Despite Late Surge, Markets Still Show Signs of Instability

Global stocks have experienced wild fluctuations this week in the wake of the U.S. government's seizure of insurance giant American International Group, the failure of Lehman Brothers, the disappearance of Merrill Lynch as an independent company and reports the U.S. government will set up a government entity to take on bad debts from financial institutions.
By Glenn Kessler
Washington Post Staff Writer
Friday, September 19, 2008

The rampaging credit crisis continued to roil the world's markets yesterday, but in a week of steep downdrafts, U.S. stock prices rallied on news of the government efforts to shore up the global financial system.

The respite came despite ominous signs that the markets remained remarkably unstable. Investors on Tuesday withdrew nearly $80 billion from money-market funds -- long viewed as among the safest of investments -- and some firms took the dramatic step of shutting down their funds at a loss to investors. Morgan Stanley, one of the two remaining independent investment banks, continued to flirt with selling a huge stake to a Chinese investor or agreeing to an outright sale.

Throughout the day, governments around the world worked to contain the crisis. In the morning, the Federal Reserve and central banks in Europe, Japan and Canada teamed up to inject as much as $180 billion into global markets to ease the cash crunch. Later, regulators here and in London took steps to crack down on trading tactics that have hammered the stocks of vulnerable companies. By evening, congressional leaders met with their counterparts at the Federal Reserve and Treasury and the Securities and Exchange Commission to hash out a plan to ease pressure on the beleaguered banking community.

The markets reacted to every step, rallying in the morning on news of the global cash infusions, weakening when President Bush issued a subdued statement on the government's efforts, falling in the afternoon as concerns returned, and then rebounding sharply as word of the latest rescue plans circulated.

Traders cheered from the floor of the New York Stock Exchange as the Dow Jones industrial average surged 617 points from its lowest point, closing at nearly 11,020, up more than 410 points, for a gain of nearly 3.9 percent. The sudden swing wiped out much of Wednesday's losses, though the market is still down for the week.

"I think people would like to see a comprehensive solution to this crisis," said Bill Stone, chief investment strategist for PNC Wealth Management. "What we have seen so far is reacting to companies that are staring into the abyss, instead of getting ahead of it."

Badly battered financial stocks, such as Wachovia, Goldman Sachs and Morgan Stanley, also rose on reports that regulators were limiting the abilities of investors to profit when a stock plunges in value. A type of trading strategy known as short selling had contributed to the downfall of four financial giants over the past two weeks and now threatens the existence of the remaining investment firms.

Regulators, law enforcement and private investors in the United States and Britain announced steps to fight short selling. New York Attorney General Andrew M. Cuomo launched an investigation yesterday to determine whether short sellers used illegal tactics, such as spreading wrong information about companies or engaging in conspiracy, to clobber stocks. Across the Atlantic, Britain's Financial Services Authority said it is stopping short selling of shares in financial companies for at least a month. The SEC is considering a total ban.

Meanwhile, two massive public pension funds in California -- covering public employees and teachers -- said they have stopped lending shares of Goldman Sachs, Morgan Stanley and Wachovia to try to curb short selling in them. Short sellers typically need to borrow shares from an investor in order to bet against them.

President Bush, changing his tone after weeks of generally optimistic assessments on the economy, offered a subdued statement on the "extraordinary measures" undertaken by the administration in recent days, including extending an $85 billion loan to prop up the nation's largest insurance company. "Our financial markets continue to deal with serious challenges," he said. "As our recent actions demonstrate, my administration is focused on meeting these challenges."

Indeed, the turmoil in the once-staid money-market-fund sector posed another threat to the financial system. Shaken investors pulled $78.7 billion from money-market mutual funds Wednesday, a drop of 2.6 percent, according to Crane Data, which tracks the industry. Investors also moved $56 billion from money-market funds that invest in corporate debt into funds that invest only in government debt.

The movements were disproportionately made by institutional investors, raising concerns that the outflow would expand as retail investors join in. Such funds are not federally insured, but they have been marketed as safe investments akin to bank accounts.

CONTINUED     1        >

© 2008 The Washington Post Company