Morgan Stanley sought shelter from the growing financial storm Wednesday, entering preliminary merger talks with Wachovia Corp. and other banks as a seventh straight decline in the company's share price sent the stock to its lowest level since 1998.
After a harrowing day, Morgan Stanley's shares finished down $6.95, or 24%, to $21.75. Goldman Sachs Group, the largest U.S. investment bank by market value, also fell $18.51, or 14%, to $114.50.
While the situation is more acute at Morgan Stanley, the two Wall Street banks are both battling extraordinary market pressures that have already pushed stable franchises such as Lehman Brothers Holdings Inc. and Merrill Lynch & Co. into bankruptcy protection or hasty merger deals. At Morgan Stanley and Goldman Sachs, two of the oldest and most successful investment banks, market confidence withered in the past 24 hours for firms that were once trusted and envied.
As employees stared at their trading screens and television sets, a sense of disbelief hung over people who had thought themselves largely insulated from credit-market fears. "I've lost more than half my net worth in a month," said one Goldman employee.
The perception hurting investment-bank shares is that they can no longer rely on jittery global markets to replenish the cash necessary to fund their trading and lending businesses. That has forced the companies' borrowing costs higher, which means, ultimately, it will likely become prohibitively expensive for them to fund their businesses.
Commercial banks such as Wachovia are perceived as more stable, creating strong incentive for investment banks to link up with them, as Merrill Lynch did earlier this week with Bank of America Corp. But even some retail banks are under attack, such as the large savings-and-loan Washington Mutual Inc., which was exploring its own deal Wednesday with several other banks. WaMu has received expressions of interest from Wells Fargo & Co., Citigroup Inc. and other large banks, including one based outside the U.S., according to people familiar with the situation.
Inside Morgan Stanley there was a growing feeling that the firm's chief executive, John Mack, would have to explore a merger or outside investment. Just 10 days ago Mr. Mack said in a Fortune magazine interview that he was "not thinking about selling the firm."
But markets have moved with such force that yesterday Mr. Mack fielded a call from Wachovia CEO Robert Steel about a potential tie-up. Messrs. Mack and Steel both attended Duke University and have been on its board of trustees for more than a decade. Mr. Mack grew up in Mooresville, N.C., about 30 miles from Charlotte, N.C., where Wachovia is based.
A spokeswoman for Morgan Stanley said that the firm is "focused on solutions" to address the falling stock price. Wachovia declined to comment.
As much as Morgan Stanley is suffering, Wachovia faces its own uncertain future. Saddled with a mountain of troubled adjustable-rate mortgages inherited through its 2006 takeover of Golden West Financial Corp., Wachovia has seen its financial condition weaken and its stock price plunge. After the disastrous Golden West acquisition, few Wachovia shareholders are likely to relish the idea of another huge deal, particularly one with another battered financial institution.
Morgan Stanley is also exploring preliminary tie-ups with a range of other banks around the globe, say people familiar with the matter. Morgan Stanley may well remain independent, but if a deal were struck it could come with the likes of HSBC Holdings PLC of the U.K., Banco Santander SA of Spain, Japan's Nomura Holdings Inc., a Chinese financial institution or a domestic partner such as Bank of New York Mellon Corp., say the people familiar with the matter.
Mr. Mack also took another tack Wednesday. He dialed U.S. Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox, as well as Goldman Sachs CEO Lloyd Blankfein, to discuss how to stop the rapid decline in the two firms' share price. The two firms didn't discuss a merger but focused instead on how to stop short sellers betting on a decline in Goldman and Morgan shares, people familiar with the matter said.
Mr. Mack entertained the idea of a lockup with Merrill Lynch last weekend as banking executives met at the Federal Reserve Bank of New York to discuss the future of Lehman Brothers, but Merrill wanted to move too quickly for Mr. Mack, according to people familiar with the matter.
Goldman Sachs has publicly toed a much more independent line in recent weeks. Its share price hasn't fallen as much as Morgan Stanley's, but its latest quarterly earnings report was its worst since 2005. The company says it has managed risk better than many commercial banks. Goldman officials add that commercial banks use the same funding markets as Goldman and Morgan Stanley do for large parts of their businesses.
Mr. Mack and his fellow executives had hoped that their stock price would react better to the company's earnings announcement this week. The company's profits and net revenue topped even Goldman Sachs, which has avoided the blowups suffered by many peers.
But after the earnings announcement late Tuesday afternoon caused initial enthusiasm among investors, Morgan Stanley shares resumed their downward march Wednesday. They continued lower even after the SEC announced that new restrictions would be placed on investors who bet on declines in share prices.
