By Tomoeh Murakami Tse and Neil Irwin
Washington Post Staff Writers
Wednesday, August 29, 2007

NEW YORK, Aug. 28 -- Stocks tumbled Tuesday after a report showed that turmoil in the financial markets had sharply reduced consumer confidence and investors worried that the Federal Reserve would not respond aggressively to the problems.

All major stock indicators shed more than 2 percent, with the Dow Jones industrial average dropping 280 points to erase last week's gains. Trading curbs at the New York Stock Exchange meant to limit wild swings that kicked in as the slide steepened after the 2 p.m. release of minutes from the Aug. 7 meeting of the Federal Reserve's policymaking committee.

At that meeting, members of the Federal Open Market Committee viewed inflation as a greater risk to the economy than any slowdown because of trouble in the financial markets. They "expected a return to more normal market conditions, but recognized that the process likely would take some time, particularly in markets related to subprime mortgages," according to the minutes.

In the 10 days after the meeting, financial markets froze up even more, and the committee revised its stance, saying that it viewed problems in the economy spurred by the market unrest to be its greatest concern.

But at the Aug. 7 meeting, Fed policymakers expressed mild concern about the impact of market turmoil on business investment. "Recent financial market developments were thought unlikely to have an appreciable adverse effect on capital spending," the minutes said.

Those words, while not surprising, seemed to reinforce worries by investors that the Fed is confident enough in the economy that it will not cut a key interest rate at its Sept. 18 meeting.

The market slide was particularly deep in the last hour of trading, continuing the late-day volatility that has been common in recent weeks.

The Dow, made up of 30 blue-chip stocks, ended the day down 280.28, or 2.1 percent, to 13,041.85. The Standard & Poor's 500-stock index, a broader market measure, lost 34.43, or 2.3 percent, to 1432.36. The tech-heavy Nasdaq composite index fell 60.61, or 2.4 percent, to 2500.64.

Leading stocks lower were shares of companies in the financial sector, which lost more than 3 percent. Contributing to their downfall, traders and money managers said, was an analyst report from Merrill Lynch, which downgraded the shares of Citigroup, Lehman Brothers and Bear Stearns to "neutral" from "buy," citing weakness in the mortgage and credit markets.

"Major brokers are downgrading other brokers," said David Dietze, chief investment strategist at Point View Financial Services. "They certainly don't like to take potshots on their peers. . . . Investors tend to give extra weight to those type of" reports.

The financial sector has taken a beating since concerns about subprime mortgages, or loans to home buyers with tainted credit, came to the fore six months ago. Those mortgages, which are now experiencing spiking defaults, were pooled together, sliced and diced into tradable securities by Wall Street investment banks and dispersed to pension funds, hedge funds, asset management firms and other investors around the world.

Fresh reports on the economy frayed investors' nerves, although the declines were not as large as some analysts had expected.

The consumer confidence index fell to 105 this month from a multiyear high of 111.9 in July, according to the Conference Board, a private economic research group. The drop from July to August was the biggest since the aftermath of Hurricane Katrina in 2005.

"It's a warning sign. It's just another development that strengthens the case for the cutting of the federal funds rate," said John Lonski, chief economist at Moody's Investors Service. He added that the August drop "does not promise a downward spiral for consumer spending, especially if the Fed responds to takes remedial action."

The housing sector put a drag on financial markets yesterday when S&P/Case-Shiller reported that home prices fell 3.2 percent nationwide in the second quarter, from the comparable quarter last year.

The decline was the steepest since economists Karl E. Case and Robert J. Shiller started tracking housing prices in 1987. Their national index measures repeat sales of existing single-family homes in the nine divisions defined by the Census Bureau.

The national numbers show that the housing market was on the ropes even before the worst of the credit crunch hit in August and walloped global financial markets, said Brian Bethune, a U.S. economist at Global Insight. "The situation indicates that there were already fracture lines, and now those fracture lines have become more like fissures," he said.

[Asian stocks fell sharply Wednesday, with Japan's benchmark index down 2.59 percent by the end of the morning session and South Korea's down 3.1 percent in morning trading, the Associated Press reported.]

Irwin reported from Washington. Staff writer Dina ElBoghdady in Washington contributed to this report.