Morgan Stanley and Goldman slide as HBOS in takeover talks

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Shares of Wall Street firms Morgan Stanley and Goldman Sachs plummeted on Wednesday and the UK's biggest mortgage lender, HBOS Plc, looked set to be bought as signs of financial industry distress abounded.

Tuesday's $85 billion rescue of insurer American International Group by the U.S. Federal Reserve did little to calm nerves on Wall Street and around the world.

In the latest sign of regulatory anxiety, the U.S. Securities and Exchange Commission tightened enforcement of rules against abusive short-selling, or investor bets on declining share prices.

The cost of borrowing overnight dollars spiked above 10 percent, indicating a deep lack of trust spooking the inter-bank lending market in Europe.

Shares of the two largest U.S. investment banks, Goldman and Morgan Stanley , fell 11 percent and 16 percent respectively in early trading, even after both reported better-than-expected earnings on Tuesday.

The cost of protecting their debt spiked, reflecting investor fears that their debt issues are no safer than junk bonds. Both are currently rated investment grade.