Dow Flirts With Bear as Financials Drag

The Dow shed 1.6 percent, putting it dangerously close to bear territory, as a fresh wave of worries about fallout from the mortgage crisis slammed financials.

The Dow Jones Industrial Average shed more than 180 points to close at 11479.39. All 30 Dow components declined, leaving the blue-chip index off 19 percent from its October high. The bear mark is at 20 percent.

The S&P 500 index and Nasdaq each lost about 1.5 percent.

Investors dumped shares of Fannie Mae and Freddie Mac after a weekend report that the U.S. Treasury is growing increasingly likely to recapitalize the home-financing giants. The Treasury Department reiterated Monday that it is not going to backstop Fannie and Freddie but the stocks continued to slide as investors worried that the stocks could get wiped out either way.

The stocks shed 22 percent and 25 percent, respectively.

"I think the mood was generally positive but I think it’s starting to turn negative as people start to think the other shoe hasn’t dropped yet in the financial sector," said Matt Cheslock, a senior specialist at Cohen Specialists.

The last two weeks of August are typically slow, and earnings season is done, which helped give this negative news some traction, Cheslock said.

Indeed, volume was about 984 million shares on the New York Stock Exchange, less than half of what it normally is.

Crude oil fell 90 cents to settle at $112.87 a barrel as concerns subsided about the threat of Tropical Storm Fay to supply from the Gulf of Mexico.

JPMorgan analysts said they see opportunities in taking short positions on energy and long positions in financials. Analysts led by Thomas Lee downgraded the U.S. energy sector to "neutral" from "overweight," and said the next two years will see a shift toward a long financials trade.

But the drop in crude wasn't enough to offset the flurry of negative news from the financial sector.

Lehman Brothers shares skidded 7.1 percent after a report in the Wall Street Journal that the brokerage firm's third-quarter loss could be $1.8 billion or more.

The financial crisis won't end until next year or even 2010, Morgan Stanley co-President Walid Chammah told Germany's Handelsblatt newspaper.

Billionaire investor Wilbur Ross said as many as 1,000 banks could fail before it's all over and Cumberland Advisors' David Kotok went so far as to name names, telling CNBC that Merrill Lynch and Wachovia could be among them.

Merrill Lynch fell 5.9 percent and Wachovia lost 3.9 percent.

Citigroup , AIG and Bank of America were among the biggest decliners on the Dow, all down more than 4 percent.

General Motors skidded 7.3 percent, making it the biggest drag on the Dow, after a weekend report in the Wall Street Journal that the auto maker won't buy advertising for the 2009 Academy Awards. The auto maker is also readying a big promotional kick for its 100th anniversary. On Thursday, GM is expect to announce investment plans for an Ohio plant.

In the closely-watched auction-rate securities (ARS) saga, a group of brokerage firms are rallying against efforts by New York State Attorney General Andrew Cuomo to have brokerage firms repay investors who purchased auction rate securities, CNBC has learned.

Separately, Merrill Lynch continues to negotiate with Cuomo's office, which is seeking a fine of $100 million or more in its ARS case, in addition to repaying investors. Sources inside Merrill and Cuomo's office said progress is being made on a settlement.

Lowe's ticked higher as the home-improvement chain beat profit and sales expectations, helped by the tax-rebate checks. The company expects a slowdown in the second half but raised its full-year outlook due to the robust second-quarter results.

Rival Home Depot dropped more than 2 percent ahead of its results, due out before the bell Tuesday.

Profit at the world's biggest miner BHP Billiton surged 30 percent in the first half of the year on the back of strong demand from China but the company warned of weaker global growth ahead.

That's been a pattern this earnings season: solid second-quarter results but a weak outlook. A weak second half would surely rattle the market, making the summer rally seem more like a head fake than a market bottom.

Adding to the market's gloom was a report that showed homebuilder sentiment remained at a record low in August as banks continue to tighten lending standards and more homes flood into the pool of foreclosures.

Homebuilder stocks were all off about 4 percent or more, with Hovnanian shedding nearly 10 percent.

Even tech stocks, which had been the market leader, declined. Intel fell 1 percent while Amazon was off nearly 4 percent.

Hewlett-Packard shed more than 2 percent ahead of the computer maker's earnings, due out after the bell Tuesday.

Broadcom, however, jumped after a report in Barron's suggested the stock could gain as much as 40 percent as the chip maker grabs some of the "smartphone" market.

THIS WEEK:

TUESDAY: Housing starts; producer prices; State Street investor-confidence index; Fed's Fisher speaks; Earnings from Home Depot, Target, Medtronic, Saks, HP and Analog Devices
WEDNESDAY: Weekly mortgage applications; crude inventories; Videogame conference in Leipzig, Germany; Earnings from BJ's Wholesale and Limited Brands
THURSDAY: Jobless claims; leading indicators; Philly Fed survey; GM announces investment plans for Ohio plant; Earnings from Gamestop, Heinz, Hormel, Aeropostale, Gap and Intuit
FRIDAY: Fed conference in Jackson Hole begins; Earnings from WPP, AnnTaylor

WATCHERS: Obama is expected to select a running mate this week ahead of the convention

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