According to the New York Times, Morgan Stanley (MS) is considering a merger with Wachovia Bank (WB). The paper is reporting that Wachovia (WB) approached Morgan Stanley’s (MS) CEO John Mack, and very preliminary talks are now underway.

Both companies are under tremendous pressure, as their stocks have been beaten down in the wake of the credit crisis, the Lehman (LEH) bankruptcy and the takeover of AIG (AIG) by the government.

Companies typically worry about their stock price as a general course of business, but this time there is an added sense of concern. The meltdown of Bear Stearns started with a rapid decline of that company’s stock. Then credit default swaps, which are used to insure against default of a company’s debt, for Bear Stearns debt rose dramatically in price and this is seen as a sign that a company is now very risky and has diminishing chances of paying off those debts. A company in that position is also seen as having little chance of survival. The same is now happening to other banks and Wall Street firms.

When this happens, it has a tendency to become a self-fulfilling prophecy. As concerns as to whether a company can pay of its debt grows, customers may start pulling money while trading partners stop doing business with the company so as not to take on undue risks. This then leads to failure. With Morgan Stanley (MS) and Wachovia (WB) now in that boat, they are looking for ways to stay alive and shore up investor confidence.

Morgan Stanley (MS) shares are down a further 8% in after hours trading on the news, while Wachovia (WB) is up 3%.

Tags: Morgan Stanley  Wachovia  Merger