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* Morgan Stanley, Wachovia in merger talks - source
* Putnam shuts $15 billion money-market fund
* VIX at multi-year high, financial-sector worries rise
* Central banks launch $180 bln liquidity boost
* Dow off 1 pct; S&P off 1.5 pct, Nasdaq off 1.1 pct (Updates to midday)
By Steven C. Johnson
NEW YORK, Sept 18 (Reuters) - U.S. stocks fell on Thursday as renewed anxiety about the outlook for U.S. financial firms, including Morgan Stanley (MS.N), drove a fresh sell-off in bank shares, reversing earlier gains.
The market’s move back into the red wiped out a morning rally sparked as central banks pumped billions of dollars into distressed global markets to thaw the credit freeze
Financial shares tumbled, with the S&P financial index .GSPF down more than 5 percent. Morgan Stanley, one of only two U.S. investment banks left standing, fell about 40 percent as investors wondered whether it could continue as an independent entity.
“There’s real panic and fear in the market. People are talking about financial institutions, and people are going to start asking whether their money is safe,” said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.
The CBOE Volatility Index, or VIX .VIX, Wall Street’s favorite barometer of fear, jumped over 15 percent to a session high at 42.16, its highest level since October 2002.
The Dow Jones industrial average .DJI was down 119.52 points, or 1.13 percent, at 10,490.14. The Standard & Poor's 500 Index .SPX was down 19.40 points, or 1.68 percent, at 1,136.99. The Nasdaq Composite Index .IXIC was down 24.58 points, or 1.17 percent, at 2,074.27.
“There are no safe havens right now. There are so many moving parts and so many variables.” said Anthony Conroy, head trader for BNY ConvergEx, an affiliate of the Bank of New York.
Central banks’ efforts to inject cash into the global financial system were helpful, he said, “but fear and greed dictate the short-term market, and that’s what we’re living through right now. There’s a lot of anxiety, and anxiety breeds volatility.”
Also unnerving for investors was news that the board at Putnam Funds voted to close its $15 billion institutional “Putnam Prime Money Market Fund” effective Sept. 17. For details, see [ID:nN18230180]
Saluzzi said the Putnam fund closing “is huge news,” adding that “people have no idea where this is going to end. It’s got a mind of its own now.”
Earlier this week, the Reserve Primary Fund fell below $1 a share in net asset value because of losses on debt issued by the now bankrupt Lehman Brothers.
Stocks got a boost from a report that showed an unexpected rise in a gauge of U.S. mid-Atlantic factory activity in September, calming worries about the economy.
Meanwhile, the news of added liquidity from the central banks helped to ease the overnight dollar inter-bank lending rate, whose sharp spike in the last two days came as a crisis of confidence caused banks to horde cash. For details, see [ID:nLI490821]
“The liquidity issue was a major burden as far as confidence is concerned,” said Alan Lancz, president of Alan B. Lancz & Associates Inc, an investment advisory firm, based in Toledo, Ohio. “Anything that the Fed can do to inject confidence in the system is critical.”
But shares of Morgan Stanley, which was among Wednesday’s biggest losers, dropped 39.3 percent to $13.20, while rival Goldman Sachs (GS.N) shares slid 22 percent to $89.29.
The scramble for deals in the financial sector follows Lehman Brothers’ LEH.N bankruptcy and the takeover of insurer American International Group (AIG.N) by the U.S. government.
A source familiar with the situation said Morgan Stanley was in merger talks with regional banking powerhouse Wachovia WB.N, whose shares rose 10.5 percent to $10.08.
Fear about slower global growth and the impact on technology spending continued to weigh on tech stocks. Apple Inc (AAPL.O), maker of the iPod and iPhone, was a top drag on the Nasdaq, down 5.1 percent at $121.34. (Additional reporting by Ellis Mnyandu; Editing by Jan Paschal)