0.90

Earnings per basic common share	$	1.52		$	1.83		$	6.73		$	5.19

Earnings per diluted common share:
Income from continuing operations	$	1.38		$	1.50		$	5.79		$	4.12
Discontinued operations		0.06			0.25			0.61			0.87

Earnings per diluted common share	$	1.44		$	1.75		$	6.40		$	4.99

Regional revenues(4):
Americas	$	4,172		$	4,528		$	16,374		$	13,909
Europe, Middle East, and Africa		2,439			1,825			8,125			5,780
Asia		1,347			711			3,977			2,301

Total	$	7,958		$	7,064		$	28,476		$	21,990

*Statistical Data.*

Book value per common share(5)	$	32.14		$	31.24		$	32.14		$	31.24
Average common equity (dollars in billions)(6):
Institutional Securities	$	25.1		$	18.6		$	22.6		$	17.5
Global Wealth Management Group		1.7			2.8			1.7			3.1
Asset Management		3.6			2.5			3.3			2.3
Unallocated capital		3.5			3.4			4.2			3.1

Total from continuing operations		33.9			27.3			31.8			26.0
Discontinued operations		1.9			5.3			4.4			5.1

Total	$	35.8		$	32.6		$	36.2		$	31.1


		50

Statistical Data—(Continued).

Three Months

Ended August 31,

Nine Months

Ended August 31,

2007

2006(1)

2007

2006(1)

Return on average common equity(6):