Nightmare on Wall St as Dow falls 450

The US stock market took another nosedive as the American banking system appeared even shakier and investors worried that the financial crisis is spinning so far out of control that even government rescues cannot stop it.

The Dow Jones industrial average, which only two days earlier had suffered its steepest drop since the days after the September 11 2001 attacks, lost another 450 points. About $700bn (€490bn) in investments vanished.

A day after the Federal Reserve stepped in with an emergency loan to keep American International Group, one of the world’s largest insurers, from going under, Wall Street wondered which companies might be the next to falter.

A major investor in ailing Washington Mutual removed a potential obstacle to a sale of the bank, and stock in two investment banks, Morgan Stanley and Goldman Sachs, was pummelled.

It was the fourth consecutive day of extraordinary turmoil for the American financial system, beginning with news on Sunday that another venerable investment house, Lehman Brothers, would be forced to file for bankruptcy.

The Dow fell 449.36 to 10,609.66, finishing near its lowest point of yesterday’s trading day. The index is down more than 7% just this week and more than 25% since its record close less than a year ago, on October 9 2007.

The 4% drop in the Dow yesterday reflected the stock market’s first chance to digest the Fed’s decision to rescue AIG with a €60bn taxpayer loan that effectively gives it a majority stake in the company. AIG is important because it has essentially become a primary source of insurance for the entire financial industry.

As the stock market staggered, the price of gold, which rises in times of panic, increased as much as €63,75 an ounce. Bonds, a traditional safe haven for investors, also climbed.

“The economy is not short of money. It is short of confidence,” said Sung Won Sohn, an economics professor at California State University.

The financial stocks in the Standard & Poor’s 500 dropped even more, falling 10%, and insurance that backs corporate debt soared for the last two surviving independent US investment banks, Morgan Stanley and Goldman Sachs.

“It seems as though banks are hoarding cash, no matter what rate they could be lending it at,” said David Rosenberg, North American economist at Merrill Lynch.

Markets around the world also tumbled, with stocks dropping from Hong Kong to London. Brazil’s benchmark index saw the largest drop, losing nearly 7% in a day.

Worse, the short-term credit markets remained frozen, with overnight interest rates soaring for loans between banks and for overnight loans to businesses. Long-term loans, however, did not rise as much.

“The worry on short-term loans is you’re not sure who the ultimate borrower is,” said Brian Bethune, chief US economist at Global Insight.

And in case anyone needed additional symbolism, a glass panel near the top of a Bank of America skyscraper in Midtown Manhattan fell more than 50 floors on to the street below and shattered. No injuries were reported.

Mortgage rates, which had fallen after the government’s takeover of mortgage giants Fannie Mae and Freddie Mac, rose again, removing a glimmer of hope that the housing crisis, the kindling for the broader financial meltdown, was hitting bottom.

And new statistics showed that construction of new homes and apartments fell a surprising 6.2% in August to the weakest pace in 17 years.

The US Treasury Department, for the first time in its history, said it would begin selling bonds for the Federal Reserve in an effort to help the central bank deal with its unprecedented borrowing needs.

Treasury officials said the action did not mean that the Fed was running short of cash, but simply was a way for the government to better manage its financing needs.

Separately, the Securities and Exchange Commission tightened rules on short selling, the practice of betting that a stock will fall.

A €43.7bn money market fund – Primary Fund from Reserve – saw its holdings fall below its total deposits on Tuesday, a condition known as “breaking the buck” that has not happened to a money market fund since 1994, Mr Rosenberg said. Money market funds are supposed to be conservatively invested and almost as safe as cash.

Democratic presidential nominee Barack Obama appeared yesterday in a two-minute commercial to outline his economic plans and warned it would not be easy to fix the nation’s worsening financial problems.

“The truth is that while you’ve been living up to your responsibilities, Washington has not,” he said.

Republican John McCain’s running mate, Alaska governor Sarah Palin, said of the AIG move: “It’s understandable but very, very disappointing that taxpayers are called upon for another one.”

Many economists worried about the unintended consequences of the Fed’s actions.

“Every time that umbrella widens, it gets heavier and heavier for those holding it up – which is the taxpayer,” said Bernard Baumohl, chief economist at the Economic Outlook Group in Princeton, New Jersey.