Despite Late Surge, Markets Still Show Signs of Instability

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Wall Street in Turmoil

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.

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Already that image is suffering. Putnam Investments closed a $12.3 billion money-market fund to limit losses to its investors, while a $22 billion fund managed by Bank of New York Mellon said it would impose a 1 percent loss on investors. New York-based Reserve Management closed nearly two dozen funds to new investment. The credit ratings agency Moody's warned it might downgrade 13 money-market funds managed by a subsidiary of Lehman Brothers, indicating increased concern about their health.

"The money funds as a whole can tolerate a couple of days, maybe even a week of those kinds of outflows," said Peter Crane of Crane Data, "but if it continues those little cracks are going to start getting bigger."

Withdrawals from money market funds were not the only threat on the horizon. The credit ratings agency Standard & Poor's this week said financial institutions face "another large wave of write-downs in the second half of 2008" in the value of securities backed by mortgages. S&P predicted that write-downs on subprime-mortgage investments would reach $378 billion, and that the total could be "well over $500 billion" if securities backed by other types of impaired mortgages are included. The forecast was far worse than in March, when S&P said subprime totals could reach $285 billion.

The economic uncertainty is spurring a frenzied restructuring of the financial market. British bank Lloyds is acquiring mortgage lender HBOS for $22 billion, creating that country's largest mortgage lender. Constellation Energy Group, parent of Maryland's biggest utility, is being purchased by MidAmerican Energy Holdings, a unit of Warren E. Buffett's Berkshire Hathaway, for $4.73 billion in a cash-and-stock deal.

Reports continued that Washington Mutual, the nation's largest savings and loan, is trying to raise capital or sell itself. The company's shares closed up 48.8 percent.

Morgan Stanley executives weighed several options yesterday, including a combination with Wachovia and an increased investment from China's sovereign wealth fund, according to sources who spoke on condition of anonymity because the talks were ongoing. Officials said they are also examining the prospect of staying independent. At a town-hall-style meeting this morning at Morgan Stanley's headquarters, chief executive John J. Mack told employees that the markets had become irrational, and he offered assurances that the firm had adequate capital and the confidence of clients.

Staff writers Binyamin Appelbaum, Zachary A. Goldfarb, David S. Hilzenrath and Renae Merle and special correspondent Heather Landy in New York contributed to this report.