Dow Drops 500 Points
AIG Tumbles 61%, Pushing
Dow to a 500-Point Decline
September 15, 2008 6:13 p.m.
The stock market suffered its worst daily plunge in nearly seven years Monday as the bankruptcy of Lehman Brothers Holdings threw the U.S. financial system into an abyss, uncertain where the bottom of its credit-related problems lies.
Lehman's demise makes it the biggest casualty yet in the long-running credit crisis, which has so far seen torrents of red ink, restructurings and acquisitions, and shutterings of a few commercial banks. But until Sunday night, no Wall Street firm of such size and stature had suffered an all-out meltdown.
The Dow Jones Industrial Average, which languished with a loss between 200 and 300 points for most of the day, saw its losses accelerate in the last hour of trading to suffer its worst daily point drop since trading resumed after the 9/11 terror attacks. The Dow ended down by 504.48 points on Monday, off 4.4%, at its daily low of 10917.51, down 18% on the year.
All 30 of the Dow's components fell, save for Coca-Cola, which rose 0.5%.
American International Group plunged 60.8%. The Federal Reserve Monday asked Goldman Sachs Group and J.P. Morgan Chase to help make $70-$75 billion in loans available to the company, according to people familiar with the situation. The insurer has been racing to restructure its business and raise fresh capital to avoid a downgrade of its credit ratings.
The number of big players on Wall Street is dwindling, but traders said it remains to be seen where and for how much longer the ill effects of soured credit bets will continue to surface. A series of events through the end of the week, including a Fed meeting Tuesday and stock-options expiration Friday, could shed more light on the state of the financial system and send investors on another dizzying ride.
"It's a dicey situation right now," said Bill King, chief market strategist at M. Ramsey King Securities in Burr Ridge, Ill. "You have a lot of guys right now who don't know who to trade with because of counter-party issues," especially in the credit markets, where traders said it remained difficult to find buyers for certain securities despite the last 24 hours' realignment on Wall Street.
Bank of America was another big decliner among Dow stocks, off 21.3%. The company had been a suitor for Lehman but pulled out of talks as it became apparent in recent days that the Fed would not guarantee the financing of an acquisition as it did in J.P. Morgan Chase's purchase of Bear Stearns in March. Instead, Bank of America quickly moved to buy Merrill Lynch on Monday. Merrill shares ended little changed.
Two remaining big investment banks -- Goldman and Morgan Stanley -- saw their shares fall. Goldman was off 12.1%, while Morgan Stanley fell 13.5%. Both firms are due to report their fiscal third-quarter results in the next few days and are expected to try to make the case that they're very different from Lehman and Merrill. Analysts are expecting each to stay in the black but are bracing for write-downs of $1 billion to $2 billion each at Goldman and Morgan Stanley.
Financial stocks in the S&P 500 fell 9% as a group. The sector has shed $1.27 trillion in market value since October 2007. Financials now comprise 14.4% of the S&P 500, down from 22% at the end of 2006.
"Too much leverage is the alpha and omega of this story," said Doug Kass, president of the hedge fund Seabreeze Partners Management in Palm Beach, Fla., referring to financial firms' use of borrowed money to make bets on securities tied to risky mortgages. In a note to clients Monday, he criticized some banks' use of 30 dollars in leverage for each dollar of collateral in recent years – a practice that effectively amplified losses once prices of homes and the credit bets themselves began to fall.
In an interview, Mr. Kass added: "We're moving into the timeframe in which it makes sense to look for well-valued (financial) stocks. But investors should still take a conservative approach," including relatively small-sized bets on a recovery after more than a year of rocky credit trading and plummeting share prices in the financial sector.
In particular, the last few days' events have underscored the challenges facing the Fed, the Treasury Department, and other federal regulators, who are trying to strike a delicate balance between establishing a sturdy framework for the financial system while at the same time allowing markets to reward smart decisions and punish bad ones. By taking the rescue option off the table for Lehman, the U.S. government effectively declared that there are limits to its role as backstop-in-chief -- a concept that could have implications for other troubled firms in the months ahead.
Just last week, the government seized mortgage giants Fannie Mae and Freddie Mac, and months prior it brokered the sale of Bear Stearns to J.P. Morgan. But now, Washington appears to want Wall Street to largely fix its own problems.
"We've re-established 'moral hazard,'" a person involved in the Lehman talks told the Journal, referring to the notion that the government should eschew bailouts, since financial firms might take more risks if they're insulated from the consequences. "Is that a good thing or a bad thing? We're about to find out."
Other financial bellwethers suffered Monday. Wachovia plummeted 25% as analysts raised questions about the potential need for Wachovia to raise new capital to absorb future losses. Mike Mayo of Deutsche Bank downgraded the stock to "Hold" from "Buy," concerned about Wachovia's large portfolio of risky bets on adjustable-rate mortgages, which he called a wild card in analyzing the company.
"Our view has been that Wachovia does not need more capital," he said in a research note, since he thinks loan losses over the next few years will be less than expected. However, given increased concerns about economic growth and intense stress in financial markets, "this margin of safety has been reduced."
Troubled Washington Mutual tumbled 26.7% as investors feared it wouldn't be able to find a buyer to shore up its books.
After the close, S&P Ratings Services lowered its credit ratings on Washington Mutual to junk. "Increasing market turmoil and the related impact from managing its concentrated mortgage franchise in this troubled housing and credit cycle led to the downgrade of WAMU," said S&P credit analyst Victoria Wagner. "The company's weak equity pricing in the markets is also a concern, and it increasingly appears that market conditions could overtake credit fundamentals and leave the company with greatly diminished financial flexibility."
Other stock yardsticks suffered Monday. The Nasdaq Composite Index was off 4.7% to 2179.91, near a 6-month low and down 18% on the year. The small-stock Russell 2000 fell 4.2% to 689.76, down 19% on the year. The S&P 500 was off 4.7% to 1192.96, down 19% on the year. All the broad measure's sectors fell.
Among names listed on the New York Stock Exchange, about 8.1 billion shares changed hands, a new record. Decliners outnumbered advancers nearly 19 to one on the exchange.
Credit markets showed few signs of relief. The Fed-funds rate traded as high as 6.5% Monday, well above the central bank's 2% target as demand for cash far outstripped supply. The shortage forced the Fed to inject a massive $70 billion cash via its daily repurchase-agreement operation, which helped bring down the rate to 3.5%.
Traders said that various Wall Street firms offered a staggering $173 billion in mortgage-backed paper to use as collateral for repo agreements, but the Fed only accepted about $49 billion of it -- a sign that much of that debt remains too toxic for the Fed to assume on its books.
In the meantime, the three-month Libor/OIS spread, a gauge of stress in the money markets, widened to around 104.6 basis points from around 84.5 basis points Friday. Monday's reading was its widest since December when the gap increased to above 110 basis points, a record.
"These markets just continue to be broken," said Don Wilson, head of DRW Trading, a proprietary firm active in Chicago's interest-rate pits.
Treasury prices surged, pushing interest rates lower as investors sought safe havens. The two-year note was recently up 23/32, yielding 1.844%. The benchmark 10-year note was up 1-18/32, yielding 3.527%. The 30-year bond jumped 2-3/32 to yield 4.193%.
Crude-oil futures settled down $5.47 at $95.71 on the New York Mercantile Exchange on Monday on fears that the financial crisis could further slow the wider economy and fuel demand. It was oil's first finish below $100 since early March.
The dollar dropped against the Japanese currency, changing hands recently at 105.47 yen, down from 107.87 yen late Friday. But the dollar managed to post gains against the euro and British pound.
Write to Peter A. McKay at firstname.lastname@example.org