Economy Shows New Signs Of Stress

Merrill Lynch Loss, Home-Sales Data Expose Weaknesses

Many of the nation's biggest companies have cut back their sales expectations in recent days and the financial system is showing signs of new stress, evidence that the U.S. economy is more threatened by the sharp downturn in housing than it appeared to be only a few weeks ago.

The investment firm Merrill Lynch yesterday reported its first quarterly loss in six years and said the value of assets on its books had fallen $7.9 billion. The National Association of Realtors reported that the number of existing homes sold in September was the lowest in the eight years the data have been tracked.

The developments were the latest to undermine investors' confidence that the August financial crisis has passed since the stock market reached an all-time high Oct. 9. Stocks fell in early trading yesterday, with the Dow Jones industrial average down about 200 points before recovering most of its loss by the end of the session.

"On the fundamental economics, there's a perception that things are getting worse," said Kenneth Kim, an economist at Stone & McCarthy Research Associates. "On the credit-market problems, people had started to think the worst was behind us. Now they think that's not necessarily the case."

The problems started last week in the banking sector. Citibank, Bank of America and Wachovia each reported disappointing earnings, mostly from losses on a variety of credit products. The banks indicated that their portfolios of home loans, credit card debt and some forms of corporate debt were worth less than was previously thought, and led to write-downs of $2.2 billion at Citigroup, $4 billion at Bank of America and $1.3 billion at Wachovia. Bank of America said last night that it would lay off 3,000 employees at its investment-banking division and reevaluate the unit's strategy.

Losses of that size are often manageable for such large institutions, but the write-downs added to worries on Wall Street and at the Federal Reserve that U.S. banks may be even more exposed to the problems in the world credit markets than even the banks had previously realized.

Fed leaders have been counting on the banks to be the economy's shock absorber by making capital available to consumers who wish to spend and businesses that want to expand. If the banks think they no longer can trust the value of their assets and liabilities, then they could become less willing to lend, a prospect that could cause more damage to the economy.

The Fed's policymaking committee is to decide Wednesday whether to intervene by cutting a key interest rate, but the group's signals have been mixed. In a speech last week, for example, Chairman Ben S. Bernanke said that the U.S. economy, aside from the housing sector, has been holding up well but also that damage to the financial system continues to pose risks and that the outlook is more uncertain than it had been.

Barely a week ago, futures markets were indicating that investors thought the Fed would probably stand pat and not cut rates, but by yesterday, the prediction had reversed.

With companies still filing third-quarter earnings reports, bad news has come from many sectors of the economy.

Last week, the construction-equipment maker Caterpillar warned that the housing downturn was spreading to other parts of the economy, raising fears about the economy's strength and its ability to avert a recession. Capital One Financial of McLean, meanwhile, last week posted its first-ever quarterly loss and said it had an increasing number of delinquencies and defaults in both the credit card and auto finance sectors.

On Tuesday, luxury leather-goods maker Coach, citing a "weakening retail landscape," said it expects sales at its stores in the United States to rise only moderately.