Global Stocks Plunge as U.S. Crisis Spreads
Sell-Offs on All Major Exchanges

By Neil Irwin and Zachary A. Goldfarb
Washington Post Staff Writers
Tuesday, January 22, 2008

Stock markets around the world plummeted yesterday as a financial crisis that began in the market for U.S. home mortgages spread to almost all corners of the globe.

U.S. markets were closed for Martin Luther King Jr. Day, but all the world's other major economies experienced sell-offs. Stock prices fell more than 7 percent in Germany and India, 5.1 percent in China, 5.5 percent in Britain and 3.9 percent in Japan. Many countries experienced their worst market declines since Sept. 11, 2001, and the only country whose stock market rose was Sri Lanka.

Asian markets continued their steep drop today, with Japan down 4.4 percent in morning trading. As the market opened in India, shares fell nearly 10 percent, triggering an automatic halt to trading.

"Where the bottom is now is anyone's guess," said Wesley Fogel, a market strategist for HSBC.

Officials at the Treasury Department, in the Federal Reserve system and at major stock exchanges worked the phones yesterday -- calling one another and their counterparts around the world. They were preparing for what looks likely to be a volatile week on Wall Street: Futures markets yesterday forecast a 4.5 percent drop in the Standard & Poor's 500-stock index when exchanges open this morning.

A Treasury spokeswoman said only that the department is always monitoring markets and in touch with participants. A spokeswoman for the Fed declined to comment.

The markets fell as fears spread that massive losses on loans made to U.S. home buyers would cascade through the world financial system. Some of the firms that play important, but usually invisible, roles in the global financial architecture are turning out to be exposed to the downturn in the housing market in such a way that their ability to function is threatened.

The companies that insure bond investors against defaults are having to make massive payouts. One, ACA Financial, owes $60 billion that it cannot afford to pay and has been taken over by the Maryland insurance regulator. Its credit rating has been lowered.

The problems among bond insurers have meant that a wide variety of financial institutions cannot count on receiving payments due them, causing further losses.

Other news yesterday shows just how widely the damage has spread. A Chinese newspaper reported that the Bank of China is exposed to subprime U.S. mortgage loans to a degree it had not previously disclosed and may have to write down the value of its $8 billion in such investments. Several large European banks have taken similar hits.

Those losses could have importance beyond the hit they cause to the banks' share prices. Banks and other financial institutions play an important role in an economic downturn: lending to businesses and consumers so they can help the economy get back on track. The multibillion-dollar losses could make them unable to play that role.

Moreover, foreign investors have been plowing capital into U.S. banks to help them continue lending, which made the losses particularly worrisome, some analysts said.

"Those infusions of capital have been crucial to maintaining performance to date," said Joseph Mason, a finance professor at Drexel University in Philadelphia. "If foreign investors should significantly retreat from U.S. markets, that leaves us to our own recovery. In that case, the current credit crunch will continue to bite and we maintain a very high risk of recession."

Many economists have argued that continued growth in the rest of the world -- especially in fast-growing markets like China -- will help ease the pain of the slowdown in U.S. growth.

With their houses less valuable, U.S. consumers may start spending less, goes this logic, while Asian and European consumers will do just fine, preventing a global economic slump. Yesterday, analysts worried that this theory won't hold up.

"People are scared, and they are reacting with behaviors which are based on psychology," said David Kotok, investment chief of Cumberland Advisors. "Some of that can be seen in the stock market, but they are also changing consumer behaviors."

Many market analysts argued that stock markets in developing countries have appeared to be overvalued for some time, which would suggest that some of the market declines were necessary. For example, even after yesterday's 5.1 percent drop, the Shanghai composite index in China has risen more than fivefold in the past three years, sparking worries of a bubble.

"Many of the markets, especially the European and Asian markets, have been priced for eternal growth," said Axel Merk of the Merk Hard Currency Fund.

European officials stressed the underlying strength of their economies, arguing that they can continue to thrive despite weakness in the American economy.

"It seems that the markets are considering the possibility of a more pronounced slowdown, even a recession in the U.S.," European Union Monetary Affairs Commissioner Joaqu┬┐n Almunia told reporters yesterday. "I hope they will pay attention also to the real information . . . because, at least in Europe, the economic fundamentals of our economies are sound."

Most world markets were digesting for the first time the Bush administration's proposal to try to stimulate the U.S. economy with tax benefits. (It was announced Friday, after Asian and European markets had already closed.)

Traders around the world seemed to have little faith that the plan would arrest the slowdown in the U.S. economy, even if some version of it is passed by Congress.

"Foreign markets are doubtful about the ability of Congress to move quickly, and foreign markets have watched the Federal Reserve move slowly in August, September, October and November," Kotok said. "So the concern from abroad is that the U.S. has been too slow and done too little and is now playing catch-up."

White House spokesman Tony Fratto said in a statement yesterday that, while he wouldn't comment on daily market moves, "We're confident that the global economy will continue to grow, and that the US economy will return to stronger growth with the economic policies the President called for."

Congressional leaders yesterday acknowledged how serious the European and Asian sell-offs were and said they may have to rethink the size of the stimulus and its content. Democrats still favor tilting the package toward middle-class and poorer Americans, who would be the quickest to spend any tax refunds or government checks. But Republicans have been pushing for more incentives for investors and business, a possible reaction to the stock-market jitters.

"I don't want to use the word 'panicky,' but you can't look at the size of these [losses] and not be extremely nervous," said Rep. Rahm Emanuel (D-Ill.), a former investment banker. Emanuel cautioned that policymakers should not be chasing the markets, trying to reverse losses already in the books.

Toyota and Honda were down more than 5 percent as the sharply rising yen -- at a 2 1/2 -year high against the dollar -- increased fear of slowing sales in the United States. "There is a sudden sentiment shift to a worst-case, most pessimistic view," said Naoki Kamiyama, Japan equity strategist at Morgan Stanley. "The market has lost faith in a second-half recovery."

Staff writers Michael Abramowitz and Jonathan Weisman in Washington, Ariana Eunjung Cha in Shanghai, Blaine Harden in Tokyo, Molly Moore in Paris, and Kevin Sullivan in London contributed to this report.

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