Investors were getting a lesson in gravity Wednesday.
Not the Newtonian kind, mind you. This was a sharp, sudden education in just how grave the crisis in world financial markets has become, featuring a multibillion dollar bailout of an ailing financial giant with extensive ties to other investment firms, freeze-ups in world credit markets, desperate moves by regulators to curb stock speculators, a new borrowing plan from the Treasury, and a huge jump in gold prices amid rising investor fear.
But maybe the physics part is relevant after all, for the force of all this gravity sent global stock markets sharply lower Wednesday.
The major U.S. stock indexes were under water for the entire session, with selling picking up into the closing minutes of trading Wednesday as market players lost their appetite for equities after digesting more extraordinary developments on Wall Street. Late Tuesday, the U.S. government extended an $85 billion lifeline to crippled insurer American International Group (AIG), which because of its role in the credit default swaps (CDS) market is a vital cog in the world financial system. The AIG bailout raises concerns that there are other problems lurking for major financial institutions, says S&P MarketScope.
Selling picked up steam in the last hour of trading Wednesday, sending the Dow Jones industrial average plunging 449.36 points, or 4.06%, to 10,609.66. The broader S&P 500 index lost 57.20 points, or 4.71%, to 1,156.39. The tech-heavy Nasdaq composite index skidded 109.05 points, or 4.94%, to 2,098.85.
Activity in the broader market was resoundingly negative. On the New York Stock Exchange, 29 stocks fell in price for every 2 that gained. The ratio on the Nasdaq was 24-4 negative. Trading was active.
Bonds were up, but off session highs. Gold futures soared to $867 per ounce. Oil futures, aided by inventory data, rose to $96.14 per barrel as commodities once again became a safe haven for wary investors.
However, after the market close, some deal talk hit the wires and helped boost some of the battered financial stocks in after-hours trading. The New York Times reported that Washington Mutual (WM) has hired Goldman Sachs (GS) to look for buyers. Among the potential bidders for WaMu are Wells Fargo (WFC), JPMorgan Chase (JPM) and HSBC (HBC) -- but no buyers may materialize, says the Times. Earlier, The New York Post reported that federal regulators recently called a number of banks asking if they would consider buying Washington Mutual should it eventually falter. The Post said federal banking regulators contacted Wells Fargo, JPMorgan, HSBC and several other financial institutions to gauge their interest in a possible acquisition of WaMu.
Morgan Stanley (MS) is considering a merger with Wachovia (WB), reports The New York Times. Also, in a memo reportedly released by Morgan Stanely, CEO Mack said "short sellers are driving our stock down."
On Wednesday, the SEC moved issued rules against naked short selling aimed at protecting stock investors, according to press reports. According to press reports, the new rules promulgated by the SEC on Wednesday will apply to all public companies starting Thursday, requiring traders who short a stock to deliver securities at the settlement date, with penalties for failure to do so within three days. Such penalties will include banning further short sales in the same security or a declaration of fraud if shorts deceive the broker-dealers about their intentions. However, the SEC failed to reinstate the uptick rule.
Fear was the name of the game Wednesday. Middle East traders were selling securities and buying gold as a result of one of Wall Street's worst-ever financial crises, according to S&P MarketScope. Russian markets were also in financial turmoil.
Market pros were trying to come to grips with how to control the panic. PIMCO CEO Mohamed El-Erian said that more targeted actions will be required by the government after the AIG bailout, along with systemic and global counter-measures as well. These would include coordinated rate cuts, direct securities purchases and capital injections into banks and brokers.
"It seems pretty clear at this stage of financial malignancy that some sort of [Resolution Trust Corp.]-style umbrella is needed before the financial system is hollowed out entirely," wrote Action Economics analysts.
Shares of venerable Wall Street firms Morgan Stanley (down 24%) and Goldman Sachs (down 14%) were under attack on Wednesday. After the close of trading Tuesday, Morgan Stanley reported better than expected third-quarter results, which it released ahead of schedule. It didn't matter much to panic-stricken investors concerned about big Wall Street firms' liquidity.
The rush to the exits for Goldman and Morgan Stanley investors was puzzling to some. "[I]f this is not an issue of liquidity like Bear Stearns, and not an issue of solvency like Lehman, we find it disconcerting that the illiquid CDS market (or the rating agencies) can have so much influence on the fate of these companies and alter the landscape of the brokerage industry," wrote UBS analyst Glenn Schorr in a note Wednesday.
S&P equity analyst Matthew Albrecht believes the market is punishing Goldman and Morgan Stanley for their reliance on outside funding sources, and that the companies may be pressured to seek partners with more permanent funding solutions, such as a large deposit base.
In just under two weeks, financial markets have absorbed some astonishing developments: the bailout of giant mortgage firms Fannie Mae (FNM) and Freddie Mac (FRE), the bankruptcy of Lehman Brothers (LEH), and the takeover of Merrill Lynch (MER) by Bank of America (BAC).
Stresses remained in global financial markets Wednesday. The cost of insuring against default continues to rise, if not soar, across market instruments, reports Action Economics.
News that money market fund Reserve Fund "broke the buck" Tuesday also damaged confidence after the fund wrote off $785 million in Lehman debt and suspended redemptions.
The Treasury announced a temporary Fed supplemental financing program using T-bill auctions to raise cash for the central bank as it bails out tottering financial institutions. With the Fed backstopping the financial sector to a greater degree, its own balance sheet is now getting lean.
In an 11th-hour effort to stave off a Chapter 11 filing, AIG secured an $85 billion bridge loan from the Federal Reserve Tuesday night. AIG reportedly has pledged all of its assets and will cede 79.9% of shareholders' equity to the Fed. But the deal may not provide the reassurance Wall Street needs that major players in financial markets have put the worst of their liquidity problems behind them.
The Fed's loan to AIG will allow a more orderly liquidation of the huge insurer, says S&P chief economist David Wyss. "The Fed has blinked, worried that there is no easy way to unwind the massive AIG structure." The problem, Wyss says, is centered on the huge credit-default swaps outstanding at AIG. "It is not clear that anyone knows the net positions involved, or how expensive they would be to unwind. I do not expect the shareholders of AIG to get any real benefit from this, but it should protect creditors and policy-holders."
The AIG bailout news late Tuesday capped another event-filled day on Wall Street that included a Federal Reserve policy meeting. The central bank stood pat at its rate-setting meeting Tuesday, as policymakers seem equally worried about inflation and an economic slowdown.
In other deal news, Barclays (BCS; -2.7%) said it has agreed, subject to U.S. court and relevant regulatory approvals, to acquire Lehman Brothers' North American investment banking and capital markets operations and supporting infrastructure for a cash consideration of $250 million; Barclays will also acquire Lehman's New York headquarters and two data centers.
The U.S. financial sector is not alone in its woes. According to a report on www.Telegraph.co.uk, Lloyds TSB Group (LYG; -3.1%) is in talks to acquire HBOS, Britain's biggest mortgage lender.
In economic news Wednesday, U.S. housing starts plunged 6.2% to a 0.895 million unit annual pace in August, below a downwardly revised 0.954 million in July (from 0.965 million) and the 0.95 million expected by markets. Starts were down 33.1% over last year, vs. -29.6% the month before. Permits declined 8.9% to a 0.854 million pace, down 36.4% over last year.
The Mortgage Bankers Association said its seasonally adjusted index of mortgage applications increased 33.4% to 661.7 in the week ended Sept. 12, the highest level since the week ended May 9, as borrowing costs on 30-year fixed-rate mortgages, excluding fees, averaged 5.82%, down 0.24 percentage point from the previous week. Interest rates were below year-ago levels of 6.29%.
The U.S. current account deficit widened to $183.1 billion in the second quarter, from a revised -$175.6 billion in the first (from -$176.4 billion previously).
Among other stocks in the news Wednesday, Nortel Networks (NT) said that with a sustained and expanding economic downturn, it is experiencing significant pressure as carrier customers cut back their capital spending further than previously expected, other customers are deferring investments.
General Mills (GIS) reported first quarter EPS of 96 cents (excluding items), vs. 81 cents one year earlier, on a 14% sales rise.
VeraSun Energy (VSE) said in a regulatory filing that it expects a third quarter loss of 40-65 cents per share due to a sharp drop in corn prices. Separately, the company said it has commenced a 20 million share offering.
SanDisk (SNDK) announced that its board has rejected an unsolicited, non-binding proposal from Samsung Electronics Co., Ltd to acquire SanDisk for $26 per share cash. The board concluded that the proposal "significantly undervalues SanDisk given the long-term prospects of its business."
Citigroup upgraded Evergreen Solar (ESLR) to hold from Wednesday. On Tuesday, Evergreen said, in connection with its Senior Notes offering, it entered into a capped call transaction with Lehman Brothers OTC Derivatives to reduce ultimate dilution that would otherwise occur.
Longs Drug Stores (LDG) said it has determined not to furnish information to, nor have talks and negotiations with, Walgreens (WAG), which recently offered to buy the company at $75.00 per share. Longs continues to recommend its holders accept the tender offer by CVS Caremark (CVS).
Markets overseas were mostly sharply lower Wednesday in the wake of the AIG news. In London, the FTSE 100 index fell 2.25% to 4,912.40. In Paris, the CAC 40 index shed 2.14% to 4,000.11. Germany's DAX index dropped 1.75% to 5,860.98.
Japan's Nikkei 225 index finished higher by 1.21% Wednesday, but the Hang Seng index in Hong Kong slumped 3.63%.
Bloomberg reported that Russia poured $44 billion into its three largest banks and halted stock trading for a second day today in a bid to stem the worst financial crisis since the devaluation and default a decade ago. Russian stocks have lost more than $425 billion in value since reaching an all-time high May 17, according to Bloomberg.