McClatchy Washington Bureau

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Shares of Wachovia were up about 12 percent today while Morgan Stanley's stock plunged by nearly 27 percent, as investors reacted to last night's reports that the two companies talked about a merger in the midst of a spreading crisis in financial markets.

In New York this morning at Morgan Stanley's headquarters in Times Square, CEO John Mack addressed workers in a meeting, while TV trucks idled outside. One employee said that Mack essentially gave a pep talk. "Think positive, go Morgan Stanley," is how she described the message.

The Wall Street Journal, citing a person familiar with the matter, said Morgan Stanley continues to talk to Wachovia about a possible deal, though the Charlotte bank's troubled mortgage portfolio is leading Morgan Stanley to look at a good-bank/bad bank structure as part of a deal.

In the regularly scheduled quarterly town hall meeting at 8:30 a.m., Mack and Chief Financial Officer Colm Kelleher and fellow co-presidents Walid Chammah and James Gorman said the company is exploring many options including a Wachovia tie-up and China Investment Corp. increasing its stake in the New York investment bank, the Journal reported.

Some of the employees who left the building afterward wore grim faces. Most said they couldn't comment.

"There certainly is a little bit of fear the way the stock was tumbling," said one employee of the mood inside.

Uniting Wachovia and Morgan Stanley would give Wachovia a much bigger brokerage and investment banking unit. That division is based in Charlotte, but it has built a presence in New York in recent years.

Wachovia may be in no position for such a major purchase. It is still digesting the $24 billion acquisition in 2006 of mortgage lender Golden West, which shoulders much of the blame for Wachovia's second-quarter loss of $9.1 billion. In June, the bank ousted chief executive Ken Thompson amid shareholder ire, and in July it hired Bob Steel, an undersecretary at the U.S. Treasury, to right the ship.

Wachovia's corporate and investment unit, like most of its peers, has suffered in the credit crunch. It has taken billions in write-downs over mortgage-related investments. Morgan Stanley rushed out third-quarter earnings ahead of schedule Tuesday evening, trying to soothe circling investors, reporting profits of $1.4 billion, down 7.6 percent.

Banking analyst Nancy Bush said today she didn't think Wachovia or Morgan Stanley would benefit from a merger. "Morgan Stanley may get core deposits, but why can't it use the Fed window if it needs liquidity. And Wachovia, they've got a huge brokerage operation already. I've talked to Morgan Stanley brokers and they're not anxious to be part of Wachovia Securities, let me tell you."

Wachovia has just under 15,000 financial advisers in its brokerage unit, making it a top player in line with Citigroup. Morgan has 8,500 brokers.

"I don't see that there's any scenario for Wachovia right now, other than sitting there and working out their problems," Bush said. "They've got a huge black hole with Golden West."

Steven Mann, a finance professor at the University of South Carolina, said that while Steel was brought in to fix an ailing bank, "I infer that he thinks this is his best chance of surviving. These are desperate times."

Tim Vorick, a Florida shareholder who has been a vocal critic of Thompson and the Golden West purchase, said he thinks that any kind of deal with Morgan Stanley could be beneficial but only if it's properly managed.

"If there's an opportunity at the right price, you should look at it, and I don't think Morgan Stanley is that bad off. ... I do feel a little more comfortable with Robert Steel at the bank. I don't believe that he is a loose cannon like Ken Thompson was. Mr. Thompson just got on an ego trip like a lot of these big boys do, and the shareholders suffered."

If a Wachovia-Morgan Stanley deal did take place, it would be the second time this week that a bank on Tryon Street snapped up a venerable investment firm on Wall Street. As panic spread in credit markets, Charlotte's Bank of America on Monday announced its plan to buy Merrill Lynch after a whirlwind of weekend discussions.

It was unclear whether any deal would emerge between Wachovia and Morgan Stanley, or whether a transaction would be a takeover or a merger of equals.

The New York Times said Morgan Stanley CEO Mack tried unsuccessfully Tuesday evening to persuade Citigroup chief executive Vikram Pandit to enter into a combination, then talked with Wachovia and several other banks, people briefed on those discussions said.

James Early, an analyst at The Motley Fool, described a Wachovia/Morgan deal as a "somewhat sickly bank taking on a somewhat sickly brokerage operation." He said a merger of equals is more likely than a big cash deal, but added: "These are strange times we're living in. I guess anything is possible."

A sale of 73-year-old Morgan Stanley would have been almost unthinkable a short time ago. But as the nation's historic credit crisis deepened, some analysts predicted that Morgan Stanley and Goldman Sachs would run into the arms of more stable commercial banks. Morgan and Goldman are the only major investment banks left standing on Wall Street, following the collapse of Bear Stearns and Lehman Brothers and the purchase of Merrill.

Steel, 57, and Mack, 63, are both North Carolina natives - from Durham and Mooresville, respectively. Both are graduates of Duke University and have served together for more than a decade on the school's board of trustees.

Spokeswomen for Wachovia and Morgan Stanley declined to comment on the possibility of a merger.

Steel said Monday in a TV interview that Wachovia has "a great future as an independent company." Asked by the Observer this week about a merger with an investment bank, Wachovia spokeswoman Mary Eshet said, "Wachovia experiences distinct benefits from our diversified business model, which includes an investment bank that has consistently gained market share."

Mixing a buttoned-down commercial bank with a risk-taking investment bank can be tricky. Commercial banks make most of their money from traditional banking services, like taking deposits and making loans. Investment banks rely on riskier but potentially more lucrative ventures such as trading and underwriting stocks and other securities. Such mergers got a boost from the 1999 repeal of the Glass-Steagall Act, a Depression-era regulation that segregated commercial and investment banks.

Wachovia-Morgan Stanley rumors have popped up over the years, particularly with Mack's N.C. ties. When dissension emerged within Morgan Stanley's ranks in 2005, Wachovia and Bank of America were both named as possible buyers of the New York firm.