A day that opened dismally for financial stocks ended with a flurry of merger buzz as all of Wall Street struggled to assess the implications of Tuesday night's government bailout of American International Group Inc.

Wachovia Corp. and Washington Mutual Inc. both returned to the M&A spotlight late Wednesday, the former amid reports that it had raised the possibility of a merger with Morgan Stanley — itself one of the hardest hit financials. The New York Times reported on its Web site that John Mack, Morgan Stanley's chief executive, had received a call from Wachovia expressing interest in a merger with the Wall Street bank.

Meanwhile, TPG Inc., the investor group that led a $7 billion capital injection into Wamu last April said late Wednesday that it had waived its right to extra compensation should the thrift company try to raise more capital or pursue a sale. Such a move could speed a deal for the ailing thrift and some reports had Wamu putting itself up for auction. A Wamu spokesman was not immediately available.

Wachovia's shares fell 21%, and Wamu's shares ended down 13.4%. The declines preceded reports of the new and unusual pairings in a week that has already seen the face of the financial sector altered drastically.

Meanwhile, an analyst said Wednesday that Wachovia could see a 15-cent-per-share hit to third-quarter earnings from exposure to Lehman Brothers Holdings Inc., which filed for bankruptcy Monday. Evergreen Investments, Wachovia's asset management arm, said in a press release that three of its funds have $494 million of total exposure to Lehman.

Wachovia spokeswoman Christy Phillips-Brown said the company's direct exposure is "modest" and any losses would be tied to mark-to-market adjustments in the money market funds, beginning this quarter.

Wachovia declined to comment on the deal rumor, and Morgan Stanley did not immediately return calls on the report that it had discussed a deal.

The stocks of both Morgan Stanley and Goldman Sachs Group Inc., the last two independent investment banks, fell sharply. Aside from the Wachovia rumor, Bloomberg News reported that the cost to protect against a default by the banks rose to a record Wednesday.

Goldman saw its shares fall 13.9%, though they had been down more during the session. Morgan Stanley's shares, off 44% at one point, closed down 24.2%.

CNBC reported that Mr. Mack said in an internal memo that short-sellers were behind the sharp decline in Morgan Stanley's shares. On Wednesday, the Securities and Exchange Commission banned naked short-selling in all publicly traded companies as of Sept. 18. (See story on this page.)

Tim Curran, a trader at Regions Financial Corp.'s Morgan, Keegan & Co. Inc., said recent news has made investors very skittish. "People are still waiting for the next shoe to drop," he said, so bank stocks "are free falling."

Banks, however, did seem to rebound a little in the afternoon, "but we're still seeing a ton of sellers out there."

The KBW Bank Index ended down 7.7%, after several days of extreme volatility in the wake of Monday's news on the Lehman Brothers bankruptcy filing and Merrill Lynch's decision to sell itself to Bank of America Corp.

The broad market was also beaten down again: The Dow Jones industrial average fell 4.06%%, and the Standard & Poor's 500 index, 4.7%. Dow components JPMorgan Chase and Citigroup Inc shed 12.2% and 10.9%, respectively. AIG fell 45.3%. Gainers included Popular Inc., up 3.6.% and Central Bancorp Inc., 6.1%.

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