Crisis deepens amid fear of continued stock dive

The global financial crisis deepened Wednesday as stock prices cratered and credit markets seized up, teetering financial institutions sought salvation in buyouts and government officials scrambled to find a way out of the mess.

Investors awaited the opening of trading on Wall Street this morning with trepidation, fearing a repeat of the landslide of selling that sent the Dow Jones industrial average tumbling nearly 450 points to its lowest level in almost three years.

“It’s a hurricane blowing through” is how strategist Peter Boockvar at New York brokerage Miller Tabak & Co. described the mood on Wall Street. “Close your windows and lock your doors, and don’t stick your head out until the storm passes.”

Markets around the world have been struggling to cope with the fallout from the collapse of the U.S. housing market, a slow-motion disaster that began almost two years ago and has claimed a growing roster of victims. The mountain of bad mortgages -- and securities derived from those soured loans -- has caused chaos in financial markets, affecting everything from the health of huge financial houses to the ability of consumers to get an auto loan.

Late Wednesday, word came that two more financial giants facing doubts about their ability to remain independent -- New York-based investment bank Morgan Stanley and Seattle-based savings and loan Washington Mutual Inc. -- might soon be acquired.

The latest plunge in stock prices was especially unnerving because many analysts had hoped that the unveiling Tuesday night of an eleventh-hour federal bailout plan for giant insurer American International Group Inc. would calm investors.

“All of us felt after the AIG rescue that we would have a very positive day today because a rescue is a lot better scenario than the alternative,” said Alan Skrainka, chief market strategist at Edward Jones in St. Louis.

The bailout set off a flood of proposals in Congress to deal with the country’s financial predicament. The White House said it was keeping an open mind about such ideas, including having the U.S. buy distressed mortgages and debt.

In another sign of how the credit crisis has made the federal government more willing to intervene in financial markets, the head of the Securities and Exchange Commission proposed an emergency rule that could limit “short selling” -- betting that the price of a stock will decline. The regulation would require public disclosure of such trading by hedge funds and other big investors.

The level of fear among investors Wednesday was evident in the price of gold, viewed by many as a haven during financial storms. The metal soared $70.10 to $846.60 an ounce -- its biggest one-day gain ever in dollar terms.

Meanwhile, President Bush canceled a trip to Alabama and Florida planned for today to consult with his economic advisors in Washington.

In the credit markets, spooked banks, brokerages, hedge funds and other financial firms continued to hoard cash, typically in the form of short-term Treasury debt.

Demand for those securities was so strong that investors were willing to accept virtually no interest on their money. By the end of the day, a buyer of a three-month Treasury bill was receiving an annualized yield of just 0.06% on the security, down from 0.7% on Tuesday and 1.47% on Friday.

“Today has marked a new low for the credit crisis,” said Dominic Konstam, head of interest-rate strategy at brokerage Credit Suisse in New York. “Clients are shellshocked. No one’s taking any risks.”

An unwillingness by fearful banks and brokerages to lend to one another -- and other companies -- could have dire implications for the economy, which requires credit to grease the gears.

Frederick “Fritz” Henderson, president of General Motors Corp., said in an interview this week that the automaker was effectively shut out from financing.

“In May and June the markets were open. We had access to capital,” Henderson said. “Now the banks are saying, ‘Don’t do anything this week because we can’t help you.’ ”

The world’s major central banks, including the Federal Reserve, have been pumping short-term money into the global banking system this week, but to little effect.

“Nothing here seems to make anybody feel better,” said David Resler, economist at Nomura Securities International in New York. “I can’t really comprehend it, frankly.”

As credit markets tightened further Wednesday, corporate borrowing costs soared. The average yield on an index of 100 “junk” bonds jumped to 11.28%, up from 11.03% on Tuesday and 10.57% a week earlier.

In the stock market, the Dow fell 449.36 points, or 4.1%, to 10,609.66, its lowest close since November 2005. The blue-chip average has fallen 25% since hitting an all-time high of 14,164.53 in October. That’s worse than the 20% decline most market professionals consider the benchmark for a bear market.

The bleeding continued with Asian stock markets sinking early today.

Showing the global scope of the crisis, authorities in Russia suspended trading altogether after stocks there plunged Tuesday and early Wednesday. In Britain, embattled HBOS, originator of about one-fifth of all mortgages written in the country, said it was in advanced talks to be taken over by the Lloyds TSB Group.

The AIG deal came on the heels of the government’s declaration that it was out of the bailout business. After rescuing mortgage giants Fannie Mae and Freddie Mac this month, the government let Lehman Bros. Holdings Inc., the nation’s fourth-largest investment bank, slide into bankruptcy Monday. The same day, Merrill Lynch & Co. rushed to accept a buyout by Bank of America Corp.

Lawmakers raised the prospect Wednesday of creating a government-sponsored entity to buy up and liquidate the bad debt sinking Wall Street, much as the Resolution Trust Corp. was launched to clean up the savings-and-loan crisis almost two decades ago.

Some analysts have said financial companies won’t recover until they somehow unload their bad mortgage holdings -- or the value of the debt rises after home prices bottom.

Meanwhile, the prospect that another bailout might be needed was raised by the sharp declines Wednesday in the shares of Morgan Stanley and fellow investment bank Goldman Sachs Group Inc.

“They are the backbone of the whole investment-banking business and to see them take these types of body blows is nerve-wracking,” Dietze said. “These are not dot-com penny stocks. This is the heart and soul of American financial business.”

In recent days, several financial institutions, including North Carolina-based Wachovia Corp., have contacted Morgan Stanley about a possible acquisition of the investment bank, a person familiar with the matter said.

And as the already depressed shares of Washington Mutual fell 13% on Wednesday, the big mortgage lender put itself on the auction block, according to people who were briefed on the move.

The stocks of Washington Mutual, Morgan Stanley and many other financial firms increasingly have been the target of short sellers, who borrow and then sell shares of a stock, expecting the price to fall. If the bet is correct, the investor can buy shares later at a lower price to replace the borrowed stock, pocketing the difference between the sale price and the purchase price.

With a proposal to require big investors to disclose short sales, SEC Chairman Christopher Cox apparently hopes that some investors will be discouraged from shorting.

One area of finance that seemed to escape major damage Wednesday was the nation’s money market industry, which holds $3.5 trillion in what are supposed to be ultrasafe accounts. But late Tuesday the news that shares of a big money fund had slipped below $1 apiece in value -- a very rare occurrence -- raised concerns that investors would race to pull money from other funds.

That appears not to have happened. But any doubt about the safety of money market funds was likely to spook at least some investors, said Richard Weiss of City National Bank in Beverly Hills.

“If we were able to get stats on it,” Weiss said, “I think we’d find that there’s a considerable amount of money being moved under people’s mattresses.”

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martin.zimmerman@latimes.com

maura.reynolds@latimes.com

tom.petruno@latimes.com

Zimmerman and Petruno reported from Los Angeles, Reynolds from Washington. Times staff writer Walter Hamilton contributed to this report.

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Daily developments

* The Dow Jones industrials plunged almost 450 points to nearly a three-year low.

* Gold skyrocketed $70.10 an ounce, the biggest one-day dollar gain ever.

* Giant savings bank Washington Mutual and investment bank Morgan Stanley came under pressure to find buyers as their stock prices continued to plummet.

* Russia suspended trading altogether after the country’s stock market plunged for a second day.

* The crisis in the financial markets could make it tougher for consumers to get home and car loans.

* Federal regulators adopted rules that could curb a form of short selling, bets that stock prices will go down.