Dow Drops 411 Points After Paulson Changes Bailout Plan

Wall Street had a bad reaction to Paulson's statement that the bailout funds won't be used to buy illiquid assets. Sales figures from Best Buy also worried investors

Wall Street got some promised financial relief yanked away by Treasury Secretary Henry Paulson, sending stocks sharply lower on Wednesday. Paulson urged expansion of TARP funds, but said that money won't be used to purchase illiquid mortgage-related assets of financial institutions as originally planned.

This news gave jittery investors even more reason to keep selling stocks. The major indexes were already deep in the red before Paulson's morning announcement on news that retailers Best Buy (BBY) and Macy's (M) continued to show strain from the weak economy. Traders were also watching the fate of U.S. automakers being decided in Washington.

Selling picked up in the last half hour of trading on Wednesday. The Dow Jones Industrial Average finished down 411.30 points, or 4.73%, to 8,282.66. This level is still above the Dow's trading low of 7,773.71 on Oct. 10, and its recent closing low of 8,175.77 on Oct. 27.

The broad S&P 500 index fell 46.65 points, or 5.19%, to 852.30. And the tech-heavy Nasdaq composite dropped 81.69 points, or 5.17%, to 1,499.21.

In a major change, Paulson said the $700 billion government rescue program will not be used to purchase illiquid mortgage-related assets of financial institutions. He said the administration will continue to use $250 billion of the Troubled Asset Relief Program (TARP) to purchase stock in banks as a way to bolster their balance sheets and encourage them to resume more normal lending. He said the Treasury Dept. was considering a second round of capital injections to match private injections.

"He basically came out and said [buying troubled assets] was a bad idea," says Peter Cohan, author and management consultant at Peter S. Cohan & Associates in Marlborough, Mass. "I thought it wouldn't work because of the challenges of setting the prices of the troubled assets." Under the original rescue plan to purchase bad assets, there was no way to set a price that works for the taxpayer and the banks - so it was a nonstarter to begin with, Cohan says.

The Treasury has just $60 billion left in its rescue fund, and either the current or next administration will have to turn to Congress to request the second half of the promised $700 billion, according to the Wall Street Journal. So far, the Treasury has committed $250 billion to banks and is spending an additional $40 billion to buy preferred shares in American International Group (AIG), the WSJ reports.

The lingering worries about a recession aren't going away anytime soon and are likely to keep pressuring stock prices. Cohan notes that the market has gone from a volatile one with a lot of ups and downs to just big downs. "It's just maximum selling every day," he says.

Cohan notes that many hedge funds and endowments continue to dump stocks. "There's just a lot of big institutional selling pressure," he says, while smaller investors are already out of the market.

Shares of General Motors (GM) and Ford (F) were higher Wednesday on news Democratic leaders will push legislation to use a portion of the $700 billion bailout fund to rescue U.S. automakers, which also include the privately owned Chrysler.

Best Buy (BBY) said October same-store sales dropped 7.6%, and estimates that same-store sales for November to February could decline 5% to 15%. The electronics retailer cut its 2009 fiscal year earnings guidance from a range of $3.25-$3.40 to a range of $2.30-$2.90.

"Since mid-September, rapid, seismic changes in consumer behavior have created the most difficult climate we've ever seen," said Best Buy chief executive Brad Anderson. "Best Buy simply can't adjust fast enough to maintain our earnings momentum for this year."

Best Buy’s troubles reflect "a huge division in consumer goods, between products that consumers can buy with cash vs. goods that need to be financed," says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "Financing is scare -- that's hurting sales. We're seeing it in autos, we're seeing it in furniture."

However, another retailer's outlook wasn't as dire. Macy's (M) posted a narrower-than-expected loss of 8 cents per share in the last quarter, vs. earnings of 10 cents a year ago, as same-store sales fell 6% and total sales dropped 7%. The department store chain reiterated its fiscal 2009 earnings guidance, and said it expects same store sales to fall 1% to 6% in the fourth quarter.

American Express (AXP) shares fell on reports that the company is seeking roughly $3.5 billion in taxpayer-funded capital from the federal government.

Prudential Financial (PRU) declared an annual dividend of 58 cents per share, a 50% decrease from 2007's common stock dividend.

Bob Evans Farms (BOBE) posted earnings of 37 cents per share, vs. 45 cents a year ago, as same-store sales fell 0.5%. The firm raised its quarterly cash dividend 14%.

AK Steel Holding Corp. (AKS) said the economic downturn was prompted the company to temporarily idle its Mansfield, Ohio plant and close most of its Ashland, Kentucky operations.

In other U.S. markets, NYMEX crude oil fell $3.63 to $55.70 a barrel, making a 20-month low on concerns about the economic outlook. Gold futures were off $16.90 to $715.90.

Bonds rose in price Wednesday after returning from a Veteran's Day break. The 10-year notes yield fell to 3.65%, and 30-year bond yield fell to 4.17%.

In a speech in Luxembourg, Federal Reserve Vice Chairman Donald Kohn said the central bank is prepared to take additional steps to stabilize malfunctioning financial markets and support a faltering U.S. economy, Reuters reports. "Although we have seen signs of improvement, financial market functioning remains impaired in many ways, and we will need to continue to consider whether additional steps are needed to reopen credit flows and support the economy," Kohn said in prepared remarks at a Banque Centrale du Luxembourg event. He said some tools created to combat the crisis may become a permanent part of central bank instruments; these include currency swaps between central banks and the Fed's auctions of discount window credit.

World stock markets were mostly lower Wednesday. Reuters reports the Bank of England predicted the British economy will shrink sharply next year and inflation will tumble, suggesting that it will cut interest rates even below their current half-century low. In its gloomiest set of forecasts in more than a decade, the central bank said the economy had probably already entered recession and was likely to contract more throughout 2009.

On Wednesday, in London, the FTSE 100 index was down 1.5% to 4,182, Paris' CAC 40 index lost 3.1% to 3,233.96, and Germany's DAX index fell nearly 3% to 4,620.80.

Major Asian indexes were also lower. Japan's Nikkei 225 index dropped 1.29% to 8,695.51. In Hong Kong, the Hang Seng index lost 0.73% to 13,939.09.

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