The Wall Street Journal is reporting that major Wall Street firms placed large bets against Morgan Stanley (MS) using credit-default swaps, two days after Lehman Brothers sought bankruptcy protection.

The firms included Merrill Lynch , Citigroup (C) , Deutsche Bank (DB) and UBS, according to the paper.

The paper said that a close examination of the trading revealed that the swaps played a critical role in magnifying bearish sentiment about Morgan Stanley.

A false rumor that Deutsche Bank had yanked a $25 billion credit line to the firm helped trigger a cascade of bearish bets on Sept. 17 against Morgan Stanley , the paper said.

The Journal said that the account was pieced together from the trading documents and more than six dozen interviews with Wall Street executives, traders, brokers, hedge-fund managers, regulators and investigators.

A UBS spokesman said that the bank does not comment on market speculation or rumor, while a spokesman for Deutsche Bank also declined to comment.

But apparently they are perfectly alright with spreading rumors!

This confirms speculation that the same banks who fought so hard for U.S. Securities and Exchange deregulation are now revealed as institutions desperately eating each other alive as a result of that same deregulation.  Is it a comedy or a tragedy?

You have to love the hypocrisy of these guys who want protection from rumors and short selling when it benefits them, and the rest of the time they're the ones doing it.