July 10 (Bloomberg) -- Lehman Brothers Holdings Inc., once the largest U.S. underwriter of mortgage-backed bonds, fell to an eight-year low in New York trading as home-loan financing companies Fannie Mae and Freddie Mac extended yesterday's drop.

Lehman declined $2.44, or 12 percent, to $17.30 in New York Stock Exchange composite trading, the lowest level since Feb. 28, 2000, according to data compiled by Bloomberg.

Financial stocks sank this week on speculation government- backed Fannie Mae and Freddie Mac will need to raise more capital to withstand the credit contraction that has saddled banks and brokerages with $408 billion of writedowns. Lehman was also hit by speculation that some of its biggest customers had ceased doing business with the firm, which the clients denied.

``Constant pounding of the company's stock with one rumor after another may eventually get to the business,'' said Richard Bove, an analyst at Ladenburg Thalmann & Co. ``After a while, people might start worrying about doing business with Lehman. It seems there's a concentrated effort to break Lehman.''

Pacific Investment Management Co., manager of the world's biggest bond fund, and hedge fund SAC Capital Advisors LLC both said speculation they had backed away from Lehman was unfounded.

Pimco ``continues to trade with Lehman,'' the company said today in an e-mailed statement. Pimco fund manager Bill Gross said in an interview with CNBC that there's ``no question'' about the firm's solvency.

SAC Capital

``SAC is continuing to do business with Lehman Brothers as usual,'' Jonathan Gasthalter, a spokesman for the hedge fund company, said in an e-mail.

Similar speculation led to the demise of smaller investment bank Bear Stearns Cos. in March when clients and creditors stopped doing business with the firm. To prevent a similar collapse, the Federal Reserve has since allowed brokers to borrow from the central bank directly. Lehman has also boosted its cash holdings and reduced dependence on short-term funding.

Freddie Mac shares dropped 22 percent today to $8, after falling 24 percent yesterday. Fannie Mae sank 14 percent to $13.20, on the heels of yesterday's 13 percent decline.

``The financial turmoil is ongoing. Our efforts today are concentrated on helping the financial system return to more normal functioning,'' Federal Reserve Chairman Ben S. Bernanke said today on Capital Hill.

Congress should consider rules and mechanisms in the event it becomes necessary to liquidate ``a systematically important securities firm that is on the verge of bankruptcy,'' he said.

Credit Default Swaps

The cost of protecting debt sold by Lehman Brothers from default rose to the highest in almost four months, according to traders of credit-default swaps.

Contracts on the New York-based broker jumped 40 basis points to 325, according to Phoenix Partners Group in New York. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

``Lehman is very vulnerable,'' said Mayiz Habbal, an analyst at Celent, an independent research firm. ``This is a reflection of the amount of confidence the market has in the firm.''

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

Last Updated: July 10, 2008 16:35 EDT