Morgan Stanley, in the throes of market turmoil, has stepped up its merger negotiations with Wachovia as it considers ways to shore up its finances in a deal that could also include the involvement of a Chinese sovereign wealth fund, people involved in the talks said.
The advanced talks come as some hedge funds have pulled back their business and other clients have reduced their trading with Morgan, these people said Thursday.
John Mack, Morgan Stanley's chief executive, spent the day going from meeting to meeting, working to find a solution, these people said. The discussions came after a town hall meeting for employees at Morgan's headquarters in New York, where he spoke and answered questions.
He spent time on the telephone with regulators in Washington, pressing the Securities and Exchange Commission and the Treasury Department to suspend short-selling of stocks in the financial industry.
As part of Mack's talks with Wachovia's chief executive, Robert Steel, both of whom are trustees of Duke University in North Carolina, the two companies are also considering bringing in a third-party investor, most likely a sovereign wealth fund, to infuse new capital into the combined firm.
Morgan Stanley has been holding talks about such a possibility with China Investment Corp., which is run by Gao Xiqing, another Duke University trustee, these people said.
Morgan Stanley would still prefer to remain independent, these people said, and is seeking to raise enough capital to calm the anxiety of its investors and clients. Mack has discussed whether Gao would be prepared to invest more in Morgan Stanley.
It is unclear whether the Chinese fund, which bought a 9.9 percent stake last year and has lost billions of dollars on its investment, will have the appetite to increase its stake.
Shares of Morgan Stanley increased 3.7 percent Thursday, closing at $22.55, after falling as low as $11.70 before the market reversed course in the afternoon. In after-hours trading, they rose to $24.21.
Among the options that Morgan Stanley is considering is a complicated plan to split Wachovia into a "good bank" and a "bad bank" and then merge with the "good bank," people involved in the talks said. The goal of such a complex transaction would be to prevent Wachovia's exposure to subprime loans and other toxic investments from infecting the combined company after a merger, these people said.
Officers of Morgan Stanley and Wachovia declined to comment on the reports.
Questions still remain in the marketplace about whether a link between Morgan Stanley and Wachovia would be a good combination.
Wachovia has been ravaged by the trouble in the housing market. Its 2006 acquisition of Golden West Financial, a large California mortgage lender that specialized in so-called pay-option mortgages, proved disastrous.
The bank also faces mounting losses on loans to builders and commercial real estate developers. And its investment bank was a big player in complex mortgage-related investments and buyout financing to middle-market companies, two areas hit hard by the crisis.
Since taking over in July, Steel has moved quickly to make changes.
He embarked on a major cost-cutting plan, ousted the bank's finance and risk chiefs and announced 10,000 layoffs. He has repeatedly vowed to keep Wachovia independent.
Wachovia, based in Charlotte, North Carolina, has long excelled at retail banking but has struggled to build a presence on Wall Street.
The company was run more like an oversize regional bank than a global financial powerhouse, and it lacked the risk management systems to keep up with its enlarging empire.
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