What Shoe Will Drop on Wall Street Next?

The Fed Board and Treasury Secretary Paulson hold key to solving financial woes.

September 16, 2008, 8:21 AM

Sept. 16,2008—, 2008 -- After a gut wrenching day of trading, the worst since Sept. 11, 2001, Wall Street returned Tuesday morning to face another potentially volatile day. Markets in Asia, which were closed Monday due to national holidays, saw significant losses that in turn could lead to more sell-offs in the United States.

And thousands of financial service employees around the world, and especially in New York City, worry whether they'll have a job in the months ahead, or have already joined the growing number of unemployed in the United States.

Wall Street will focus in on two events today. First, will the Federal Reserve, at its previously scheduled meeting, lower interest rates in an attempt to stimulate the economy even further? Economists believe that if the Fed were to lower the already low 2.0 percent federal funds rate, it would do so dramatically by dropping it 0.5 percent. But some of those same economists argue against a cut.

"We, however, believe a rate cut could backfire, because the ongoing market crisis is not about the price of credit but rather the availability of credit. Right now, financial institutions are fearful of further bankruptcies and counterparty risk. A lower fed funds rate does not directly address this," wrote Joseph LaVorgna, chief economist at Deutsche Bank.

Second, what exactly is Treasury Secretary Henry Paulson's view of the source of the nation's current economic slump, the housing market? The New York Times reports today that Paulson had a list of major institutions in mind that "might not be able to resolve their huge investments in troubled real estate, and that the list consisted of Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch and Washington Mutual. The official said that Mr. Paulson also decided that it was paramount to first resolve the problems at Fannie Mae and Freddie Mac, the two huge mortgage finance companies, before turning to the others."

Only one company remains on that list, Washington Mutual. As an indication that investors believe it could be the next financial institution to hit bottom, its stock has plummeted in value, dropping nearly 27 percent Monday to $2 a share.

Traders will not only keep their eyes on the nation's largest savings and loan, but onother banks that have also seen major sell-offs. And Goldman Sachs, one of the few investment banks left standing in the wreckage on Wall Street, reports its quarterly earnings Tuesday.

It's not just banks, however, that are in trouble. In what seems like a death watch, AIG is quickly trying to put together financing -- through public or private funds -- to stay alive. Its shares fell more than 60 percent on Monday and could fall further on Tuesday if it appears unable to secure the $75 billion it needs to prop up its finances.

The world's largest insurer is largely an invisible presence for many Americans. Not only does it provide traditional insurance products, but it is also the largest provider of liability insurance for the nation's businesses. The company's finances have suffered after it essentially insured the performance of those mortgage-backed securities that are now toxic on Wall Street and have led to the downfall of Bear Stearns, Lehman Brothers and Merrill Lynch.

For consumers with AIG insurance it is expected that the New York Insurance Commissioner would take control and administer the insurance policies if the company were to go under. That office is reported to be working with Goldman Sachs, JPMorgan Chase and the Federal Reserve Bank of New York to find solutions to the company's finances.

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