Oct. 28 (Bloomberg) -- Morgan Stanley fell as much as 26 percent in New York trading while larger rival Goldman Sachs Group Inc. dropped as much as 11 percent amid speculation a surge in Volkswagen AG shares may have saddled some banks with losses.

Morgan Stanley was down $1.32 to $12.41 at 1:15 p.m. after dropping as low as $10.15 earlier today. Goldman lost $4.43 to $88.45 after reaching $82.22. Both firms are based in New York.

Traders cited unconfirmed speculation that Goldman may have been affected by the jump in Volkswagen shares today after Porsche SE began buying the stock. Trading in Volkswagen, Europe's largest carmaker, is under investigation by the German financial-markets regulator after Porsche triggered a fourfold increase in the shares over two days.

Morgan Stanley has ``virtually no exposure,'' to Volkswagen, spokesman Mark Lake said. Goldman Sachs has no significant losses tied to Volkswagen, CNBC reported, citing unidentified sources at the firm. Goldman spokesman Ed Canaday declined to comment.

``There's speculation that Goldman was involved in the Volkswagen trade,'' said Michael Nasto, senior trader at U.S. Global Investors Inc., which manages $5 billion in San Antonio. ``Fundamentally, there's nothing else that we see that would be a reason why this stock is down.''

Max Warburton, an analyst at Bernstein Research in London, wrote in a report dated Oct. 13 that Porsche may be profiting by forcing hedge funds that have bet on a decline in Volkswagen's stock to buy it back at a higher price.

Short Volkswagen

``A lot of people were short Volkswagen and apparently Goldman Sachs had a big short position, that's the rumor,'' said Frank Ingarra, a money manager at Hennessy Advisors Inc., which oversees $600 million in Novato, California. ``It's by no means substantiated.''

Morgan Stanley's capital infusion from Mitsubishi UFJ Financial Group Inc., Japan's biggest bank, seems less comforting after Mitsubishi announced this week that it plans to sell 990 billion yen ($10.45 billion) in stock, Ingarra said. Mitsubishi UFJ acquired $9 billion of Morgan Stanley preferred stock earlier this month.

``Morgan Stanley had a lifeline to Mitsubishi and now it turns out that Mitsubishi has to raise money and maybe it's not as bulletproof as people thought,'' Ingarra said.

Morgan Stanley ``is in a `self-fulfilling fear' position,'' said David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller in New York. ``Like peers that have either gone bankrupt or were forced to sell, we believe fundamentals were sound enough to overcome problem asset exposures, but there is no antidote for unbridled fear.''

Trone added that maintaining the confidence of trading counterparties is ``crucial'' because the revenue ``keeps the lights on and without it these firms will incur large operating losses.''

To contact the reporters on this story: Christine Harper in New York at charper@bloomberg.net; Jeff Kearns in New York at jkearns3@bloomberg.net.

Last Updated: October 28, 2008 13:32 EDT