Stocks Reel as Oil Surges, Financials Get Hit

The Dow chart looked like a yo-yo Thursday as traders pounded financials including Freddie Mac and Lehman Brothers, overshadowing any positive news the market had to offer.

"Right now, on a short term basis, it’s painful," Sean Clark, investment chief of Clark Capital Management, said on CNBC. "Investor sentiment is pathetic right now," he added. "We're looking at levels of pessimism not seen in three decades."

Oil shot up more than $5, settling at $141.65 a barrel , after U.S. Secretary of State Condoleezza Rice said the U.S. won't back down on its stance on Iran and Iran fired back with more missile tests.

Fannie Mae and Freddie Mac plummeted amid concerns that shareholders may be wiped out if the government has to bail out the mortgage-finance firms.

Some analysts say the dual crisis at Fannie and Freddie marks a crucial juncture that is necessary for financials -- and therefore, the broader market -- to reach capitulation.

Bush administration officials are meeting with regulators to try to develop a contingency plan in case the firms are unable to raise the money they need, according to a report in the Wall Street Journal.

Fanning the flames, former St. Louis Federal Reserve President William Poole told Bloomberg that Fannie and Freddie were "insolvent'' and may need a U.S. government bailout.

Amid the firestorm, a Freddie Mac spokeswoman shot back that the firm "absolutely" has enough capital.

And Treasury Secretary Henry Paulson rushed to defend them. "Their regulator has made clear that they are adequately capitalized," Paulson told a House panel. Paulson and Federal Reserve Chairman Ben Bernanke were on Capitol Hill testifying about the need for a safety net on Wall Street.

Freddie was hit a lot harder than Fannie, which can be attributed to the fact that Freddie is worse off than Fannie, even though the two often get lumped together as one story, said Len Blum, managing director of Westwood Capital. Blum points out that Freddie's capital position is already $5 billion in the negative, if you look at its assetes at market value.

"Fannie and Freddie have histories of undependable accounting, and they continue to pile risk onto their already highly levered balance sheets," Blum wrote in a note to clients. "They are a train wreck waiting to happen."

Offering fresh evidence of how bad things are in the housing market, RealtyTrac reported that U.S. home foreclosure filings jumped 53 percent in June from a year earlier, although they were down 3 percent from May, and are expected to rise further.

Lehman Brothers , which has already been pummeled over concerns about the need for more capital, took a fresh beating that sent the stock down more than 12 percent. The culprit was likely dangerous rumors that firms don't want to do business with Lehman anymore.

The Lehman speculation was so rampant that Pimco and SAC Capital came out and said that they continues to trade with Lehman, despite rumors that they are among the firms cutting off trading with the brokerage, CNBC's Charlie Gasparino reported.

Wachovia took a hit after the regional bank said mortgage and legal problems will result in a $2.6 billion to $2.8 billion second-quarter loss, much larger than expected, and named a new CEO. Its shares dropped more than 9 percent.

Merrill Lynch and BlackRock have scheduled talks about a possible sale of at least part of Merrill's 49 percent stake in the money-management firm, sources familiar with the situation told CNBC, adding that the discussions are likely to continue through the end of the week.

The market was buzzing with deal news.

Dow Chemical announced plans to buy rival Rohm & Hoss  for $18.8 billion. The deal represents a 74 percent premium on Rohm & Hoss's $44.83 market close Wednesday, sending shares up more than 60 percent . Dow shares fell 1.5 percent.

The deal boosted water-related stocks as it expands Dow's water business through Rohm's partnership with water-treatment firm Nalco.

Calgon Carbon, which makes activated carbon, an essential component of water purification, jumped 10 percent , while Nalco advanced more than 1 percent .

Retailers logged their best month for retail sales in more than a year, with more than two-thirds beating expectations, helped by good weather and the tax rebates.

Discounters led the way.

Wal-Mart said its same-store sales rose 5.8 percent, more than expected, and raised its second-quarter earnings forecast. TJMaxx and Ross Stores