Dow Falls 387 Points, Second-Biggest Drop of the Year

Aug. 9, 2007 — -- Stocks went on a free-fall moments after the opening bell rang this morning, following more bad news related to investments in subprime mortgages and never recovered.

The Dow Jones industrial average closed down 387, losing more than 2.8 percent of its value in its second biggest-single drop of the calendar year. On Feb. 27, the Dow lost 416 points, or 3.3 percent.

Still for the week, the Dow is up 88 points, following three strong, but wild days on Wall Street.

Today was the ninth greatest point loss in the Dow's history. But it didn't crack the top 20 list of biggest percentage drops in the market.

The NASAQ lost 2.16 percent of its value and the Standard & Poor's 500 fell 2.96 percent.

The market has seen tremendous swings in the last few weeks, leaving many investors on edge and wondering who will be next.

A handful of hedge funds have collapsed after falling victim to the nation's growing mortgage problems, and several others have warned that they no longer know their precise value due to the same mortgage issues.

What initially began as a problem on the fringes of the market is starting to frighten a larger part of the mainstream.

The latest blow came this morning from Paris, where France's biggest listed bank, BNP Paribas, froze $2.2 billion worth of funds, citing the U.S. subprime mortgage problems.

BNP Paribas -- like several U.S. firms -- said it was barring investors from redeeming cash from the funds.

Other European banks have also signaled problems stemming from the U.S. housing market. The European Central Bank moved to provide more cash to money markets, a move that only intensified Wall Street's fears as investors saw it as confirmation of the credit markets' problems.

An already-jittery Wall Street did not react favorably to any of the news. The Dow Jones industrial average fell 235 points in the market's first five minutes of trading before recovering a bit.

Similar repercussions have spread beyond the markets. Many of the nation's lenders have tightened their grip on credit. Homeowners now need to provide more documents and are subject to more reviews in order to get mortgages. Businesses are also finding it harder to secure a line of credit which they need to grow and -- for larger corporations -- to acquire other companies.

How Does My Mortgage Affect Wall Street

So how did this happen?

The route from the individual mortgage sector to Wall Street is long and sometimes opaque.

Banks and other lenders issued mortgages to people looking to buy homes. Such mortgages are then often bundled together and sold to investors who take on the risk. Those investors can then in turn sell the loans again.

The selling and reselling is complicated and often hard for individual investors to track. Complicating matters further, these bundles are often bought by hedge funds, which tend to keep their investments a secret.

These multitiered steps also make it difficult for the ultimate owners to know if their investments have gone bad -- homeowners who default on their loans are several steps removed from the primary owners of their loans.

The French bank's decision to bar investors from redeeming their cash was put in effect so that the bank could properly determine the total value of its funds.

Such an action, however, causes a ripple effect in the financial markets, said Art Hogan, an analyst at Jeffries and Co.

The market is asking, "Who else is going to have to do this? What other shoe is out there to drop?" Hogan said.

The French problems come on the heels of fund issues at UBS and Sowood Capital, and the announcement that Bear Stearns -- one of Wall Street's best-known investment banking firms -- saw two of its real estate hedge funds lose up to $1.6 billion in capital because of poor mortgage investments.

The market plunged in the final minutes of trading Wednesday upon rumors that Goldman Sachs was going to make an announcement regarding problems with one of its hedge funds. Goldman quickly denied it was making any announcement and the market shot right back up.

But all is not perfect at Goldman. Global Alpha, its widely known international hedge fund, is down 16 percent for the year, according to The Wall Street Journal.

Why Are People Defaulting?

Until recently, mortgage rates were at historic lows and globally there were way too many investors looking for places to stash their cash.

Lenders extended more credit than they should have to people who, for the most part, could not afford the loans. To compound matters, many borrowers got introductory rates that shot up after a year or two and further climbed when interest rates started to creep up to more normal levels.

Richard Moody, chief economist for Mission Residential in Austin, Texas, said that there was so much capital out there that lenders had an incentive to keep making loans regardless of what happened six months down the road.

Now, "people are coming to realize, standards do matter," he said.

Melissa Cohn, CEO of Manhattan Mortgage, said "the collapse of some of these mortgage banks has really turned the market on its heels."

She said in the past two weeks there has been a "tsunami of guideline change" with programs being eliminated and rates being raised. "Every day we get a new set of guidelines," Cohn said.

She described the environment as one of "Wild West financing" in which banks were "aggressively making loans because the secondary market would buy as much as it could sell."

Can Businesses Still Get Loans?

The short answer is yes -- but with a lot more difficulty.

The corporate credit market has by no means dried up, according to several analysts. Mission Residential's Moody said such a crunch is not happening and that there is still capital out there.

"But in the riskiest markets, riskiest borrowers are being cut off or asked to pay higher prices," Moody said. There is "still plenty of credit available, it just costs more today than a week go."

However, Joseph Mason, a professor at Drexel University, said $400 billion worth of deals are on the table and not getting done because people are not willing to invest in them.

David Weiss, chief economist for rating agency Standard & Poor's, predicted two weeks ago that there would be some fallout, but he said today that the reaction has been even worse than he originally predicted.

"It's going to get worse before it's going to get better," he said. "They'll be a few months here before people settle down and start really initiating new deals, but I don't think [the credit market] is going to freeze up."

Cerbus had added difficulties in finding credit to finalize its purchase of Chrysler. Cadbury Schweppes and Allison Transmission also had financing problems with their own multibillion-deals this summer. Las Vegas-based Silverton Casino had to pull a $215 million high-yield bond sale because of market conditions and Oneida Ltd., a dinnerware and flatware maker, had to pull its $120 million offering.

"You try to take advantage of a very, very good rate, but when the market isn't there you just put it aside and wait for a better day," said Oneida spokesman Richard Mahoney. Weiss said that the corporate credit market is not completely closed. Many companies -- even some with poor credit -- can still find financing but they're having to a pay a premium for those loans.

"I'm not sure that there are any [companies] yet that can't get credit," he said, before adding: "But there certainly have been a few big deals recently that they've been unable to syndicate."