March 24 (Bloomberg) -- U.S. stocks fell as the nation’s top two banking officials called for stronger regulation of financial firms and Nobel Prize-winning economist Paul Krugman said the government will have to seize major lenders.

Citigroup Inc. and Bank of America Corp. retreated after the shares jumped more than 19 percent yesterday on the Treasury’s plan to purge toxic assets from banks. Southern Co. led a gauge of utilities to a 2.2 percent drop amid concern the U.S. will levy fees on fossil-fueled power plants. Walt Disney Co. slumped 3.3 percent following a downgrade by Goldman Sachs Group Inc., which said the stock is expensive.

The Standard & Poor’s 500 Index lost 2 percent to 806.25 a day after its fourth-biggest rally since the 1930s. The Dow Jones Industrial Average slid 115.89 points, or 1.5 percent, to 7,659.97. Nasdaq OMX Group Inc. canceled its daily auction that helps determine closing prices because of a technical issue, causing shares and indexes to fluctuate after exchanges closed.

“When you’re buying equities, you’re buying a stream of earnings and current earnings are in freefall,” said Douglas Cliggott, the Greenwich, Connecticut-based manager of the $81 million Dover Long/Short Sector Fund, which beat 97 percent of its peers last year. “We haven’t hit bottom yet.”

The S&P 500 jumped 7.1 percent yesterday, extending its rebound from a 12-year low on March 9 to 22 percent, on speculation the U.S. plan to finance purchases of toxic assets will spur growth. Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Timothy Geithner called today for new powers to take over and dismantle failing financial firms after the troubled rescue of American International Group Inc.

AIG Rescue

The government spent $182.5 billion in rescuing AIG from losses tied to the housing market collapse. The New York-based insurer then spurred outrage after paying $165 million in bonuses to employees of the division that triggered the bailout with losses on credit-default swaps.

Citigroup lost 3.8 percent to $3.01. Wells Fargo & Co., the biggest West Coast bank, declined 11 percent to $15.50. An index of S&P 500 financial stocks dropped 6.5 percent for the steepest tumble among 10 industries. The measure is down 28 percent this year even after rallying 58 percent from March 6 through yesterday. Huntington Bancshares tumbled 16 percent today.

Financial shares extended declines after Krugman said in an interview with Bloomberg Television that the financial crisis will force the government to take over big banks. He also predicted the U.S. economy, which shrank 6.2 percent last quarter, won’t stabilize until late this year.

“In the end, we’ll come to it,” Krugman said, referring to nationalizing lenders. “You guarantee the liabilities of everybody but seize the big ones.”

Bernstein Says Sell Banks

Investors should sell bank stocks because the Treasury’s plan won’t stop profits from dropping, according to Richard Bernstein, Bank of America’s chief U.S. quantitative strategist who is leaving the bank in mid-April to start his own money management firm. Analysts project profit at financial companies in the S&P 500 will decline 33 percent this quarter and 34 percent in the next, according to estimates compiled by Bloomberg.

Bank of America slid 7.4 percent to $7.22 after surging 26 percent yesterday. A company spokeswoman said David Rosenberg, the firm’s chief North American economist, is also leaving. He will join Gluskin Sheff & Associates in Toronto, according to a person familiar with the decision.

Utility stocks in the S&P 500 posted the second-steepest decline among 10 groups after U.S. Representative Rick Boucher introduced legislation to tax fossil-fueled power plants and create a $1 billion annual fund to support projects that capture and store carbon dioxide.

Utilities Slump

Southern Co., the biggest U.S. electricity generator, dropped 3.5 percent to $30.72, snapping a seven-day advance. Duke Energy Corp., owner of utilities in the U.S. Southeast and Midwest, lost 3.3 percent to $14.20 for the steepest decline in three weeks.

Walt Disney Co. dropped 3.3 percent to $18.29 after Goldman Sachs analysts cut their recommendation to “neutral” from “buy.”

Newell Rubbermaid Inc. tumbled 9.5 percent, the most since March 2, to $6.56. The maker of Calphalon cookware cut its quarterly dividend for the second time in two months and said sales will drop more this quarter than it previously projected.

The S&P 500 took seven weeks to fall 20 percent and give President Barack Obama a bear market. To reach a bull market gain of more than 20 percent, it needed only 10 days.

Obama’s Market

Growing confidence in Geithner’s program to unfreeze credit markets boosted equities yesterday after his first proposal on Feb. 10 spurred a 4.9 percent drop in the S&P 500, the largest since Obama took office. Shares have rebounded in the past two weeks after the S&P 500 slid 20 percent from Inauguration Day to March 9. The decline was the steepest for a newly elected president in at least 80 years, according to data compiled by Bloomberg.

“Two weeks ago, the sentiment indicators were exceptionally weak and the market was very oversold,” Ajay Kapur, chief global strategist at Mirae Asset Securities Co., said in an interview with Bloomberg Television from Hong Kong. “That condition doesn’t hold today.” Kapur was formerly Citigroup’s chief global equities strategist.

Marc Faber, managing director of Marc Faber Ltd., said Geithner is doing the “right thing” from a short-term perspective by implementing his plan for the economy. The S&P 500 may reach 880, Faber predicted in a Bloomberg TV interview today.

BlackRock Inc.’s global macro fund, the world’s second-best performer over two years among hedge funds that invest based on economic trends, is betting against the equities rally. Its manager David Hudson said the fund is buying bonds as a recovery from the worst credit crisis since the Great Depression falters.

Allergan Inc. rallied 13 percent to $48.95 for the steepest gain in the S&P 500. A report sent to subscribers of the Web site dealReporter.com said GlaxoSmithKline Plc may be interested in acquiring the maker of the Botox wrinkle treatment, citing a person familiar with Glaxo’s policy.

To contact the reporter on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net.

Last Updated: March 24, 2009 18:03 EDT