By Heather Landy and Renae Merle
Washington Post Staff Writers
Tuesday, September 30, 2008
NEW YORK, Sept. 29 -- Without a federal bailout plan to prop up confidence in the U.S. financial system Monday, stocks fell sharply around the globe, oil sank, gold soared and yields on government debt skidded closer to zero as traders ran from risk and sought safe-haven investments.
The Dow Jones industrial average tumbled 7 percent, or 777.68 points, eclipsing the record point drop after the Sept. 11, 2001, terrorist attacks, to close at 10,365.45. The technology-heavy Nasdaq composite index slid 9.14 percent, or 199.61, to 1983.73, and the broader Standard & Poor's 500-stock index lost 8.79 percent, or 106.62, to close at 1106.39.
A rush into safer securities pushed down yields on Treasury debt, while crude oil fell more than $10 a barrel on concern that the financial crisis would put a big dent in demand for petroleum products.
Underlying the panic is a seizing-up of the credit markets that provide companies with financing for expenses such as payroll and inventory. Analysts said banks are lending less as they try to conserve cash for their own balance sheets, while nervous investors are forcing companies to pay higher interest rates to borrow in the debt markets.
"The credit markets are kind of like the oil for an engine that allows companies to buy something and finance it. And if they don't have the ability to finance that at a reasonable cost, then all of the sudden their profit margins are going to get squeezed and they're perhaps not going to be able to hold as much inventory, and this is happening around the globe," said Jim Hannan, managing director for fixed-income strategy at MTB Investment Advisors in Baltimore.
"You need to be able to have credit, and it needs to be at a reasonable price, for the economy to function," Hannan said. "If companies can't finance future production or expansion plans, at the end of the day, that is going to equate to slower economic growth."
Marc Pado, U.S. market strategist at Cantor Fitzgerald, said the effects of constricted lending already are showing up in the agriculture business, where farmers often are dependent on short-term loans to buy seeds and fertilizer for the next season's crop. "If the bank says no, they're not going to plant. The fertilizer companies aren't seeing the orders they normally see at this time of year," Pado said. "It goes beyond comprehension once you start digging into who uses short-term debt and the impact they have on the next person in line."
In the commercial-paper market, where companies can sell debt maturing in nine months or less, some companies that used to pay less than 3 percent to borrow are now paying double that rate, investors said.
Debt holders also are demanding richer premiums to offset the risk of holding longer-term corporate debt. Caterpillar, the farming and construction equipment maker, last week sold $1.3 billion of five- and 10-year notes that were priced to yield at least 3.2 percentage points more than Treasurys with similar maturities. That was nearly a full percentage point wider than the spread on previously issued Caterpillar notes, investors said.
The credit markets have been socked before. Lending froze up a decade ago after the failure of the hedge fund Long-Term Capital Management, and in the decade before that after the 1987 stock market crash. But in both of those instances, the markets loosened after a day or two, said Glenn Migliozzi, chief investment officer at Green Eagle Capital in Lake Forest, Ill.
"The Fed is going to lower rates," he said. "They're going to have to."
Federal Reserve Chairman Ben S. Bernanke, along with Treasury Secretary Henry M. Paulson Jr., had urged Congress to pass legislation that would allow the government to buy bad debt such as mortgage loans from financial firms.
Hours before the House rejected the bailout plan, by a vote of 228-205, the Federal Reserve more than doubled, to $620 billion, the funds available to nine other central banks -- in Europe, Australia, Canada and Japan -- to make short-term loans to banks and other financial institutions. It also tripled, to $225 billion, the amount available for short-term loans to U.S. financial firms.
Lawmakers may take up the bailout bill again, but probably not until later in the week. Uncertainty about the fate of the proposal comes at a crucial time, the end of the third quarter, when firms will be seeking to refinance short-term debt.
Without a bailout plan, it may become more difficult for many companies to roll over their financing to meet immediate debt requirements and payroll obligations, said Joseph Brusuelas, chief U.S. economist at Merk Investments.
"If Congress does not get its act together, we could see an increasingly sharp sell-off across all global markets," he said. Bank stocks were among the biggest decliners after the takeover of Wachovia by Citigroup. Shares of National City fell 63 percent, or $2.35, to close at $1.36. Sovereign Bancorp fell 72 percent, or $6.04, to close at $2.33.
Asian and European markets were down across the board Monday, with indexes in London, Paris and Germany all experiencing losses close to or in excess of 4.5 percent. In early trading Tuesday, Asian stocks continued their slide, with Japan's benchmark Nikkei 225 index down as much as 5 percent.
Investors sought safety in gold, pushing the price for October contracts up $36 an ounce at one point on the New York Mercantile Exchange. Oil retreated to $96.37 a barrel. "There were three reasons for the price decline" in oil, said Adam Sieminski, chief energy economist at Deutsche Bank Securities. "The economy, the economy and the economy." Sieminski said that the oil markets were stricken by fear that the problems of big financial institutions would start to spread and hurt other industries.
"Wall Street doesn't use any oil," he said. "It's the rest of economy."
A drumbeat of negative news helped raise investors' concerns. Consumer spending stalled in August, according to government figures released Monday, and at least two banks in Europe required government rescues over the weekend.
Billionaire financier and corporate turnaround veteran Wilbur Ross, who backed the bailout plan, said the $700 billion proposal would have helped to grease the wheels of the credit markets. But he doubted that it would have been a cure-all for an ailing economy.
"We still are faced with the situation that the average citizen is having a tough time making mortgage payments and car-loan payments. We still have the problem of unemployment rising, we still have the problem of a housing market in free-fall, and we still have the problem of the auto industry's bad volume," said Ross, chairman of Invesco's WL Ross investment subsidiary.
As lawmakers prepare to revisit the bailout debate, tectonic shifts in the financial industry continue.
Wachovia joined a growing list of financial institutions set to disappear in the restructuring of Wall Street, following the demise of Bear Stearns, the bankruptcy filing of Lehman Brothers, the purchase of Washington Mutual by J.P. Morgan Chase and Bank of America's agreement to buy Merrill Lynch. Citigroup is buying Wachovia's banking operations, which hold billions in risky mortgage debts.
"The morgue of financial institutions continues to get fuller," said Art Hogan, chief market analyst at Jefferies & Co. "The longer we wait for that rescue package, the fuller it gets. The market is pricing in the realization that there are more problems that are not going to be fixed by this rescue plan."
Merle reported from Washington. Staff writer Steven Mufson contributed to this report.