Market Dispatches

Market Dispatches9/18/2008 2:45 AM ET

Dow falls 449 as fear sweeps Wall St.

Stocks plunge despite the Federal Reserve's decision to lend insurance giant AIG up to $85 billion to stave off bankruptcy. The 3-month Treasury bill yield drops nearly to zero. The SEC issues new rules to curb short-selling. Housing starts fall to a 17-year low.

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By Charley Blaine and Elizabeth Strott

Stocks fell to their lowest levels in three years today after the Federal Reserve agreed to lend up to $85 billion to troubled insurance giant American International Group (AIG, news, msgs).

The Fed move was designed to prevent the nation's credit system from seizing up. Instead, it seemed to create more fear both in the United States and abroad as investors sought safety from the carnage.

Gold had its biggest-ever one-day gain. Yields on government securities fell as investors sought refuge from the carnage in stocks; one short-term yield fell to levels not seen at least since January 1941, the Financial Times noted.

At the close, the Dow Jones industrials were down 449 points, or 4.1%, to 10,610. The Standard & Poor's 500 Index was down 57 points, or 4.7%, to 1,156, and the Nasdaq Composite Index was down 109 points, or 4.9%, to 2,099.

All 30 Dow stocks were lower, along with 478 S&P 500 stocks and 92 stocks in the Nasdaq-100 Index ($NDX.X), which tracks the largest Nasdaq stocks.

In addition, 19 of the stocks in the Philadelphia Semiconductor Index ($SOX.X) were lower, as well as 19 of 20 stocks in the Dow Jones Transportation Average ($DJT). The chip index was down 1.4% to 312; the transports were off 3.5% to 4,856.

Thursday is also likely to be volatile. Stock markets in Japan, Korean, Australia and Taiwan were all fell back on Thursday. Japan's Nikkei 225 Index ($N225) closed down 2.25% to 11,489. Stocks in Europe were modestly higher in early trading.

A few bulls, however, think the U.S. market is terribly oversold and could be set up for a snap-back rally.

Meanwhile, the financial crisis that The Wall Street Journal said was the worst since the 1930s has caused a number of financial companies to look for merger partners. The most prominent talk today centered around investment bank Morgan Stanley (MS, news, msgs), which was reportedly discussing merger possibilities with a number of companies, including Wachovia (WB, news, msgs).

There was investor skepticism that a deal might work out. Morgan Stanley's shares fell 3.5% to $20.98 in after-hours trading after falling 24.2% to $21.75 today. Wachovia was up 5.3% in after-hours trading after dropping 20.8% to $9.12 in regular trading.

In addition, The New York Times and The Wall Street Journal reported late this afternoon that troubled savings bank Washington Mutual (WM, news, msgs) has started to make moves to sell itself. The Journal said that Citigroup (C, news, msgs) and Wells Fargo (WFC, news, msgs) have expressed "preliminary interest" in WaMu.

WaMu shares, down 13.4% to $2.01 in regular trading, were up 7% to $2.15 after-hours.

An important development came late today from private-equity firm TPG, which invested $7 billion in WaMu in April. TPG waived its right to be compensated if WaMu sold more shares to raise capital or find a buyer. TPG has already lost nearly 76% of its WaMu investment, The Times said.)

Financial stocks were battered without relief today. Goldman Sachs (GS, news, msgs) fell 13.9% to $114.50. The Selector Sector SPDR-Financial (XLF, news, msgs) exchange-traded fund fell 9.6% to $18.55.

While stocks fell, a simmering battle erupted between the heads of some of the largest financial institutions and speculators who have made fortunes driving their stock prices lower. "We're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down," John Mack, Morgan Stanley's CEO wrote employees today.

General Electric (GE, news, msgs) was down 6.7% to $23.39; the stock had been down as much as 11% to $22.30.

The damage extended well beyond financial stocks. Apple (AAPL, news, msgs) fell 8.6% to $127.83; the stock is down about 25% this month and 35% this year. U.S. Steel (X, news, msgs) slumped 10.8% to $90.20; the stock is down 53% since peaking on June 25 at $191.96.

Of 42 domestic stock indexes that Market Dispatches, only three were higher, and two tracked gold stocks.

GoldCorp. (GG, news, msgs) was up 11% to $30.59.

The Dow is off 812 points this week

In three days of trading, the Dow is down 812 points, or 7.1%. If that holds for the week, it would be the worst week since the week of Feb. 27, 2007. It is 25% below its all-time high on Oct. 9, 2007. The S&P's decline is 26%, and the Nasdaq's decline from its Oct. 31 high 26.6%.

With today's close, 2008 now ranks as the eighth most volatile year for stocks since 1928, according to Standard & Poor's analyst Howard Silverblatt.The selling came with sizable volume. New York Stock Exchange volume was 1.8 billion shares; a normal day is about 1.6 billion shares. Nasdaq volume was about 3.1 billion shares, about a third greater than normal.

The volatility forced the Securities and Exchange Commission to enact new rules on short-selling in an effort to stabilize the markets. Some of the selling may be by traders hoping to beat down stocks before the rules take effect at 12:01 a.m. Thursday.

The problems in U.S. markets weren't unique. Stocks fell in the United Kingdom, Germany, France and Canada. Brazil's Bovespa Index was off 4.2%. Russia had to close trading in its two main markets for a second day in a row, and the Russian government pledged up to $44 billion to shore up its banking system.

The bear market scoreboard
WednesdayChange from closing peak Date of peak
Dow Jones Industrial Average

10,609.66

-25.10%

Oct. 9, 2007

S&P 500 Index

1,156.39

-26.12%

Oct. 9, 2007

S&P 100 Index

532.03

-27.10%

Oct. 9, 2007

Nasdaq Composite Index

2,098.85

-26.59%

Oct. 31, 2007

Nasdaq-100 Index

1,632.45

-27.09%

Oct. 31, 2007

S&P Midcap 400 Index

736.25

-19.73%

Oct. 9, 2007

Russell 2000 Index

676.38

-20.96%

July 13, 2007

Dow Jones Utilities Average

423.67

-23.35%

Dec. 10, 2007

Dow Jones Transportation Average

4,856.90

-11.58%

June 5, 2008

Nikkei 225 Index (Japan)

11,749.79

-32.70%

Oct. 11, 2007

FTSE 100 Index (Britain)

4,912.40

-27.02%

Oct. 12, 2007

Dax Index (Germany)

5,860.98

-27.11%

Oct. 12, 2007

The feverish hunt for safety

Investors seeking safety fled to government bonds and, especially, gold. Gold finished up $70 an ounce, or 9%, to $850.50 in New York. The dollar gain was the biggest ever. Silver was up $1.16, or 11%, to $11.675.

The yield on 13-week Treasury bills fell to 0.2% in trading today. (Yes, that's 0.2%.)

That's the lowest level since at least 1954, Bloomberg News said.

A yield that low means, essentially, that some investors were willing to take no interest at all in exchange for the certainty that the government will return their money.

There were even reports that investors paid extra-premiums just to get their hands on Treasuries. The yield on the 10-year Treasury note fell to 3.4%, its lowest level since June 2003.

A key measure of fear in fixed-income markets -- the so-called Ted spread, which tracks the difference between three-month London interbank offered rate (LIBOR) and Treasury bill rates -- moved above 3%, higher than the record close after the Black Monday stock market crash of 1987, the FT said.

Crude oil closed up $6.01 to $97.16 and pulled energy stocks higher.

Energy prices -- New York close
 Wed.Tues.Chg.Month chg.YTD chg.
Crude oil (NYMEX) (per barrel)$97.16$91.15$6.01-15.85%1.23%
Heating oil (per gallon)$2.8247$2.7197$0.1050-11.23%6.62%
Natural gas (per million BTU)$7.9100$7.3270$0.5830-0.42%5.71%
Unleaded gasoline (per gallon)$2.4630$2.4300$0.0330-18.17%-1.12%

SEC's new short-selling rules

Remember that old adage "A day late and a dollar short"? The Securities and Exchange Commission's new rules for short-selling come about a billion dollars short.

The SEC this morning issued three new rules to help curb so-called "naked" short-selling, a controversial practice that has been blamed for the downfall of many financial stocks. Earlier this summer, the SEC announced an order that protected 19 financial companies from naked short-selling; the new rules, however, cover all companies.

In an ordinary short sale, the short-seller borrows a stock and sells it, with the understanding that he must repay the loan by buying the stock in the market at a later day -- hopefully at a lower price. But in a naked short transaction, the seller doesn't actually borrow the stock and fails to deliver it to the buyer. For this reason, naked shorting can allow manipulators to force prices down far lower than would be possible in legitimate short-selling conditions.

"These several actions today make it crystal clear that the SEC has zero tolerance for abusive naked short-selling," SEC Chairman Christopher Cox said in a statement.

The SEC had been under pressure from financial companies, as well as other groups. But Sen. Christopher Dodd (D-Conn.) on Tuesday said the SEC moved too slowly.

The SEC's new rules go into effect at 12:01 a.m. ET Thursday. The SEC did not address the "uptick rule," which it got rid of last summer. That rule prevented short sales unless they were made at a higher price than the previous trade of the shares.

AIG deal puts the Fed in control

AIG shares were down 45.3% to $2.05 this afternoon in the aftermath of the Fed's decision.

The Fed will give AIG an $85 billion bridge loan in exchange for warrants to purchase stock worth roughly 80% of the company. Warrants effectively become equity when exercised, so the deal will severely dilute existing AIG shareholders.

The Fed said it needed to act to protect the economy: "A disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance," the central bank said in a statement late Tuesday.

AIG stock had plunged 79% in the past three trading sessions.

The Treasury Department said this morning that it will raise cash to help fund the Fed's loan to AIG.

The Treasury will auction $40 billion in 35-day cash through a Supplementary Financing Program. The move will "provide cash for use in the Federal Reserve initiatives," the Treasury said.

The Fed had close to $800 billion on its balance sheet at the beginning of the year. The central bank likely has only $195 billion left, according to Tony Crescenzi, bond analyst for Miller Tabak, MarketWatch reported.

How the deal works

AIG responded to the Fed bailout with a statement late yesterday describing the arrangement as the "best alternative" for the company.

AIG is expected to sell assets and use those proceeds to repay the loan, which is collateralized by all the assets of AIG and its main subsidiaries.

Stock Chart (Year)

American Intl Group
Graphical chart for AIG
AIG will pay a steep interest rate on the loan -- the three-month London interbank offered rate (LIBOR) plus 8.5 percentage points. Based on Tuesday's LIBOR quote of 2.81%, that would be an annual interest rate of 11.31%.

CEO Robert Willumstad is being replaced by Edward Liddy, the former CEO of Allstate (ALL, news, msgs).

The deal gives the Fed the right to veto dividend payments to AIG common and preferred shareholders.

AIG: Too big to fail?

So why did the Fed bail out AIG?

The short answer: AIG is an enormous global entity, with $1.1 trillion in assets and 74 million clients in 130 countries.

The company's main short-term problem was heavy participation in credit-default swaps. These are essentially insurance policies between two parties who are betting on whether a borrower will default. If a default occurs, one player pays off the other.

AIG was a huge player in the business of selling swaps on subprime and higher-quality mortgages and securities backed by mortgages. Waves of mortgage defaults have hit AIG hard. And if AIG had defaulted on its swaps, the result might have been a massive domino effect around the world.

"Suddenly banks would be holding a lot of bond-like instruments that were no longer insured," Suresh Sundaresan, the Chase Manhattan Bank professor of economics and finance at Columbia University, said in an interview with The New York Times. "They would have to mark them down. And when they marked them down, they would require more capital. And then they would have to go out and raise capital in these markets, which is very difficult."

The White House and the Treasury Department both said they supported the Fed's move, and many people on the Street expressed relief.

The deal is a good one if it gives AIG time to sell assets and maintain its investment-grade rating at A or higher, Bill Gross, co-chief investment officer of money management company Pimco, told Bloomberg Television.

In the hours leading up to the announcement of the bailout, many observers had spoken of the potential for a global cascade of problems spinning out of an AIG default.

Housing starts fall

The housing slump that is at the core of this financial mess got another bit of bad news today.

This morning, the Commerce Department reported that housing starts fell 6.2% in August to a seasonally adjusted annual rate of 895,000 -- the lowest level in 17 years. The level was worse than economists' predictions of 955,000.

Building permits, which are a gauge of future activity, fell 8.9% last month to a rate of 854,000, a 26-year low.

Housing stocks were lower on the news. The Philadelphia Housing Sector Index ($HGX.X) was down 5.3% to 127. Pulte Homes (PULTE, news, msgs) fell 11.5% to $14.37.

Barclays to buy Lehman unit

One company on Wall Street that likely isn't cheering the Fed's deal with AIG is Lehman Bros.

Over the weekend, British bank Barclays (BCS, news, msgs) and Bank of America walked away from talks to buy Lehman because federal authorities refused to back a deal and mitigate the risk; as a result, Lehman filed for bankruptcy on Monday.

Barclays may not have wanted the whole company, but the bank didn't hesitate to snap up Lehman's North American investment bank and capital markets businesses late Tuesday.

Barclay's will pay $1.75 billion for the unit, including Lehman's New York City headquarters building near Times Square and two data centers. The New York building's current market value has been reported to be between $600 million and $900 million.

The deal will save about 9,000 Lehman jobs, according to published reports.

Shares of Barclays were down 2.4% to $22.60; Lehman shares fell 56.7% to 13 cents.

Morgan Stanley beats the Street

Morgan Stanley reported its third-quarter results a day early to ease investors' worries.

Late Tuesday, Morgan Stanley said it earned $1.425 billion, or $1.32 per share, an 8% drop from the $1.543 billion, or $1.44 per share, the company earned last year, but a lot better than analysts' expectations of 79 cents.

Revenue rose 1% to $8.05 billion.

"We are very convinced and confident in the broker-dealer model," Morgan Stanley Chief Financial Officer Colm Kelleher told Bloomberg News. "The market unfortunately is based on rumor and fear."

Andy Rosenbaum contributed to this report.

Short hits from the markets -- 4 p.m.
 Wed.Tues.Chg.Month chg.YTD chg.
Treasurys
13-week Treasury bill0.020%0.860%-0.840-98.82%-99.36%
5-year Treasury note yield2.489%2.671%-0.182-19.42%-27.96%
10-year Treasury note yield3.410%3.491%-0.081-10.57%-15.49%
30-year Treasury bond yield4.081%4.095%-0.014-7.50%-8.48%
Currencies
U.S. Dollar Index78.09079.530-1.4400.76%1.82%
British pound in dollars$1.7895$1.78220.0073-1.75%-10.04%
Dollar in British pounds £0.5588£0.5611-0.00231.79%11.16%
Euro in dollars$1.4144$1.41100.0034-3.61%-3.22%
Dollar in euros€ 0.7070€ 0.7087-0.00173.74%3.33%
Dollar in yen 104.63105.52-0.89-3.81%-6.46%
Canadian dollar in U.S. dollars$0.928$0.934-$0.0058-1.35%-6.57%
U.S. dollar in Canadian dollars$1.078$1.071$0.00671.30%6.96%
Commodities
Gold$850.50$780.50$70.001.83%1.49%
Copper$3.0425$3.0890-$0.05-10.17%0.05%
Silver$11.6750$10.5170$1.16-14.82%-21.75%
Corn$5.5400$5.5400$0.22-2.51%21.62%
Crude oil (NYMEX) (per barrel)$97.16$91.15$6.01-15.85%1.23%

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