| NEW YORK
NEW YORK The logic of a Morgan Stanley(MS.N) merger with Wachovia Corp WB.N was questioned Thursday by investors and analysts, who worried that embattled investment bank Morgan would not improve its prospects by merging with Wachovia, a bank with severe credit problems.
Talks began Wednesday when Wachovia Chief Executive Robert Steel called Morgan Stanley CEO John Mack to propose a deal. Since then the talks have progressed and are now in a more formal stage, a person familiar with the matter told Reuters.
Yet the proposal has left investors flat, since it would marry a broker-dealer seeking stability with a commercial bank reeling with credit woes.
The merger "would make more sense if Morgan were seeking synergies rather than seeking safety," said Christopher Low, chief economist at FTN Financial in New York.
Morgan and Wachovia declined to comment.
Merrill Lynch analyst Guy Moszkowski in a note said the deal would do little to ease Morgan's challenges, because the depth of Wachovia's own credit risk is uncertain. The combination also would not deliver the reliable short-term funding it really needs, he said.
"The merger wouldn't create new deposits, and most of the combined company would still need market-based funding," said Moszkowski, who declared the deal "unlikely" and a mismatch.
"This could help Wachovia but would give Morgan Stanley considerable credit risk," he said.
Morgan stock sank 21 percent, while Wachovia shares surged 28 percent in afternoon trade.
Morgan's Mack insists the firm can remain independent, and with its capital and cash balances both solid. Still, the bankruptcy filing of Lehman Brothers Holdings Inc LEHMQ.PK and bailout of American International Group Inc (AIG.N) this week added fuel to the fires spreading across the marketplace.
Morgan Stanley shares have plunged 55 percent in just the past four days amid the same kind of speculation that brought down Bear Stearns Cos Inc and Lehman and convinced Merrill Lynch & Co Inc MER.N it should merge with Bank of America Corp (BAC.N).
The moves have reinforced the sense that investment banks can no longer stand on their own and need the stable deposit base of commercial banks to survive the protracted credit crunch. Morgan investors may want a different deal.
Wachovia has $122 billion of adjustable-rate mortgages, largely from its disastrous 2006 purchase of California's Golden West Financial Corp. It recently declared the entire portfolio "distressed" and projected losses of 12 percent on that portfolio -- an estimate some analysts say may be too low.
The bank has also said rising unemployment and a slowing economy could boost losses in its $217 billion commercial real estate and commercial and industrial loan portfolios. For now most of those credits are performing well.
Wachovia is trying to cut annual costs by $1.5 billion, sell noncore assets and eliminate 11,350 jobs. It lost a record $9.11 billion in the second quarter.
"At first blush, this deal doesn't make a lot of sense to me," Sandler O'Neill analyst Jeff Harte said. "If you look at the Merrill-Bank of America deal, that's worked so far. Merrill's merging with a large, safer balance sheet."
By contrast, he said, investors looking at Wachovia and Morgan "have concerns about both of their balance sheets."
Morgan shares have lost more 61 percent of their value since September 5, when markets fell on fears that giant struggling mortgage finance companies Fannie Mae FNM.N and Freddie Mac FRE.N needed a government bailout.
The shares are down 80 percent since reaching a record high last June, falling to their lowest levels in more than 10 years.
(Additional reporting by Jon Stempel; Editing by John Wallace and Gerald E. McCormick)