Feb. 28 (Bloomberg) -- U.S. stocks declined for a third straight week, sending the Standard & Poor’s 500 Index to a 12- year low, as the government rescued Citigroup Inc. and drugmakers and insurers fell on President Barack Obama’s health-care plan.

Citigroup slid 23 percent, extending losses for what was once the largest U.S. bank to 94 percent during the past year. Humana Inc. led the health-care industry’s retreat on concern Obama will cut Medicare payments to insurers and raise rebates drugmakers must provide to Medicaid recipients. SLM Corp., the largest provider of U.S. student loans, tumbled 40 percent after the president’s first budget called for an end to loan subsidies.

“Before the end of a bear market, every group gets taken out and shot, and that’s what we’re experiencing here,” said Robert Lutts, who manages $400 million as president of Cabot Money Management in Boston. “The prospect of a recovery is good, but not in the short term.”

The S&P 500 dropped 4.5 percent to 735.09, its lowest close since December 1996. The Dow Jones Industrial Average fell 302.74 points, or 4.1 percent, to 7,062.93. The Russell 2000 Index of small companies lost 5.3 percent to 389.02.

The S&P 500 has dropped 18 percent this year following a 38 percent decline in 2008 that was the steepest annual retreat since 1937. The Dow average has fallen 20 percent. For both benchmarks, it’s their worst start to a year.

Goldman Sachs Group Inc. and UBS AG strategists cut their year-end forecasts for the S&P 500 this week on expectations earnings will keep declining. David Kostin at Goldman Sachs lowered his estimate to 940 from 1,100 and said the index may sink to 650 during the year. UBS’s David Bianco cut his prediction to 1,100 from 1,300.

‘Irrational Exuberance’

The S&P 500 traded yesterday for as little as 12.8 times company profits from the past decade. That gave the U.S. stock market the cheapest valuation since February 1986, according to data compiled by Yale University professor Robert Shiller and author of “Irrational Exuberance.” He uses a decade of earnings to smooth out short-term fluctuations.

Citigroup fell 23 percent to $1.50, the lowest price since November 1990. The U.S. Treasury said it will convert as much as $25 billion of preferred shares into common stock if private holders agree to the same terms. The conversion would give the government a 36 percent stake.

Financial stocks as a group rose despite Citigroup’s slide after Federal Reserve Chairman Ben S. Bernanke said he hoped to avoid government control of banks in favor of a public-private partnership that the U.S. would eventually exit.

‘Destroy the Franchise’

“I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary,” Bernanke said at a Senate Banking Committee hearing on Feb. 24. “We don’t need majority ownership to work with the banks.”

Regional banks in the S&P 500 rose 19 percent, the second- biggest gain among 154 groups in the index. Fifth Third Bancorp, the largest lender based in Ohio, jumped 105 percent to $2.11 for the biggest gain. Atlanta-based SunTrust Banks Inc. climbed 64 percent to $12.03. Marshall & Ilsley Corp., Wisconsin’s biggest bank, added 34 percent to $4.58.

Banks are driving S&P 500 companies as a group to their first quarterly loss. The 74 financial companies in the index that have reported fourth-quarter results lost a combined $50.5 billion, their third straight quarterly shortfall, according to data compiled by Bloomberg.

37% Profit Drop

Profits fell 37 percent on average at the 457 companies in the S&P 500 have reported quarterly results since Jan. 12. Those reporting next week include American International Group Inc., the insurer in talks to restructure its $150 billion bailout from the U.S. government, and Costco Wholesale Corp., the nation’s biggest warehouse-club chain.

This week, General Electric Co., Textron Inc., Gannett Co., Lincoln National Corp., Allstate Corp. and JPMorgan Chase & Co. joined 27 other S&P 500 companies that cut their dividends this year. Citigroup suspended the payout on its common and preferred shares as part of its agreement with the government. S&P forecasts aggregate dividends by companies in the index will fall 23 percent this year, the biggest decline since 1938.

Health-care stocks in the S&P 500 fell 11 percent, the most among 10 industries. Humana, an insurer, lost 42 percent to $23.67, while rivals UnitedHealth Group Inc. and Coventry Health Care Inc. dropped more than 26 percent. Drugmakers also slumped. Eli Lilly & Co. decreased 12 percent to $29.38. Pfizer Inc. slipped 10 percent to $12.31.

Federal Budget

Obama’s budget, released Feb. 26, calls for paring subsidies to insurance companies participating in the government’s Medicare health-care system by $170 billion. The proposed budget would also raise rebates that drugmakers must provide for patients on Medicaid, the nation’s health plan for the poor, to 22 percent of the manufacturer’s price from 15 percent. Lilly and AstraZeneca Plc said they would lose “several hundred million” dollars each in sales.

SLM fell 40 percent to $4.60. The company known as Sallie Mae may lose three-quarters of its origination business under Obama’s plan to end government subsidies for school lenders.

International Business Machines Corp. limited the Dow average’s decline, climbing 3.7 percent to $92.03. IBM reaffirmed its 2009 profit forecast, signaling the computer-services provider will withstand the deepening recession.

The U.S. economy contracted at a 6.2 percent annual rate in the fourth quarter, its worst performance since 1982, the Commerce Department said yesterday.

U.S. employers cut payrolls by 650,000 workers, the most since 1949, and the jobless rate probably surged to 7.9 percent in February, according to the median economist estimates before the Labor Department’s March 6 report.

To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net

Last Updated: February 28, 2009 08:00 EST