Stocks Finish at 3-Year Low on Bank Panic

Wall Street suffered another beating Wednesday at the hands of investors panicking over the state of large banks, as they flocked from stocks and sent safe-haven areas like gold soaring.

Stocks hit a three-year low amid swelling lack of confidence that saw short-sellers beat financials to a pulp, a day before a new "zero tolerance" rule takes effect against naked shorting.

All 30 Dow components lost for the day as did all but 10 on the 100 stocks on the tech-heavy Nasdaq. The last time the Dow saw this territory was November 2005 and the S&P 500 hasn't been here since May of the same year.

The only thing mitigating further damage was a surge in oil prices, which pushed up Dow components ExxonMobil and Chevron against a flock of losers.

Another investment bank was targeted by sellers, as Morgan Stanley plummeted more than 40 percent to a five-year low. Also, a steep lack of investor confidence in the American International Group rescue weighed on Wall Street.

"The fear is who is next," said John O'Brien, senior vice president at MKM Partners LLC in Cleveland. "It almost feels like people scour the books and say who is the next likely target that we can put a short on and that spreads continuous fear."

The damage can go beyond the turmoil in the financial services sector and hurt the outlook for corporate profits, O'Brien said.

Panic measures soared on Wall Street, with the Volatility Index hitting levels normally associated with a capitulation bottom.

The market's woes worsened after Securities and Exchange Commission Chairman Christopher Cox announced the new rules aimed against abusive short-selling across all publicly traded companies. The rules require the securities involved to be delivered at the close of business on the settlement date. However, the rule does not take effect until Thursday, giving short-sellers one more day to take their positions against the banks and other stocks.

"You hopefully will see some type of stabilization tomorrow," said Dennis J. Barba, managing partner of the Oxford Group of Raymond James in Cleveland. "It's insanity driving the price of these stocks."

Biggest Banks Hit Lows

The charge against bank stocks sent Wachovia below $10 for the first time since stocks hit their July 15 lows and drove Citigroup to a loss of more than 15 percent, which would be a 10-year low close for the nation's biggest bank.

The overall slump reflected a sense that the worst had not passed for the markets and the economy, despite the recent blowout of bad news. The worries seemed focused especially on liquidity and the refusal overnight of banks to lend.

The negative feeling started in the large financial institutions and swept through the markets.

Morgan Stanley fell on news that officials are weighing whether the firm should remain independent or merge with a bank, given the recent turbulence in the company's stock, CNBC has learned.

At the same time, news that the Federal Reserve will lend up to $85 billion to AIG for two years in exchange for a 79.9 percent equity stake did little to brighten the outlook for the financial sector. The move brings the total tab for U.S. government rescues to more than $900 billion.

AIG will pay interest at a steep 8.5 percentage points above the three-month London Interbank Offered Rate, making the current rate equal to about 11.4 percent, to encourage AIG to sell assets to repay the loan.

But investors bailed out of AIG shares, sending the stock price more than 35 percent lower. Rebecca Darst, of Interactive Brokers, analyzes the options market's reaction to the AIG deal in video.

Commodities Gain Favor

Stocks also were pressured on a report showing that construction starts on new homes plummeted to a 17-1/2-year low during August as builders scaled back sharply to try to cope with the worst slump in U.S. housing since the Great Depression.

And oil prices turned higher after two straight days of sharp declines, rising above $95 a barrel, while gold saw its biggest single-day gain ever as investors flocked to safety from the stocks storm.

Elsewhere British bank Barclays agreed to buy bankrupt Lehman Brothers' North American investment banking and capital markets businesses, its New York headquarters and two data centers for a total of about $1.75 billion.

The New York Federal Reserve provided at least $87 billion to help underpin trades with bankrupt Lehman Brothers, in an effort to shore up the financial system, court documents show. Lehman's decimated stock continued to get hammered; more than 190 million shares had traded hands and the stock lost more than half its value.

Goldman Sachs continued to get pounded a day after releasing its earnings early that, although ostensibly better than analyst estimates, failed to satisfy the market's concerns about capital.

Techs Weaken, Consumer Stocks Hang On

Outside the financials the damage ran deep as well amid fear that economic weakness would stifle consumer spending and hit corporate bottom lines.Tech stocks were hit hard, dragging the Nasdaq down as Apple and Microsoft both drifted lower.

SanDisk was among the few brightspots in technology, with the company's shares surging after it rejected an offer from Samsung as too low.

Among index stocks, General Motors and Home Depot led Dow losers outside financials. Other financial issues further dragged down the bluechip index, with JPMorgan Chase among the other big losers outside of AIG and Citi.

The surge in fuel prices trashed airline stocks, sending Continental down the most in the sector.

© 2009 CNBC.com