Morgan Stanley Is in Talks with China for Fresh Funds

Morgan Stanley -- one of the two last independent, U.S.-based investment banks -- is negotiating with the Chinese government for a fresh infusion of funds into the beleaguered investment bank.

Morgan Stanley CEO John Mack held various conversations with potential merger partners Wednesday afternoon including top executives at Citigroup and Wachovia Bank . However, Mack continues to work to keep Morgan Stanley an independent company CNBC has learned.

Executives at Morgan are currently crunching numbers to determine how much of an additional minority stake they need to sell to settle market fears about the company.

Mack's plan is to sell a piece of Morgan Stanley to a Chinese bank. Mack has been dealing with Chinese government officials all day Wednesday to line up money from China.

He also has been dealing with top officials from the Federal Reserve and the Treasury to lobby them to give approval to a Chinese bank increasing its stake in the company.

China’s sovereign wealth fund, China Investment Corporation (CIC), already owns 9.9 percent of Morgan. However, Mack, according to people close to the company, understands that he faces significant obstacles including a turbulent market that has crushed Morgan shares.

People close to Mack say that he does not expect any deal tonight and he would like to avoid one on Thursday. However, if he has to do a deal, because of further deterioration in stock price he will.

CNBC earlier reported that the Federal Reserve has been active in encouraging the Chinese to invest in U.S. financial institutions. The Fed has even made it clear that it would look favorably upon a Chinese acquisition of a U.S.-based financial institution, sources said.

Separately, the Government of Singapore Investment Corp (GIC), the world's second-biggest sovereign fund, said it will explore investing in Morgan if it is approached.

"GIC explores all opportunities when approached," said Jennifer Lewis, a spokeswoman for the Singapore state fund, said in an email when asked if it is considering an investment in the U.S. investment bank.

Morgan Stanley stocks plunged more than 24 percent Wednesday and it is imperative that the investment bank gets a cash infusion before its shares decline further. London-based HSBC has also been cited as a possible suitor for Morgan Stanley.

Ongoing Turmoil for Big U.S. Banks

Meanwhile, Washington Mutual has put itself up for auction, people briefed on the matter also told the New York Times. Reports of both possible deals came after the market closed.

Earlier, anxious investors continued to hack away at Morgan Stanley and Goldman Sachs Group , sending the two largest investment banks' shares lower.

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Morgan Stanley's shares sank 40 percent below the depths reached during the Asian Financial Crisis and collapse of Long Term Capital Management a decade ago. Goldman stock plummeted 22 percent to a three-year low. This year, Goldman shares have fallen 45 percent and Morgan's are down 57 percent.

Investors also bid up the price of protecting against a default in debt issued by the banks, indicating growing concern that Wall Street's biggest firms are in jeopardy.

"The credit crunch and credit contraction is intensifying," said Peter Boockvar, an equity strategist at Miller Tabak in New York. "The action in Morgan Stanley in light of what was better-than-expected numbers last night is disconcerting."

Morgan Stanley on Tuesday night rushed to release its quarterly results after investors pushed its shares down 11 percent and led to widening swap spreads. Morgan out-earned the larger Goldman, which posted a 70 percent decline in profit, yet exceeded expectations.

A growing number of analysts say investment banks, which tap capital markets to fuel their business, need to combine with big commercial banks and their stable pools of deposits if they want to avoid a Lehman-like collapse.

Goldman Chief Financial Officer David Viniar and Morgan CFO Colm Kelleher both said their firms performed very well despite unprecedented turmoil.

They also contend they do not want or need to merge with a commercial bank.

"We think the markets will positively differentiate those financial institutions that have global, diversified business models and that outperformed through his crisis," Goldman spokesman Lucas van Praag said. "The issue that really matters is performance." Morgan Stanley spokeswoman Jeanmarie McFadden declined to comment.

Pressure Builds

Even so, many of the same market pressures that weighed on Bear Stearns in March and against Lehman last week have emerged again.

The cost of protecting $10 million of Morgan debt against default for five years rose to $825,000 a year, up $144,000, according to firms that track credit-default swaps, which serve as insurance policies on debt. (For more Morgan Stanley discussion, see video)

Morgan's swaps were trading as though its debts were rated deep into junk territory at "B2," or 10 steps below its actual rating of "A1," according to data from Moody's Investors Service's credit strategy group.

That is 10 steps below its actual rating of "A1" and the same level where Lehman Brothers was trading ahead of its bankruptcy filing early on Monday, Moody's data showed.

Goldman's default insurance costs rose to $500,000 a year, up $80,000 at Tuesday's close, according to data from Phoenix Partners and Markit Intraday. The swaps were trading as though Goldman were rated "Ba3," a junk level that is nine steps below its actual rating of "Aa3," Moody's data showed.

Goldman's swaps began trading at junk-like levels on Monday, the day of a bankruptcy filing by investment bank Lehman Brothers. Morgan Stanley's credit default swaps have been trading in junk territory since early June.

—CNBC Anchor and Reporter David Faber and Reuters contributed to this report.

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