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Morgan-Wachovia Deal Is Off the Table

In yet another surprising development, the Federal Reserve has granted a request by the country's last two major investment banks — Goldman Sachs and Morgan Stanley — to change their status to bank holding companies.

With that announcement, the chances of a Morgan-Wachovia deal diminishes considerably and is off the table at least for the forseable future.

The Fed's move to declare Morgan Stanley into a bank and extend credit to the firm as if it were a bank put Morgan Stanley's merger with Wachovia firmly on the back burner and in all likelihood scuttled the deal all together, sources tell CNBC.

"One thing we know for certain, there won't be a Wachovia deal tomorrow, and probably ever," said one executive close to the firm. "That doesn't mean things won't change, but the Fed has now changed everything for Morgan."

Morgan Stanley had been negotiating with officials from Wachovia through Sunday night for a possible merger. At the same time, Morgan Stanley had been speaking with officials with the Chinese government about a huge cash infusion.

Meanwhile Morgan Stanley had also been dealing with officials with the fed about possibly transitioning its legal structure, meaning the Fed would extend virtually unlimited credit, making Morgan Stanley less susceptible to bear runs with hedge funds pulling lines of credit.

Morgan officials were unclear Sunday as to when and if the Fed might announce the move, which is one reason why they continued talks with Wachovia and the Chinese government.

But with the new powers, the Wachovia deal is likely off the table permanently. Any potential deal with the Chinese may become unnecessary as well, though people close to the firm said that they may still seek additional capital either from the Chinese or elsewhere, and that those negotiations continued through Sunday night. "Now we're in a better position," said one person close to Morgan. "We can negotiate better terms."

Now that Morgan Stanley is set to become a bank holding company, a person close to the firm says the company will use it's footprint of 600 retail brokerage branches across the U.S. to grow it's retail banking franchise. The company will do this by employing a strategy of acquiring small banks as time goes by.

Concern within Goldman Sachs had been mounting as well for the last week, with people close to that firm saying that they would potentially merge with a bank. The Fed's move should scuttle that as well.

The change in status makes Goldman Sachs the fourth largest bank holding company in the U.S.

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