Stocks plunge further on credit fears

Thursday, September 18, 2008

Post a comment | E-mail this story | Print

Stocks sank as the trading day began on news of AIG's near collapse.

By Alexandra Twin, CNNMoney.com senior writer

(CNNMoney.com) -- Stocks plummeted Wednesday, with the Dow industrials down 449 points at the close, as the government's emergency rescue of AIG amplified fears about the stability of financial markets.

The Dow Jones industrial average (INDU) lost about 4% of its value. The Standard & Poor's 500 (SPX) index closed down 57 points and the Nasdaq composite (COMP) down 109 points.

Selling pressure had eased up in the mid-afternoon as the jump in oil and gold prices boosted the underlying stocks. But the recovery attempt gave out as the session wound down.

Financial stocks tumbled across the board despite Goldman Sachs (GS, Fortune 500) and Morgan Stanley (MS, Fortune 500) reporting better-than-expected third-quarter results Tuesday.

The selloff comes in the wake of the government's bailout of Fannie Mae and Freddie Mac, Lehman Brothers' bankruptcy, Merrill Lynch's sale to Bank of America and ongoing worries about Washington Mutual and other firms.

"There's a fear of a financial system meltdown going on, and it's grounded in the headlines we're seeing about the series of firms that are in trouble," said Paul Rabbit, president of Rabbit Capital Management.

More On Finances

Meanwhile, a measure of corporate borrowing costs surged to levels not seen since around the time of the crash of 1987, according to reports.

Stocks slumped Monday, with the Dow losing 504 points after Lehman Brothers declared bankruptcy and AIG plunged amid worries about its solvency. Stocks bounced a bit Tuesday when the Federal Reserve held interest rates steady, cooling fears that the economic outlook has deteriorated on the financial market crisis.

But the reprieve from the selling was a short one, with a broad-based selloff in place Wednesday.

Rabbit said stocks were also under seasonal pressures, with September typically the worst month of the year for the major gauges.

According to the Stock Trader's Almanac, September has traditionally been the worst month for the Dow and S&P 500 since 1950, with the Dow averaging a loss of 1% during the month and the S&P 500 losing 0.6%. September has also been the worst month for the Nasdaq since its inception in 1971, averaging a loss of 0.9%.

By comparison, as of Tuesday's close, the Dow is down 4.2% and the S&P 500 is down 5.4% in September, while the Nasdaq has fallen 6.7% month-to-date.

Year-to-date, all three major gauges are down between 16.5% and 17.5%.

Bonds rallied, lowering the corresponding yields, as investors sought the comparatively safe haven of government debt. The dollar tumbled versus the yen and euro. Oil prices gained and gold prices soared more than $55 an ounce.

AIG: The Fed said late Tuesday that it was extending a two-year, $85 billion bridge loan to the troubled insurer in exchange for a stake in AIG that could reach 80%. AIG will have to pay back the loan in full by selling off some of its assets.

AIG had been on the verge of collapse as it scrambled to raise cash in the aftermath of the subprime mortgage collapse and subsequent credit crunch. AIG (AIG, Fortune 500) shares plunged 40% Wednesday.

(Why the Fed pulled the trigger on AIG)

Barclays and Lehman Brothers: Late Tuesday, Barclays said it will buy Lehman's North American investment banking and capital markets businesses for $250 million in cash, as well as Lehman's New York headquarters and two New Jersey data centers for $1.5 billion.

Barclays (BCS) had walked away from a deal to buy the troubled company outright over the weekend. Bank of America (BAC, Fortune 500) also walked away from a possible merger, and wound up buying Merrill Lynch (MER, Fortune 500) in a $50 billion stock deal.

Unable to find a buyer, Lehman Brothers (LEH, Fortune 500) filed for the biggest bankruptcy in history on Monday.

Although the government helped in trying to facilitate a deal for Lehman Brothers, it was reportedly unwilling to finance any buyout, as opposed to what it did with Bear Stearns in March and AIG. The government's reluctance to step in contributed to the reluctance of other banks to strike a deal with the troubled company.

The government reportedly helped AIG in order to prevent a bankruptcy that would have had broad implications for the U.S. and global markets. By comparison, the Lehman fallout was seen as more contained.

The government is also reportedly helping to facilitate a deal for the purchase of Washington Mutual (WM, Fortune 500), the mortgage lender that has also been hit hard in the housing market collapse. Any deal, however, would reportedly not include government financing.

Lehman lost 57% Wednesday, while Barclays fell 1.8%. Bank of America fell 7%, Merrill Lynch fell 12% and WaMu fell 8%.

Among other bank losers, Wachovia (WB, Fortune 500) lost 20%, Citigroup (C, Fortune 500) lost 15% and JP Morgan Chase (JPM, Fortune 500) lost 8%.

Other movers: Declines were broad based, with 27 out of 30 Dow components sliding, led by the financial shares. Other big Dow losers included Boeing (BA, Fortune 500), General Electric (GE, Fortune 500), General Motors (GM, Fortune 500) and Home Depot (HD, Fortune 500).

A variety of airline shares tumbled on the spike in oil prices, with higher fuel costs directly impacting the profits of the airlines. American Airlines' parent AMR (AMR, Fortune 500) tumbled 17%, Continental Airlines (CAL, Fortune 500) fell 16% and JetBlue Airways (JBLU) lost 9%.

Railroad and trucker stocks slipped too, as oil prices rose and investors bet on a bigger economic slowdown. The Dow Jones Transportation (DJTA) average fell 2.3%.

Negativity persists: The mood was pessimistic Wednesday, following late Tuesday news that the Fed was stepping in to help AIG avoid filing for bankruptcy - a development that could have caused massive turmoil within the already-strapped financial market.

But rather than reassure investors, the deal seemed to add to the uncertainty surrounding financial markets, coming six months after the near-collapse and government rescue of Bear Stearns.

"The whole thing is a mess," said Kelli Hill, Portfolio Manager at Ashfield Capital Partners. "When Bear Stearns collapsed, everyone thought that was the capitulation, but it wasn't. It's ongoing."

The fallout from the housing and credit market collapse "ripples through the entire financial industry and is stretching to other industries," she said. "The question everyone is asking is 'what's going to fix this?'"

The news also seemed to tighten up credit markets, despite the Fed's efforts to keep money flowing.

The Treasury Dept. said Wednesday that it would sell $40 billion of debt for the Fed to help the central bank deal with the huge cash crunch in the wake of the credit crisis.

But a key measure of borrowing costs surged to 1987 levels, Bloomberg reported, as the three-month treasury bill rates fell to multi-year lows.

The TED spread, which measures the difference between what the Treasury pays for three-month loans and what banks charge each other, surged to the highest level in more than 20 years.

A jump in the spread shows how panicky banks are, in that they are charging each other a bigger interest-rate premium than money lent to the U.S. government.

In other news, the Securities and Exchange Commission put into place new rules to limit so-called "naked" short-selling - a move aimed at soothing financial markets.

Short-selling refers to the process by which traders who have sold shares short to take advantage of a falling market need to buy them back.

Housing: Construction of new houses and apartments fell to their lowest level in 17 years last month, according to a government report Wednesday.

Fuel prices: Oil prices rallied as investors eyed the developments on Wall Street and the falling dollar, which makes dollar-traded commodities like oil cheaper for foreign investors to buy. The government's mixed weekly inventories report was also in the mix.

U.S. light crude oil for October delivery rose $6.01 to settle at $97.16 after settling at a seven-month low on Tuesday.

Prices have plummeted since peaking at $147.27 a barrel on July 11, as investors have bet that sluggish global growth will diminish oil demand.

Gas prices rose overnight, gaining for the 8th day in a row, according to a national survey of credit card activity.

Other markets: In global trade, European markets ended lower and Asian stocks ended lower with the exception of the Japanese Nikkei.

Treasury prices rallied as investors sought safety in government debt, lowering the yield on the benchmark 10-year note to 3.39% from 3.49% late Tuesday. Treasury prices and yields move in opposite directions.

In currency trading, the dollar fell versus the euro and the yen.

COMEX gold for December delivery rallied $70 to $850.50 an ounce.