On Monday, Morgan Stanley reported that its third-quarter earnings dropped 42% from a year ago, to just over $1 billion. Excluding certain accounting adjustments,its earnings per share fell an even larger 57%, to 34 cents. That was much worse than rivals, who reported earnings last week. Its earnings were nearly 30% below what analysts expected. That was a much bigger disappointment than other Wall Street firms. The shares (MS) dropped over 6% in early trading Monday and are now close to a four-month low.

What you need to know: In the wake of the financial crisis, Morgan Stanley revamped its business, expanding wealth management, and cutting back its trading operations. CEO James Gorman has sold the transformation as way to make the bank less risky and less vulnerable to market moves than rival Goldman Sachs (GS). Wealth management produces recurring, predictable fees from clients. But the third quarter showed that the transformation hasn’t insulated the firm as much as Gorman predicted. Wealth management fees were down a modest 4% from a year ago. But its investment management fees were down nearly 60%. Trading revenues shrunk by $1 billion from the second quarter. All that contributed to the big earnings miss.

The big number: Return on equity, a closely watched measure of profitability on Wall Street, fell to 4.8% in the quarter. It has long been understood that Morgan Stanley’s less risky strategy would probably produce lower returns. That’s the nature of lower-risk strategies. And that might be fine with investors if those lower profits were more stable. But, again, that wasn’t the case in the third quarter. Morgan Stanley’s ROE, prior to the third quarter, and been rising, and has almost reached 10% in the second quarter. That’s the minimum that most analyst seem to think that banks need to earn to attract investors. Morgan Stanley finds itself, once again, well short of that bar, and headed in the wrong direction.

What you may have missed: Revenue from Morgan Stanley’s fixed income trading division fell nearly 42% to $583 million, from just under $1 billion a year ago. That was a bigger drop in trading revenue than Goldman Sachs and other Wall Street firms. Morgan Stanley has already shrunk its debt trading operations. And on a conference call with analysts, Gorman said that you shouldn’t read too much into one quarter. But that didn’t stop analysts from pressing the CEO on whether its debt trading operation was still too big, and too risky. Gorman’s response was not that more layoffs are coming, though that could still be an answer. Instead, he said there are certain functions that the firm’s debt trading operation does that are key to Morgan’s other parts of its business. For example, if the bank is going to underwrite debt offerings, it’s going to have to trade bonds, at some level. The bottom line may be that a Wall Street firm can only insulate itself so much from market volatility. And Gorman may have reached the limit. Any more than that may have just been wishful thinking.