Feds' actions fail to calm markets

WASHINGTON — The U.S. government this year has placed on its books the liabilities of a major investment bank in March, two mortgage-finance giants earlier this month, and this week, the nation's largest insurer.

The world of free-market finance as we know it is over.

Turmoil was the word Wednesday as global stock exchanges plunged and investors flocked to safer havens.

The Dow Jones industrial average finished down 449.36 points to 10,609.66, while the Standard & Poor's 500 index shed 57.21 points to 1,156.39 and the technology-dominated Nasdaq composite index lost a whopping 109.05 points to 2,098.85.

All three indexes were off by more than 4 percent.

The Dow is down more than 7 percent on the week, its worst showing since July 2002. The blue chips have fallen more than 25 percent since reaching a record close of 14,164.53 on Oct. 9 last year.

Contracts for future delivery of gold, an ever-ready hedge against declining asset prices, rose $85 an ounce in trading before settling up $70.10, or 9 percent, at $846.60.

At the New York Mercantile Exchange, oil soared $6.01 to settle at $97.16 a barrel after the government reported a drop in domestic crude and gas inventories. Oil had dropped by about $10 a barrel on Monday and Tuesday.

"Nobody wants to own a 'paper' asset," said Amaury Conti, an equity trader at investment adviser Austin Calvert-Flavin.

If the Federal Reserve's Tuesday night rescue of insurer American International Group (AIG) was supposed to calm global financial markets, it didn't happen Wednesday.

Russian markets were so volatile that authorities halted trading in stocks and bonds, and Brazil's Bovespa index fell almost 6 percent.

Adding to the fear were problems in money markets, usually considered among the safest places for ordinary investors. One of the field's giants, Reserve Primary fund, which manages $65 billion, said late Tuesday it would temporarily suspend some customer redemptions because of its exposure to Lehman Brothers, which filed for bankruptcy protection Monday.

Vanguard assurances

This led other fund companies such as Vanguard to issue statements that they had no such problems in their money-market funds, but the hint that any player in this market had problems added to the anxiety.

In a span of less than 10 days, the entire landscape of U.S. finance was turned upside down.

This week's shake-up came after the Sept. 6 seizure by the federal government of mortgage-finance giants Fannie Mae and Freddie Mac, which together finance about half the mortgages in America.

Wall Street was abuzz with rumors Wednesday that one, or both, of the stand-alone investment banks left might get hitched to a commercial bank.

Morgan Stanley's shares fell 26 percent, and shortly after the close of trading, reports surfaced that the company was in early talks over a potential merger with Wachovia, based in Charlotte, N.C.

On Monday, Merrill Lynch agreed to sell itself to Wachovia's crosstown rival, Bank of America.

Meanwhile, Goldman Sachs, once run by Treasury Secretary Henry Paulson, traded down more than 20 percent for much of the day before ending just under 14 percent.

The assault by investors on the golden temples of finance came just hours after the Fed shocked the financial world by stepping up with an $85 billion, 24-month loan to AIG, which effectively bought the government a controlling interest in the global insurer.

The Fed's move was bolstered by an announcement Wednesday that the Treasury Department will auction about $40 billion in new bonds for use by the Fed in helping AIG access capital and eventually pay off its loan.

One reason for the panic is fear of where the next shoe will drop. After the clobbering financial stocks have taken, investors are worried that Seattle-based Washington Mutual may be the next domino to fall.

If WaMu were to fail, it could test the Federal Deposit Insurance Corp. (FDIC), which insures up to $100,000 per depositor.

The FDIC special fund to insure deposits already is below a congressional limit after the July seizure of lender IndyMac Bank by federal regulators.

The problems in the banking sector are dwarfing the closest crisis in modern times — over savings-and-loans — that also had its origin in bad mortgage lending.

"There was nothing like this in the S&L crisis," said Bert Ely, a banking expert who closely studied that turbulent period in the late 1980s and early 1990s.

Today's crisis is far different because of the many complex financial instruments and unregulated markets for which little information is available.

No full picture

"The systemic risk pieces are much more complicated. We don't begin to see the full picture. With S&Ls you knew who they were, they had quarterly reports. Today we don't have that," Ely said.

In a bid to protect investors from so-called "naked" short-selling of promised-but-unowned securities, the Securities and Exchange Commission is requiring short sellers and their broker dealers to deliver securities by the close of business on the settlement date, starting today.

"It would seem that the government's role in the private sector is experiencing a Renaissance following its bailouts in the finance and insurance sectors," said analysts at Action Economics.

Also weighing on equities, the Commerce Department estimated its count of new building permits for single-family homes fell to a 26-year low.

Material from MarketWatch and The Associated Press was used in this report.