Editor's note: Our "On the Brink" series will provide daily insight into the financial firms facing capital shortfalls and the growing pressure from short sellers in the market.

Morgan Stanley's

(MS) - Get Report

CEO John Mack has become the latest chief to scramble for a deal, perhaps by acquiring a commercial bank, to restore investor confidence in the brokerage firm.

But as reports gather steam that

Morgan Stanley

is considering partnering with

Wachovia

(WB) - Get Report

, one of the more troubled mortgage-heavy banks, analysts are having a hard time justifying why it would want to attach itself to the Charlotte, N.C.-based company.

"I'm kind of pressed to think of the real benefits Wachovia would provide to Morgan Stanley," says Frank Barkocy, the director of research at Mendon Capital Advisors. A combination of the two firms "doesn't do much on a near-term basis." Mendon has a small position in Morgan Stanley.

Barkocy compared the deal to Monday's agreement in which

Merrill Lynch

(MER)

agreed to sell itself to

Bank of America

(BAC) - Get Report

for roughly $44 billion.

"It's not as clear cut as the Merrill Lynch-Bank of America situation," he says. "That one makes a lot of sense. In the Wachovia-Morgan Stanley situation there are some benefits, but not nearly as clear cut and pronounced."

The New York Times

reported on the possibility of a Morgan and Wachovia combination after the close of trading Wednesday, citing people who had knowledge of the talks. According to the

Times

report, Mack got a call from Wachovia executives asking about merger possibilities.

Meanwhile,

CNBC

said Morgan's talks with Wachovia are indeed taking place and moving toward an advanced stage. At the same time, Morgan is continuing to seek capital from the Chinese government, possibly by selling part of the company to a Chinese bank, the report said.

Morgan Stanley is also apparently exploring other combinations with

HSBC

(HBC)

,

Banco Santander

(STD)

, Japan's

Nomura

, even

Bank of New York Mellon

(BK) - Get Report

, according to the

Wall Street Journal

.

If Morgan Stanley were to merge with Wachovia, it would be taking on additional risk, given its troubled mortgage portfolio, particularly the $122 billion option adjustable-rate portfolio it inherited from the 2006 acquisition of Golden West, analysts say.

"We think a merger with Wachovia would create additional earnings risk for Morgan Stanley based on Wachovia's pervasive and hard-to-forecast credit risk," Merrill Lynch analyst Guy Moszkowski writes in a note.

Wachovia has had a mountain of bad news attached to it this year following its 2006 acquisition of California residential real estate lender, Golden West, as loans once thought to be relatively good quality have soured. The option ARM portfolio is at the root of Wachovia's present troubles. Its new CEO Robert Steel, a former undersecretary to the Treasury, was hired in July to replace longtime head Ken Thompson.

Already Steel has implemented a host of restructuring initiatives and management changes at the firm. Still, analysts remain wary of the bank.

Indeed, the

Journal

reported Thursday that Morgan Stanley was looking at including a good bank/bad bank structure as part of the deal.

"To avoid marking Wachovia's balance sheet to market (which could be $30 billion pre-tax mark), a potential deal would probably be structured whereby Wachovia would buy Morgan Stanley. Strategically, this could help Wachovia but it would saddle Morgan Stanley with considerable credit risk," Moszkowski writes. "Also, while Morgan Stanley's issue in the markets is concern over its short-term funding, the merger would not create new deposits; the majority of the combined company would still require market-based funding."

To be sure, over the long term, Wachovia's $448 billion in deposits would likely provide a stable source of funding as well as earnings diversity for Morgan Stanley, but Wachovia would benefit more by the combination by gaining "a strong presence" in investment banking and institutional sales, among other things, Barkocy says.

But if the deal came to pass, it would be the latest chapter in what is already one of the most transformational weeks ever on Wall Street.

Already this week,

Lehman Brothers

(LEH)

has filed for bankruptcy,

Merrill Lynch

has agreed to be acquired by BofA and

AIG

(AIG) - Get Report

reached an arrangement for a Fed-led bailout.

The tumult has left

Goldman Sachs

(GS) - Get Report

and Morgan Stanley as the lone big U.S. investment banks. However, should Morgan join forces with Wachovia or another firm, Goldman will be the last of the large independent domestic investment banks.

On Tuesday, after both reported their quarterly results,

Morgan and Goldman

executives said they didn't need or plan to look for merger partners right now.

Meanwhile,

Washington Mutual

(WM) - Get Report

is reportedly on the auction block. A separate

Times

report said the lender has hired Goldman to find bidders, which could include

Wells Fargo

(WFC) - Get Report

,

JPMorgan Chase

(JPM) - Get Report

and

HSBC

(HBC)

.

Shares of both Morgan Stanley and Wachovia finished in the green Thursday, after news surfaced that the federal government was considering the creation of an entity to buy bad debt from financial firms, similar to the

Resolution Trust Corp.

used to stem the savings and loan crisis in the late 1980s. Morgan Stanley, which sank to a 52-week low in regular trading during Wednesday's session, closed up 3.7% to $22.55. Wachovia's stock surged 59% to $14.50.

"By combining with someone else, that truncates some of the negatives and reverses the downward pricing spiral," Barkocy says. "It could be as much a pre-emptive move, even though there was a possibility or probability that Morgan Stanley can survive on its own."

While deal speculation surrounding Morgan Stanley keeps changing, Barkocy says that it probably makes the most sense for the company if it could gain a capital infusion via a private equity firm.

"I would be surprised if Wachovia would do this deal straight up without something else occurring," says Chris Mutascio, an analyst at Stifel Nicolaus who covers Wachovia.

Mutascio speculated that Wachovia and Morgan Stanley could formulate the deal as a merger of equals so that Wachovia could undergo a simultaneous capital raise. Morgan Stanley would then get the deposit and "steady flow of funds," while Wachovia gets additional capital, he says.

"It could be a vote of confidence if it is blessed by Treasury and Fed," Mutascio adds. "

But it doesn't do anything to correct the current issues that Wachovia is facing -- at least in the eyes of some in the market."