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Dow Plunges 500 Points as AIG Rattles Market

Published: Monday, 15 Sep 2008 | 5:22 PM ET

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By: Cindy Perman
CNBC.com Staff Writer

Stocks had their worst selloff since the Sept. 11 attacks in 2001, with the Dow plummeting more than 500 points amid escalating fear about a collapse of AIG.

In the final minutes of trading, major indexes broke through their July lows, with the Dow Jones Industrial Average plunging a whopping 504.48, or 4.4 percent, to close at 10917.51. The last time the Dow lost more than 500 points in a single session was Sept. 17, 2001.

The S&P 500 tumbled 4.7 percent to close at 1192.96, while the Nasdaq lost 3.6 percent. The CBOE Volatility Index, considered the best gauge of fear in the market, jumped over 30. Each time the VIX has surpassed 30 this year — January, March and July — the market has made a bottom.

Major U.S. Indexes

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The market is worried about a possible failure of AIG — as early as tomorrow morning — said Matt Cheslock, a senior specialist at Cohen Specialists, and traders just don't want to stick their necks out amid that kind of uncertainty.

"When the Fed came out and said they [AIG] have got to go to alternative sources, that means no one would want to bail out AIG without any backup," Cheslock said. "If AIG fails tomorrow morning, it's the same thing written all over this market," he said. "I don't think anyone is going to want to take any positions overnight."

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Video: Maria Bartiromo's Market Message for Sept. 15, 2008

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AIG [AIG Loading... () ], which has lost 80 percent of its value since the start of the year, plunged 60 percent, making it the Dow's top decliner by a long shot.

Of course, financials were a heavy albatross on the Dow, with AIG, Bank of America [BAC Loading... () ] and Citigroup [C Loading... () ] accounting for about half of the Dow's decline.

Traders were encouraged, albeit briefly, by a Wall Street Journal report that the federal government has asked Goldman Sachs [GS Loading... () ] and JPMorgan [JPM Loading... () ] to lead a $70 billion to $75 billion lending facility for AIG.

Stocks got off to a rough start after a trifecta of Wall Street pain unfolded late Sunday: Lehman Brothers filed for bankruptcy, Merrill Lynch was bought by Bank of America and AIG took the unprecedented move of asking the Fed for short-term financing.

After the clanging of the opening bell, the Dow's selloff was pretty orderly, followed by a decline of about 250 to 300 points for most of the day. But the fear started to escalate after comments from Treasury Secretary Hank Paulson, which turned into panic as the clock struck 3 (ET).

(WEB EXCLUSIVE: Wilbur Ross says a thousand banks could close before the financial crisis is over. Click on the video at left.)

Consumer stock Coca-Cola [KO Loading... () ] was the only gainer on the Dow, squeaking by with a half-percent gain. (Track the Dow 30 components.)

Beaten-up airlines also advanced as crude oil dropped nearly $5.50 to settle at $95.71 a barrel [US@CL.1 Loading... () ]. United parent UAL [UAUA Loading... () ] and American parent AMR [AMR Loading... () ] were both up about 10 percent.

Lehman Brothers [LEH Loading... () ] shares, which are no longer traded on the NYSE but are trading, plunged to pocket change, ending at 21 cents a share, after the brokerage filed for bankruptcy protection late Sunday. Potential buyers, which included Barclays and Bank of America, dropped out of the bidding after the Fed wouldn't agree to backstop the deal as it did JPMorgan's fire-sale purchase of Bear Stearns.

The Lehman filing doesn't include its broker-dealer operations and other units, including Neuberger Berman. The investment bank is looking at selling its broker-dealer operations, and is still in advanced discussions with a number of potential buyers of its investment management division.

Bankruptcy represents the end of a 158-year-old company that survived world wars and the collapse of Long Term Capital Management, but could not survive the global credit crunch.

The Lehman collapse won't bring any more investment-bank bankruptcies, Dennis Gartman, founder of the Gartman Letter, told CNBC, adding that he thinks Goldman Sachs [GS Loading... () ] and Morgan Stanley [MS Loading... () ] will survive. Goldman is apparently going to be the clearing firm for Lehman specialists.

Merrill Lynch shares [MER Loading... () ] ended roughly flat at $17.06 after Bank of America, which was part of the weekend talks to buy Lehman, shocked the Street with an announcement that it has agreed to buy Merrill Lynch, the world's largest retail brokerage, in an all-stock deal worth about $50 billion. Bank of America shares lost 21 percent.

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The price, which comes to about $29 a share, represents a 70 percent premium to Merrill's share price on Friday, although Merrill's shares were trading at $50 in May and above $90 at the beginning of January 2007.

Bank of America probably could've gotten a better deal, Bank of America CEO Kenneth Lewis said in a joint press conference with Merrill Lynch CEO John Thain, but it said it was better to seize the opportunity than to wait and maybe miss out on the strategic opportunity of a lifetime. He added that there was no pressure from regulators to close a deal this weekend.

Among other banks, Wachovia [WB Loading... () ] fell 25 percent and Washington Mutual [WM Loading... () ] lost 27 percent.

Ten Wall Street banks did a little triage of their own, agreeing to set up a collateralized borrowing facility, committing to fund $7 billion each "to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets."

The banks are Bank of America, Barclays, Citibank, which is part of Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan [JPM Loading... () ], Merrill Lynch [MER Loading... () ], Morgan Stanley [MS Loading... () ], and UBS [UBS Loading... () ].

The Federal Reserve, for its part, launched a series of special measures, including accepting stock as collateral for cash loans at one of its special credit facilities, the first time that the Fed has done so in its nearly 95-year history, to calm down the markets.

"The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets," Fed Chairman Ben Bernanke said in a statement.

Adding an extra couple of pounds onto the hundreds weighing down the market this morning, the New York Fed reported that manufacturing activity in New York State unexpectedly contracted in September, and the U.S. Fed reported industrial production fell 1.1 percent in August, the biggest decline since September 2005, due to a sharp drop in auto production.

It was hard to see past the financials but there was brutality elsewhere. Commodities stocks continued to sell off, including coal company Massey [MEE Loading... () ], which fell 13 percent, and refiner Valero [VLO Loading... () ], which tumbled 12 percent.

Worries about a slump in commercial real estate battered construction and engineering firms such as Shaw [SGR Loading... () ] and Fluor [FLR Loading... () ], which fell more than 10 percent.

European stocks fell about 4 percent in part because of the Wall Street turmoil. Asian markets -- the few of them that are opened today -- also fell sharply. Trading activity was limited by market holidays across the region, including in Japan, Hong Kong, China and South Korea, which will reopen Tuesday.

"Going forward, if we can avoid a cascading market, where AIG or firms that have business dealings with Lehman are suddenly put on the rocks ... If we can avoid that sort of meltdown ... I think the market will ultimately shake this off," said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland.

However, "there may be more significant problems with some of the European banks," cautioned McCain. "Some of the Libor rates ... suggest trouble overseas that hasn't been fully recognized," he said. "Investors may need look much more carefully at overseas institutions that may be in their portfolios."