Morgan Stanley Said to Mull Deal Wachovia Calls Mack

Sept. 17 (Bloomberg) -- Morgan Stanley is weighing a merger with Wachovia Corp. and several other banks as the securities firm seeks to regain investor confidence after its shares sank 42 percent this week, people familiar with the matter said.

John Mack, Morgan Stanley''s chief executive officer, received a call from Wachovia today indicating interest, said one person, who declined to be identified because the talks aren''t public and may end without an agreement. Such a deal is one option being considered and the New York-based firm also is seeking ways to limit short sales of its stock, said the person.

``It makes more sense to try to determine your own fate than to let the market decide it,'''' said Douglas Ciocca, managing director of Renaissance Financial Corp. in Leawood, Kansas, who manages $1.8 billion and who used to work for Morgan Stanley. ``But Wachovia still has a lot of issues and I would think that would need further examination.''''

Morgan Stanley and Goldman, the biggest U.S. securities firms, tumbled the most ever after a government rescue of American International Group Inc. failed to ease the credit crisis. The cost to protect against a default by the Wall Street firms rose to a record. Wachovia, the fourth-largest U.S. bank, plunged 21 percent after saying it would support $494 million of Lehman Brothers Holdings Inc. credits held by its Evergreen Investments money market funds.

''Focused on Solutions''

``The smartest people at this firm are focused on solutions,'''' said Mark Lake, a spokesman at Morgan Stanley. Wachovia spokeswoman Christy Phillips-Brown said it was bank policy not to comment on ``market rumors or merger speculation.'''' The New York Times reported earlier today that Wachovia contacted Mack.

Wachovia, based in Charlotte, North Carolina, has a market value of $19.7 billion, 18 percent less than Morgan Stanley''s $24.1 billion.

Wachovia Chief Executive Officer Robert Steel, hired in July to replace Kennedy Thompson, is cutting $1.5 billion in expenses and reducing risk to cope with mounting losses from Wachovia''s $122 billion of option adjustable-rate mortgages.

HSBC Not Interested

A Morgan Stanley-Wachovia tie-up ``makes much more sense for Wachovia,'''' than for Morgan Stanley, Ciocca said.

HSBC Holdings Plc, Wells Fargo & Co. and JPMorgan Chase & Co. are among the potential bidders for a Wall Street firm, according to Anton Schutz, president of Mendon Capital Advisors. Goldman and Morgan Stanley have both done deals with Chinese companies: China Investment Corp., the state-controlled investment fund, bought a stake in Morgan Stanley in December, and Goldman invested in Industrial & Commercial Bank of China Ltd. in 2006.

HSBC, Europe''s largest bank, is not in talks with Morgan Stanley and isn''t interested in pursuing a deal with the company, people with knowledge of the London-based bank''s plans said today. HSBC spokesman Donal McCarthy declined to comment.

Julia Tunis Bernard, a spokeswoman for Wells Fargo, the largest U.S. bank on the West Coast, declined to comment. Joseph Evangelisti, a spokesman for JPMorgan, the second-biggest U.S. bank, also declined to comment.

Executives at Goldman Sachs and Morgan Stanley told analysts and investors yesterday that they see no need to combine with banks even after Merrill Lynch & Co.''s emergency sale to Bank of America Corp. over the weekend and Lehman Brothers bankruptcy filing. Goldman and Morgan Stanley said they have adequate capital and cash and don''t have any pressing need to borrow new money.

Pushed to Sale

Analysts including David Trone at Fox-Pitt Kelton Cochran Caronia Waller have said the demise of Lehman and Merrill may force Goldman and Morgan Stanley to pursue a sale or some sort of transaction with a bank, to gain a stable funding base of deposits and the confidence of the markets. The firms hold more than $20 of assets for every $1 in capital, making them dependent on lenders.

``From what Goldman said on their conference call, they said they''re going to go it alone,'''' said William Smith, whose firm Smith Asset Management Inc. in New York manages $80 million, including Goldman stock. ``But when you''re leveraged it''s not up to you, it''s up to your trading counterparties.''''

Morgan Stanley Chief Executive Officer John Mack and Goldman''s Lloyd Blankfein are trying to navigate declining investor confidence that prompted the emergency sales of Merrill Lynch and Bear Stearns Cos., and the bankruptcy of 158-year-old Lehman.

`Every Step Possible''

In a memo to employees today, Mack said the management committee is ``taking every step possible to stop this irresponsible action in the market'''' and urged employees to contact clients to reassure them that the firm is performing strongly and has plenty of capital.

``There is no rational basis for the movements in our stock or credit default spreads,'''' Mack wrote in the memo. ``We''re in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down.''''

Markets are reacting to ``rumor and fear,'''' Colm Kelleher, Morgan Stanley''s finance chief, said yesterday after the New York-based company reported better-than-estimated earnings for the third quarter.

The turmoil spurred the U.S. government late yesterday to lend as much as $85 billion to AIG to prevent the insurer''s collapse.

`Performance''

``We think rational markets will positively differentiate those financial institutions that have global, diversified businesses and out-performed for their shareholders through this crisis,'''' said Lucas van Praag, a Goldman spokesman in New York. ``The issue that really matters is performance, not the business model.''''

Glenn Schorr, an analyst at UBS AG, said today in a note to investors that the market reaction was ``insanity.'''' Goldman and Morgan Stanley aren''t at risk of running out of money because they keep plenty of cash on hand and can borrow from the Federal Reserve and a consortium of banks set up over the weekend, he said, noting that both have enough capital to absorb any losses.

``If you have the liquidity and capital to withstand the storm, why should CDS spreads be having such a big impact on stocks?'''' he wrote. He said investors must be reacting to concern that counterparties or clients will abandon the firms or that the credit-rating companies will cut their ratings.

``At the heart of these issues is available funding, all in funding costs and the inherent mismatch of short-term funding and longer duration, levered balance sheets,'''' Schorr said.

Locked Up

Credit markets have been locked up since New York-based Lehman, which was the fourth-largest U.S. securities firm, filed for bankruptcy protection on Sept. 15, raising concern that other financial companies may fail. Investors have been unwilling to take on new debt risk and overnight lending rates have soared.

Morgan Stanley dropped $6.95, or 24 percent, to $21.75 in composite trading on the New York Stock Exchange, after sinking as low as $16.08. Goldman slumped $18.51, or 14 percent, to $114.50, a three-year low and the biggest one-day drop in its nine years as a public company.

Credit-default swaps on Morgan Stanley, which insure against a default of the company''s debt, rose to levels typical of companies in distress.

Sellers of credit-default swaps on Morgan Stanley demanded 11.5 percentage points upfront and 5 percentage points a year to protect the company''s bonds for five years, broker Phoenix Partners Group. That means it would cost $1.1 million initially and $500,000 a year to protect $10 million in bonds, up from $680,000 a year with no upfront payment yesterday. The contracts traded as high as 21 percentage points upfront earlier today.

Contracts

Contracts on Goldman climbed 1.77 percentage points to 6.20 percentage points, according to CMA Datavision. Morgan Stanley and Goldman are based in New York.

Morgan Stanley''s plunge may add impetus to calls from Democrats in Congress for a broader effort by policy makers to address the financial crisis, including setting up a government agency to take on devalued assets.

``The private market screwed itself up and they need the government to come and help them unscrew it,'''' House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, told reporters late yesterday after top lawmakers met with Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke.

Frank this week proposed considering an agency to ``deal with all the bad paper out there'''' and get financial markets ``out of the box'''' they are in.