Stocks plunge as big shake-up on Wall Street rattles investors

— -- Stocks prices fell sharply Monday as jittery investors struggled to digest one the of the biggest and most sudden upheavals in the financial system in decades — the collapse of Lehman Brothers and the agreement by Bank of America to buy troubled investment bank Merrill Lynch.

The Dow Jones industrial average tumbled 504.48 points, or 4.4%, to 10,917.51, in the worst day for stocks since Sept. 17, 2001 when trading resumed following the terrorist attacks. That day, the Dow fell 513.76 points, or 5.1%.

The Dow's drop Monday was its sixth-biggest point drop in history.

The Standard & Poor's 500 index fell 59.01 points, or 4.7%, to 1192.70. That, too, was the biggest sell-off since Sept. 17, 2001.

The decline took the S&P 500 below 1200 for the first time since Oct. 28, 2005 and knocked out the bear market low investors hoped would hold.

The stock sales represented a loss of more than $700 billion in shareholder wealth. "It's really been surprising and historic," says Hugh Johnson of Johnson Illington Partners.

The Standard & Poor's 500 had traded at or above its closing low this year of 1214.91 set July 15 in futures trading Sunday and early Monday. But as investor fears grew during the day, so did the selling.

Much of the pain was felt in financial stocks.

Selling pressure was exacerbated by so-called short-sellers, who bet that stocks will fall further, says Todd Leone, a trader at Cowen. A short seller makes money by selling borrowed shares and buying them back at lower prices.

"It seems like everyone is saying who is next to fail," says Leone. That puts pressure on shares of financial companies that need to raise money to offset losses on bad mortgages.

Those stocks include insurer AIG, down 61%. The firm is reportedly trying to raise $40 billion. Shares of Lehman fell $3.44 to 21 cents.

The bulk of the selling centered around stocks in the insurance, diversified financial and power producing industries. Investors also jumped into the safety of the Treasuries, sending the yield on the 10-year Treasury down to 3.48%.

But while panic selling hadn't set in early Monday, that doesn't mean it won't, says Edward Wedbush, president of Wedbush Morgan Securities. "The selling is disciplined and the panic part has not shown up," he says. "The question is, will it show up? It could get considerably worse."

Wedbush says a week of daily sell-offs could eventually push investors to sell. The problem of the over liberal extension of credit needs to be solved, he says.

But other investors are optimistic this is the washing out that's needed for the financial system to heal, says Jon Merriman, CEO at investment bank Merriman Curhan Ford.

He says the firms that investors knew were overextended are the ones struggling. Meanwhile, there is plenty of cash on the sideline waiting to be invested as soon as it's more clear the problems are all out in the open, he says. The washout "is inevitable and the faster it takes place, and it is taking place in unprecedented speed, the faster it gets through the system and the better it is for the system."