Investor anxiety fuels market crisis

Global stock exchanges plunged Wednesday as nervous investors turned their attention from the government's seizure of American International Group on Tuesday to which firms are still in danger – in particular, major banks that seemed secure just days earlier.

The Dow Jones industrial average fell 449 points, more than 4 percent, closing at 10,609.66. This is the second time this week the Dow has plummeted by historic levels, following Monday's 504-point crash, the sixth-largest point drop in history.

About $700 billion in investments vanished.

“There's a growing sense that there's no end to this in sight,” investment strategist Edward Yardeni said.

In a span of a few months, the entire landscape of U.S. finance has been turned upside-down.

The government this year has placed on its books the liabilities of a major investment bank in March, two mortgage-finance giants earlier this month, and this week, the nation's largest insurer.

The price of gold, a traditional safety spot in turbulent times, on Wednesday posted its biggest single-day gain in more than three decades, rising $70 an ounce.

The financial stocks in the Standard & Poor's 500 dropped even more, falling 10 percent, and insurance that backs corporate debt soared for the last two surviving independent U.S. investment banks, Morgan Stanley and Goldman Sachs.

“Banks are hoarding their cash; that is a scary position,” said Art Hogan, chief market analyst at Jefferies & Co., adding that such reluctance is contributing to investor anxiety. “Some worry about what is today's disaster going to be.”

Asian stocks tumbled early today. The MSCI Asia Pacific Index dropped 2.4 percent to 107.90 as of 10:40 a.m. in Tokyo, the lowest since October 2005.

Adding to the fear on Wall Street and beyond are problems in money markets, usually considered among the safest places for ordinary investors. One of the giants in this field, Reserve Primary fund, which manages $65 billion, said late Tuesday that it would temporarily suspend some customer redemptions because of its exposure to Lehman Brothers, which filed for bankruptcy protection Monday.

This led other fund companies such as Vanguard to issue statements that they had no such problems in their money-market funds, but the hint that any player in this market had problems added to the anxiety.

This week's shakeup followed the Sept. 6 seizure by the federal government of mortgage-finance giants Fannie Mae and Freddie Mac, which together finance about half the mortgages in America.

The Fed's move Tuesday to bail out AIG with an $85 billion loan was bolstered by an announcement Wednesday that the Treasury Department will auction about $40 billion in new bonds for use by the Fed in helping AIG access capital and eventually pay off its loan by selling off some of its businesses.

One reason for the panic on Wall Street is fear of what's next. After the clobbering financial stocks have taken, investors are worried that troubled Seattle-based thrift Washington Mutual may be the next domino to fall. If it were to fail, it could test the Federal Deposit Insurance Corp., which insures up to $100,000 per depositor.

The FDIC special fund to insure deposits already is below a congressional limit after the July seizure of lender IndyMac Bank by federal regulators.

WaMu shares have fallen more than 85 percent since the start of the year and closed at $2.08 a share Wednesday. The company has assets in the hundreds of billions of dollars, and if were to fail, the FDIC would likely have to tap a special line of credit from the Treasury Department — something that has never happened before.

Hoping to avoid the fate of Lehman, WaMu was widely thought to be shopping itself around, and news reports said it had hired Goldman Sachs to help arrange a sale.

On the campaign trail, Democrat Barack Obama and Republican John McCain both repeated their vows to enact regulatory changes to avoid repeating these events. Never mind that earlier this year Treasury Secretary Henry Paulson sent Congress a proposal for just such changes that was widely ignored by lawmakers in both parties.

There's little doubt new regulation is coming. The debate will be over what form it takes.

Rep. Barney Frank, a Massachusetts Democrat and the chairman of the House Financial Services Committee, said Wednesday that he expected the days of allowing markets to police themselves are over.

“We can rely on market discipline within a sensible framework,” he said, but “there needs to be regulation.”

Even Sen. Richard Shelby, an Alabama Republican and the former chairman of the Senate Banking Committee, seemed ready Wednesday to accept greater regulation.

Also Wednesday, the Securities and Exchange Commission took measures aimed at reining in aggressive forms of short-selling that were blamed in part for the demise of Lehman Brothers.

Short sellers bet that a stock's price will fall so that they can profit from it. They borrow shares of the stock and sell them. If the price drops, they buy cheaper actual shares to cover the borrowed ones, pocketing the difference.

“Naked” short-selling, which the SEC is targeting, occurs when sellers don't even borrow the shares before selling them, and then look to cover positions immediately after the sale.

The problems in the banking sector are now dwarfing the closest crisis in modern times, over savings and loans, which like today's mess had its origin in bad mortgage lending.

“Confidence has been shattered,” said Nader Naeimi, a Sydney-based senior investment strategist at AMP Capital Investors. “The market is worried about a domino effect in the financial sector, with no one sure who's going to fall next.”

Bloomberg News, The Associated Press, The New York Times and The Washington Post contributed.