Goldman and Morgan's Crisis of Confidence

Updated from 12:27 p.m. EDT.

Goldman Sachs (GS Quote) and Morgan Stanley (MS Quote) shares each were plummeting Wednesday, as the only two remaining independent major broker-dealers came in the crosshairs of the crisis of confidence gripping Wall Street.

Panic is dominating the markets, with a new major financial institution seemingly under threat of extinction every day. Following Tuesday's federal bailout of AIG (AIG Quote) investors appear to be selling the shares of any institution that seems remotely vulnerable.

The problem for Morgan Stanley and Goldman Sachs -- both of which beat profit expectations Tuesday, but saw shares fall on Wednesday as much as 44% and 26%, respectively -- is that they depend heavily on the confidence of other institutions to stay open for business. Other financial institutions around the world are willing to take the opposite side of bets on loans and other trades, and because they trust Morgan Stanley and Goldman to pay them back.

In the current frenzied environment, however, that confidence could disappear in a few hours. One institution could call off its bet and ask for its money back, causing another to worry, creating a domino effect. This type of institutional bank run -- or the increasing likelihood of it occurring -- is precisely what helped drive Morgan Stanley's and Goldman's weaker and smaller competitors to sell themselves or file for bankruptcy.

"When the crisis in confidence unfolds against the institution, the confidence deteriorates to a point where no one is willing to provide it credit, and the scope, scale and leverage of these institutions just put them in a position where they are highly vulnerable to that crisis in confidence," says Steven Ricciuto, chief economist at Mizuho Securities USA.