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Wall Street braces for more

Times Staff Writers

With Wall Street already reeling from the demise of one storied investment firm and the rushed takeover of another, investors are bracing for more turbulence as the housing crisis continues to hammer the nation’s financial system.

The Dow Jones industrial average plummeted 504 points Monday -- the most since the aftermath of the Sept. 11, 2001, attacks -- after investment bank Lehman Bros. Holdings Inc. became the biggest company to file for bankruptcy protection and Bank of America Corp. announced it was acquiring Merrill Lynch & Co.

The market’s direction today could hinge in large part on what happens with insurer American International Group Inc. -- the latest financial titan struggling to stay afloat -- and on the outcome of a Federal Reserve meeting on interest rates.

Like Lehman and Merrill, AIG has recorded large losses on mortgage-related debt. Its stock price plummeted 61% on Monday as the company scrambled to borrow as much as $75 billion to tide it over.

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And, as with Lehman, investors fear that a collapse of AIG would ricochet through the financial system and prompt another wave of selling in the stock market.

“You could crater the market on Tuesday with no resolution of AIG,” said Joe Battipaglia, market strategist at brokerage Stifel, Nicolaus & Co. in Florham Park, N.J.

The Fed, meanwhile, is under increasing pressure to come to Wall Street’s aid by cutting interest rates, a move that only a few days ago seemed a remote possibility.

The depth of the crisis had analysts making comparisons to the aftermath of 9/11, the dot-com bust and the 1987 market crash -- if they were making comparisons at all.

“There’s unprecedented turmoil among the largest financial institutions in the country, and that predictably has everyone on edge,” said Jeffrey Bronchick, chief investment officer at Reed Conner & Birdwell in Los Angeles. “No one has seen this before, and it’s going to take some time to see how it plays out.”

The Dow ended the day down 504.48 points, or 4.4%, at 10,917.51. It was the worst one-session point drop since the blue-chip index plunged 685 points, or 7.1%, on Sept. 17, 2001 -- the day markets reopened after the terrorist attacks. It was the biggest one-day percentage decline since a 6.4% plunge in July 2002.

Stock prices also tumbled in Asia and Europe, and were down again in Asia early today.

The planned takeover of Merrill Lynch by Charlotte, N.C.-based Bank of America did little to reassure investors. Shares of Bank of America, which two months ago bought the largest U.S. mortgage lender, Countrywide Financial Corp., dropped 21% on Monday, slicing the value of its all-stock offer for Merrill to about $40 billion.

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Likewise, statements by President Bush and Treasury Secretary Henry M. Paulson failed to calm investors.

In fact, the selling in the stock market accelerated after Paulson’s remarks, which seemed designed to reassure investors but also make clear that the government had no plans for further intervention in the troubled financial system.

“We’re working through a difficult period in our financial markets right now as we work off some of the past excesses,” Paulson told reporters at the White House. “But the American people can remain confident in the soundness and the resilience of our financial system.”

The Treasury chief also said that he “never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Bros.” In March, the Federal Reserve, with the Treasury’s endorsement, provided financial support for the sale of tottering investment bank Bear Stearns Cos. to JPMorgan Chase & Co., a move that stabilized markets for a while but was criticized by some experts as merely postponing an eventual day of reckoning for U.S. financial firms.

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The downfall of 158-year-old Lehman, combined with the unexpected deal by Bank of America to acquire Merrill, marked the most dramatic reshaping of the Wall Street landscape since the Great Depression, analysts said. Lehman, mortally wounded by loss-ridden securities tied to real estate loans, filed Monday for protection from creditors who hold more than $600 billion of the firm’s various IOUs.

In its bankruptcy petition, Lehman reported assets of $639 billion and liabilities of $613 billion. It listed 30 unsecured creditors to whom it owes about $158 billion. The markets are likely to remain on edge for weeks, experts said, until the extent of Lehman-related losses at other firms becomes clear.

A collapse of AIG could be an even bigger problem for the country’s financial system, Bank of America Chief Executive Kenneth Lewis told CNBC. “I don’t know of a major bank that doesn’t have some significant exposure to AIG,” he said.

Part of AIG’s business is to provide a way for big investors to hedge against potential market losses in their portfolios by essentially taking the other side of the investors’ bets.

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If the investors begin to believe that AIG can’t make good on these transactions, they may decide to sell holdings to reduce risk. That could further depress prices of stocks and some bonds.

“If you’re hedging with AIG, you may be afraid you don’t have any hedge at all now,” Battipaglia said.

Reinforcing the concern, Standard & Poor’s late Monday lowered its rating of AIG’s creditworthiness in such hedging transactions.

After Monday’s loss, the Dow was down 23% from its all-time high of 14,164.54 reached last October -- well into what is generally considered bear market territory.

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Many financial advisors are urging clients to resist the urge to panic and avoid selling at what could be the bottom of the market. But investors are clearly nervous. That was evident in the huge appetite for Treasury bonds Monday, which drove yields on the securities sharply lower.

The yield on the 10-year Treasury note plunged to 3.39%, down from 3.72% on Friday and the lowest since March. If the decline holds, it could help pull mortgage rates lower, giving an assist to the housing market. But yields on corporate bonds rose, making it more expensive for companies to borrow.

And as financial institutions hoarded cash, the banking system’s benchmark interest rate -- the rate banks pay other banks for overnight loans -- rocketed to as high as 6% early in the day, up from 2%, the Fed’s current target for the rate. The central bank pumped $70 billion into the system to push the rate back down and keep money flowing.

Amid deep uncertainty about the financial system, big investors “just don’t want to part with their cash very easily,” said Brian Edmonds, head of interest rates at bond dealer Cantor Fitzgerald in New York.

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Financial planners and mutual fund companies reported a surge in calls from nervous investors Monday.

In a sign of growing fear, investors have yanked $20 billion out of stock funds so far this month, compared with $26 billion for all of July and about $5 billion in June, according to TrimTabs Investment Research, which tracks money flowing into and out of mutual funds. Much of the selling has been concentrated in funds that invest in foreign stocks, the firm said.

Weary after enduring one financial crisis after another over the last year, “People don’t believe anything that’s being said” about the health of banks and brokerages, said Todd Leone, a stock trader at Cowen & Co. “They’re selling first and asking questions later.”

Meanwhile, Asian stock markets plunged during trading Tuesday over fears of a global financial crisis from the demise of Lehman and Merrill, according to the Associated Press.

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Japan’s benchmark Nikkei 225 index was down 5.3% in mid-afternoon trading; Hong Kong’s blue-chip Hang Seng index shed 5.7%. Both markets -- Asia’s two biggest -- were closed for holidays Monday.

Also, Japan’s central bank injected 2.5 trillion yen ($24 billion) into money markets to maintain stability in the country’s financial markets.

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martin.zimmerman@latimes.com

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tom.petruno@latimes.com

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Times staff writers Walter Hamilton in New York and Maura Reynolds in Washington contributed to this report.

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(BEGIN TEXT OF INFOBOX)

At a glance

Stock prices plunged across the globe, with the Dow Jones industrials tumbling 504 points, the most since right after the Sept. 11 attacks.

Shares of Bank of America dropped 21% after news that it would buy Merrill Lynch.

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American International Group stock fell 61% as the world’s largest insurer scrambled to find as much as $75 billion to stay afloat.

The price of oil fell sharply to close below $100 -- a first since early March -- in the wake of storms along the Gulf Coast and the turmoil on Wall Street.

Asian markets plummeted in early trading today.

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MORE COVERAGE

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Wall Street: Anxiety, not bullishness. Business, C1

Extra credit: Crisis offers lessons. Business, C4

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