Reports: Morgan Stanley, Wachovia in talks

NEW YORK -- Morgan Stanley ms and Wachovia wb are in talks about a possible combination as the investment bank tries to come up with ways to survive the ongoing credit crisis, according to media reports.

John Mack, Morgan Stanley's chief executive, received a call from Wachovia about a potential deal, according to The New York Times and Wall Street Journal. Both newspapers cited people familiar with the discussions.

CNBC reported that Morgan Stanley was having deal discussions with CITIC, the China-controlled conglomerate that owns brokerage firm CITIC Securities.

Other banks have also expressed interest in Morgan Stanley, according to the reports. The talks are described as preliminary.

Spokesmen for Morgan Stanley and Wachovia declined to comment.

If a deal with Wachovia did go through, Morgan Stanley would be the fourth major investment bank to disappear from the scene since June as the year-old credit crisis builds momentum. In the past four days, the U.S. financial services industry has been through the biggest consolidation wave in a decade.

A deal would marry a company with a dominant investment bank and trading business with Wachovia, the No. 4 U.S. commercial bank with branches spanning 21 states. It would also create the largest retail brokerage force in the country with more than 20,000 advisers.

Many analysts and investors have questioned the wisdom of combining two banks that have been burned by the spreading credit crisis that began with plunging mortgage prices and spread to commercial real estate.

"Two wrongs don't make a right," said James Ellman, a fund manager and president of SeaCliff Capital in San Francisco. "Hasn't Mr. Market been saying both companies possibly are going to fail? If you put them together, how does that make a better company?"

Morgan Stanley reported stronger-than-expected results as well as a robust levels of cash and capital on Tuesday, its latest solid performance since suffering about $10 billion in mortgage trading losses late last year.

Yet its stock dropped sharply Wednesday, suffering its worst one-day decline ever and falling to a 10-year low during the session. Worse still, its credit default swaps traded as if it were in imminent danger of default.

Wachovia, meanwhile, has been hobbled by mortgage losses, stemming from its ill-timed takeover of Golden West at the peak of the housing boom in 2006. There has been speculation the bank has been seeking a merger partner, hiring Goldman Sachs to study its options.

"I don't know exactly how a deal like this would work. I don't think Morgan Stanley can buy Wachovia because of regulatory hurdles. And I don't know that Wachovia has the capital to buy Morgan Stanley," said Danielle Schembri, a bond analyst covering broker-dealers at BNP Paribas in New York.

After the close of trading Wednesday, Morgan's market value had fallen to $24.1 billion, while Wachovia was worth $19.7 billion.

Morgan Stanley shares closed down 24% to $21.75, while Wachovia shed 21% to $9.12, both on the New York Stock Exchange.

The reports of the negotiations came a day after Morgan Stanley Chief Financial Officer Colm Kelleher told reporters it does not need or desire a merger with a commercial bank.

He also dismissed the increasingly popular view that broker-dealers, with their market funding and extensive use of leverage, could not remain independent under current conditions.

"The diversification of the businesses in capital markets is what drives the broker-dealer model," Kelleher told Reuters. "Investment banks have the ability to reinvent themselves and innovate many times throughout a cycle."

But investors may have the last word.

Lehman Bros. filed for bankruptcy protection on Monday, and its core businesses will be acquired by Britain's Barclays for $1.75 billion. Bank of America agreed to buy Merrill Lynch, which was struggling with its exposure to mortgage securities, for a deal worth $50 billion when announced.

In March, JPMorgan Chase agreed to buy Bear Stearns for a little over $1 billion, at the urging of the government and with lots of federal financial assistance, as that securities firm teetered on insolvency.

Morgan Stanley approached Wachovia about a potential deal, earlier this year, but was rebuffed, the New York Times said.

Albert Yu, a portfolio manager at Clover Capital, argued the two companies may feel this is the best option in a tough situation.

"Morgan Stanley certainly saw what happened with Lehman and Merrill, so they at least need to think about all their options," he said. "I am sure that Wachovia is also thinking about what looks cheap out there, though they have their own problems. It's a little bit of opportunism and caution."