Bad news puts Dow back in the dumps

Stock markets plunged anew Wednesday, nearly wiping out Monday's record gains and sending another wave of wealth destruction washing over American households.

The government's rescue of the banks has been widely embraced, but the frenzied selling, which pushed the Dow Jones average down 733 points, underscored how the economy's troubles are too broad to be fixed by the bailout of the financial system.

Investors are recognizing that the financial crisis isn't the fundamental problem. It has merely amplified ailments that are now intensifying: vanishing paychecks, falling home prices and diminished spending.

Wednesday's rout began in the morning with reports showing retail spending slipped in September and broader signs of a pullback among suddenly thrifty consumers.

Selling picked up momentum in the afternoon as the Federal Reserve Chairman Ben Bernanke cautioned Americans that the bailout would not swiftly lift the economy and that continued weakness was certain.

“Stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away,” Bernanke said in a speech in New York. “Economic activity will fall short of potential for a time.”

By day's end, the Dow had surrendered most of Monday's 936-point gain, dropping 7.87 percent. The broader Standard & Poor's index was down 9 percent, and the Nasdaq was down 8.47 percent. Expectations that a worldwide slowdown will reduce demand for oil pushed prices below $75 a barrel.

Signs of improvement continued in the credit markets, making it somewhat easier for companies and states to secure financing, but interest rates remained elevated.

Bernanke's remarks – offered in the sober tones of a man cognizant that a stray syllable may prompt the annihilation of fresh billions on Wall Street – heightened the reality that the economy's troubles go well beyond the financial crisis. The U.S. and many other major economies are almost certainly headed into an unpleasant slog through economic purgatory, one that could last many months.

On Monday, as the Dow posted its fifth-largest one-day percentage gain in history, some investors found quantifiable proof that the crisis was solved. Yet an unpalatable historical detail complicated that takeaway: The four previous largest percentage gains occurred from October 1929 to March 1933, in the early days of the Depression.

Then, it must be noted, the markets swung far more widely than they do in this era, and an epic collapse would still be required to bring the U.S. anywhere near another Depression.

Bernanke, a leading academic expert on the Depression, offered assurances that no repeat of that disaster would unfold on his watch. The Fed stands ready to use all the tools in its kit to battle the financial crisis, he said. He exuded confidence that the economy “will emerge from this period with renewed vigor.”

He expressed concern about how huge amounts of capital are increasingly concentrated in a handful of enormous financial institutions.

“The real concern that we have is that we have got and developed, in this country, a very serious ‘too big to fail' problem,” Bernanke said. “And that problem, we've just recognized now in the current situation, how severe it is.”

It seemed a curious worry from a man whose central bank has worked with the Treasury to engineer a series of shotgun corporate weddings, such as Bank of America's purchase of Merrill Lynch and JPMorgan Chase's acquisition of Bear Stearns – deals that have further concentrated money in fewer hands.

But regardless of Wall Street's travails, a broader set of difficulties has been taking money out of the economy, putting the squeeze on households and businesses.

The economy has lost 760,000 jobs since the beginning of the year, and millions of workers have seen their hours cut, shrinking paychecks just as plunging real estate prices prevent households from borrowing against the value of their homes.

In short, American spending power is declining, and this has become a downward spiral: As wages shrink, workers spend less, and that limits demand for workers at the businesses that once captured their dollars.

Many economists now assume that unemployment, which currently sits at 6.1 percent, will climb to 9 percent by the end of next year.

“At this point, the thing has probably just got to play out,” said Martin Baily, a former chairman of the Council of Economic Advisers under President Clinton and now a fellow at the Brookings Institution. “I don't know that there's anything that we can do to avoid a mild recession. The question is what can we do to avoid a very severe recession.”