Shock waves hit Wall St.

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by Associated Press

NWCN.com

Posted on August 15, 2009 at 1:36 PM

Updated Thursday, Sep 24 at 12:36 PM

Video: Financial crisis causing Wall St. meltdown

NEW YORK - The stock market has suffered one of its worst days in years as investors reacted to a stunning reshaping of the landscape of Wall Street that took out two storied names: Lehman Brothers Holdings Inc. and Merrill Lynch & Co.

The Dow Jones industrials are down more than 504 points, their sixth-largest point drop ever and their worst showing since the aftermath of the Sept. 11, 2001, attacks.

Investors were shaken by Lehman's bankruptcy filing and what was essentially a forced sale of Merrill Lynch to Bank of America for $50 billion in stock.

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While those companies' situations had reached some resolution, the market remained anxious about other companies. Among them: American International Group Inc., which is seeking emergency funding to shore up its balance sheet.

The developments took place as U.S. voters, who rank the economy as their top concern, prepare to elect a new president in seven weeks. Presidential candidates John McCain, a Republican, and Democrat Barack Obama, immediately called for stricter financial regulation.

Obama called the news "the most serious financial crisis since the Great Depression" of the 1930s.

President George W. Bush meanwhile signaled that the government would not continue to bail out Wall Street, saying only that "we are working to reduce disruptions and minimize the impact of these financial market developments on the broader economy."

"The policymakers will focus on the health of the financial system as a whole," Bush said during the White House appearance with visiting Ghanian President John Kufuor.

The demise of the independent Wall Street institutions comes six months after the collapse of Bear Stearns and 14 months after the beginning of the credit crisis, sparked by bad mortgage finance and real estate investments.

Ominously, American International Group Inc., the world's largest insurance company, was asking the Federal Reserve for emergency funding and planned to announce a major restructuring Monday

A global consortium of banks, working with government officials in New York, announced a $70 billion pool of funds to lend to troubled financial companies. The aim of the bank consortium, according to participants who spoke to The Associated Press, was to prevent a worldwide panic on stock and other financial exchanges.

Ten banks - Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Merrill Lynch, Morgan Stanley and UBS - each agreed to provide $7 billion "to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets."

The Federal Reserve also chipped in with more largesse in its emergency lending program for investment banks. The central bank announced late Sunday that it was broadening the types of collateral that financial institutions can use to obtain loans from the Fed.

Federal Reserve Chairman Ben Bernanke said the discussions had been aimed at identifying "potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses."

Europe's major central banks also moved quickly to calm markets, pumping billions of euros and pounds into the financial system to shore up confidence.

The European Central Bank said it received 51 bids for 90.3 billion euros ($127 billion) on its one-day tender of 30 billion euros ($42.6 billion) with a bid rate of 4.25 percent, a clear sign that demand for cash is over the top.

Similarly, the Bank of England in London offered 5 billion pounds (nearly $9 billion) in a three-day auction that drew bids for 24.1 billion ($43 billion), or nearly five times the amount that was offered.

The Zurich-based Swiss National Bank said it was also providing liquidity in "a generous and flexible manner" at an overnight rate of 1.9 percent, but wouldn't say how much was on offer.

Still, the FTSE-100 share index was down 4.07 percent in London, the Paris CAC-40 was off 4.5 percent and Germany's DAX 30 index of blue chips sagged 3.23 percent.

Asia's biggest stock exchanges in Japan, Hong Kong and South Korea were closed for holidays, but India's Sensex tumbled 3.4 percent, Taiwan's benchmark index plummeted 4.1 percent and Singapore dropped 3.2 percent.

Samuel Hayes, finance professor emeritus at Harvard Business School, said the Bush administration may get a lot of blame for the situation, which could benefit Obama.

"Just the psychological impact of this kind of failure is going to be significant," he said. "It will color people's feelings about their well-being and the integrity of the financial system."

Lehman Brothers' announcement that it is filing for bankruptcy came after all potential buyers walked away. They were spooked by the U.S. Treasury's refusal to provide any takeover aid, as it had done six months ago when Bear Stearns faltered and earlier this month when it seized mortgage giants Fannie Mae and Freddie Mac.

In an effort to calm the markets, Lehman pre-announced third-quarter results on Wednesday. In an affidavit filed with the bankruptcy court, Lehman Chief Financial Officer Ian Lowitt said that action "did little to quell the rumors in the markets and the concerns about the viability of the company." He said the uncertainty made it impossible for Lehman to continue.

Employees emerging from Lehman's headquarters near the heart of Times Square Sunday night carried boxes, tote bags and duffel bags, rolling suitcases, framed artwork and spare umbrellas.

Its businesses in Britain were placed in administration Monday, said the administrator, accounting firm PricewaterhouseCoopers, and employees carrying boxes and bags were walking out of Lehman's London offices.

Merrill Lynch, another investment bank laid low by the crisis that was triggered by rising mortgage defaults and plunging home values in the U.S., agreed to be acquired by Bank of America for 0.8595 shares of Bank of America common stock for each Merrill Lynch common share.

That values Merrill at $29 a share, a 70 percent premium over the brokerage's Friday closing price of $17.05, but well below what Merrill was worth at its peak in early 2007, when its shares traded above $98.

Bank of America has the most deposits of any U.S. bank, while Merrill Lynch is the world's largest brokerage. A combination of the two would create a global financial giant to rival Citigroup Inc., the biggest U.S. bank in terms of assets.

If the deal goes according to plan, Bank of America will be able to offer Merrill's retail brokerage services to its huge customer base. Where there is duplication, however, the combination of the two companies could result in more layoffs. Both Merrill and Bank of America have already cut thousands of investment banking jobs over the past year.

The deal would not come without risks, however. Merrill Lynch, like many of its Wall Street peers, has been struggling with tight credit markets and billions of dollars in assets tied to mortgages that have plunged in value. Merrill has reported four straight quarterly losses.

Bank of America's own finances are far from robust. As consumer credit deteriorates, the bank has seen its profits decline, and the company is still in the midst of absorbing the embattled mortgage lender Countrywide Financial, which it acquired in January.

Insurer AIG, hit hard by deterioration in the credit markets, said it is reviewing its operations and discussing possible options with outside parties to improve its business after a week when its stock dropped 45 percent amid concerns about the company's financial underpinnings.

The Wall Street Journal and The New York Times both reported early Monday on their Web sites that the American International Group is seeking an additional $40 billion in emergency funds - possibly from the Federal Reserve - to help it avoid a credit rating downgrade, which would make it more expensive for AIG to raise money. The insurer has already raised $20 billion in fresh capital this year.

AIG was working with New York Insurance Superintendent Eric Dinallo and a representative of the governor's office through the weekend to craft a solution that protects policyholders, according to Dinallo's spokesman David Neustadt.

"It's clear we're one step away from a financial meltdown," said Nouriel Roubini, chairman of the consulting firm RGE Monitor.

The end of Lehman may not stop the financial crisis that has gripped Wall Street for months, analysts said. More investment banks could disappear soon.

The independent broker-dealers "are going the way of the dodo bird," said Bert Ely, an Alexandria, Virginia-based banking consultant.

That's partly because some of the firms, particularly Merrill, made bad bets on real estate. But several analysts said that investment companies will need the deep pockets of commercial banks to survive the next few years.

Roubini said it's difficult to accurately gauge the health of companies like Merrill because their financial health depends on how they value complex securities. As a result, their finances aren't very transparent, he said.

That can lead to a loss of confidence in the financial markets, he said, which can overwhelm an investment bank even if it is financially healthy by some measures.

"Once you lose confidence, the fundamentals matter less," he said.

The common denominator of the financial crisis, analysts said, is the bursting of the housing bubble. Home prices have dropped on average 25 percent so far. Roubini predicted they could drop another 15 percent.

The crisis has begun to slow the broader economy as banks make fewer loans and consumers have begun cutting spending. Many economists are now forecasting that the economy could slip into recession by the end of this year and early next year.

That, in turn, could cause additional losses for commercial banks on credit cards, auto loans and student loans.

The wreckage could prompt the Federal Reserve to do an about face and once again cut a key interest rate this week or possibly later this year. Just a few days ago, a rate cut appeared largely off the table, but now it has emerged as a possibility as the Fed prepares to meet Tuesday.

The International Monetary Fund predicted earlier this year that total losses from the credit crisis could reach almost $1 trillion. So far, banks have only taken about $350 billion in losses.

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