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Despite Late Surge, Markets Still Show Signs of Instability

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.

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.

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