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Morgan Stanley held talks with China's CITIC

(Agencies)
Updated: 2008-09-18 11:22

"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 North Carolina 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 percent to $21.75, while Wachovia shed 21 percent 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.

In March, JPMorgan Chase & Co 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 in Rochester, New York, 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."

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