By Joseph A. Giannone

NEW YORK (Reuters) - Morgan Stanley survived the recent panic in financial markets, but its prime brokerage business may never fully recover.

More than a third of Morgan's prime brokerage assets went out the door during the past month -- some rivals said attrition could be as large as one-half -- as investors unnerved by the credit crunch lost confidence in the bank.

Across Wall Street, hundreds of investment funds that relied on broker-dealers established accounts with commercial banks boasting stronger credit. The moves have shaken up a business long dominated by Morgan Stanley, Goldman Sachs Group Inc (GS.N: Quote, Profile, Research) and Bear Stearns.

"It's a $2 trillion business and in normal market conditions, people kill themselves to move 1 percent of market share. In recent weeks, probably 35 to 40 percent of global market share has been redistributed," said Alex Ehrlich, global head of prime services at UBS. "Never has there been a more disruptive period."

For years the business of providing credit, clearing trades and providing other support to hedge funds has been a gold mine for Wall Street. As the ranks of hedge funds soared, these clients generated billions of dollars from loans, trades and services elsewhere at a bank.

Yet the collapse of Bear Stearns in March and by Lehman Brothers last month reinforced the importance of doing business with the most stable counterparties.

Notably, funds that relied on a Lehman London-based broker discovered that $65 billion of collateral was frozen when the company declared bankruptcy. Many funds still cannot get access to their money.

"At the end of the day, hedge fund investors are demanding that their hedge fund manager do more business at universal banks with higher credit quality," said Todd Steinberg, head of Americas equities and derivatives at BNP Paribas in New York.  Continued...