U.S., foreign stocks plunge as financial problems spread

The stock market plunged precipitously Monday, with the Dow Jones industrials down as much as 700 points, as traders feared the financial bailout package would not pass the House.

As the vote was shown on TV, stocks plunged and investors fled to the safety of the credit markets on fears that the financial system would keep sinking under the weight of failed mortgage debt.

The Dow fell 705 points, then regained some ground to trade down about 500. The Standard & Poor's 500 index and the Nasdaq were both off more than 5%.

Credit markets were still tight, as investors in the U.S. grappled with whether the historic financial rescue bill would pass and whether it will work.

Jitters were only increased by news that Wachovia Bank would be acquired by Citigroup, making Wachovia the latest U.S. banking institution to be leveled by the credit crisis.

Overnight, global stock markets posted losses as investors watched failures in Britain and Belgium. Shares were down sharply in Europe with Britain's FTSE 100 down 5.3%, Germany's DAX index 4.2%, and France's CAC-40 5.0%.

Asian markets closed down 1.3% in Japan, 4.3% in Hong Kong and 2% in Australia.

Hugh Johnson, chief investment strategist at Johnson Illington Advisors, says the lukewarm response to the U.S. government's financial rescue plan is due largely to an array of unanswered questions.

"It's extremely complex, and it is happening very fast and if individual investors are bewildered they are not alone," says Johnson. "There is so much uncertainty. Will the House and Senate pass the bill? What will the final details be? That is why the market is so jittery," he says. "It's not good to have those questions when short-term credit markets are seizing up."

Frozen credit markets, which the government's plan is trying to fix, showed little signs of thawing Monday, says Bill Hornbarger, fixed-income strategist at AG Edwards.

The yield on three-month Treasury bills, considered a super-safe investment, plunged to 0.68% from 0.84% on Friday. At one point early Monday, the yield went negative — meaning investors were willing to pay the government a premium to stash their money in a super-safe short-term IOU.

Similarly, the spread between three-month bank-to-bank lending prices in Europe, known as LIBOR, and the three-month T-bill widened sharply. The spread was almost 3.5 percentage points, up almost a half percentage point since Friday. Under normal market conditions the spread is two-tenths of a percentage point.

The wide spread shows banks are reluctant to lend to each other without being rewarded for the risk with higher interest rates.

"There is still a lot of stress in credit markets," says Hornbarger. "Investors want to hold the safest things they can until we get through this period."

Timothy Vick, a senior portfolio manager at Sanibel Captiva Trust, says the initial sell-off could be a classic case of investors who bought on the rumor of a bailout deal selling when it became news.

"Once word leaked out last week that the plan was in the offing, we saw a huge two-day rally," says Vick, referring to the Dow's 318-point, 2.9% move on Thursday and Friday. "Now that the plan is a reality some people want to do some quick profit taking."

But Vick admits there is still a lot of fear in the market, and the heavy early selling shows investors are still skeptical the bailout plan will work.

To compound matters, the third-quarter earnings reporting season is nearing, and investors fear profit warnings are likely to rise, Vick says.

Still, Vick says investors should not panic, arguing that while the government's plan might not jump start a bull market, it will soften downside risks.

"This type of plan is necessary to help stabilize the market and help set a bottom," Vick says.

If the plan is to succeed it must boost confidence, says Johnson.

"You need all the pieces to fall into place," he says. "The House has to pass it today. The Senate has to pass it on Wednesday. President Bush must sign it on Friday. And the government must start to implement the plan next Monday."

Major institutional investors are still waiting for details on how the government will buy the toxic mortgage assets from struggling banks. They want to know what assets will be bought, what prices the government will pay, what banks and other financial institutions will participate.

Right now, "all those things are up in the air," says Vick.

Additionally, investors worry if a U.S. bailout plan will help stem the contagion that prompted rescues of two major financial firms in Europe and led central banks, including the Federal Reserve, to pump additional cash into world markets to try to thaw a credit freeze.

In Europe, the British government took over troubled mortgage lender Bradford & Bingley and three European governments partially nationalized banking and insurance group Fortis.

Investors feared the troubles facing the banking sector might worsen the economy's outlook and constrain lending, a key pillar of business and consumer spending and vital for profits.

Concerns over Europe's banking and credit woes — including a multi-nation rescue of one of Europe's biggest banks and the bailout of a second bank in Britain — were driving down markets, said Clem Chambers, CEO of ADVFN, Europe's leading stocks and shares website.

The chilly reception in Asia "doesn't surprise me," said fund manager Marc Faber, publisher of the well-known investment newsletter The Gloom Boom & Doom Report, "because the bailout plan will not change the situation very much in the financial sector."

"Everybody is dead scared," Chambers said. "Nobody knows where it's going to stop."

"There's no silver bullet for what's plaguing the financial markets," said William Kaye, managing partner of the Great Asia Hedge Fund in Hong Kong.

Kaye believes the U.S. government should have allowed financial institutions to fail if they made irresponsible bets on subprime mortgages and other risky investments.

"Why not let them go broke?" he said. "People who do stupid things should get punished." He said the Paulson bailout reminds him of the piecemeal way Japan let a banking crisis drag on throughout the 1990s by periodically rescuing banks instead of allowing them to go out of business.

Monday's plunge in European bank stocks came amid announcements that:

• The governments of Belgium, the Netherlands and Luxembourg are pumping $16.4 billion into Fortis to keep it solvent. The Belgian-Dutch bank and insurance company is one of Europe's 20 biggest banks.

• The British government is nationalizing troubled Bradford & Bingley, a mortgage bank specializing in loans to buyers of rental property. It was the second British taxpayer bailout of a mortgage lender in a year.

• The German government is guaranteeing credit that lenders are extending to liquidity-stressed Hypo Real Estate Holding, a Munich-based bank and property conglomerate.

Europe's big nations last week had rebuffed urgings from U.S. Treasury Secretary Henry Paulson to set up their own bailout plans similar to the $700 billion rescue effort Congress is to take up starting Monday.

German Finance Minister Peer Steinbrueck said last week that the year-old global financial crunch was a U.S. problem that it needed to solve. Europe's other big industrial democracies — Britain, France and Italy — agreed, he said.

However, British Prime Minister Gordon Brown hasn't ruled out following suit if the situation worsens.

Until investors know where banks stand, Chambers said, European markets will remain volatile."It will be shooting up one minute and down the next," he said. "There's going to be violent mood swings."

Contributing: Jeffrey Stinson reported from London; Paul Wiseman reported from Hong Kong; Associated Press, Reuters