Stocks continued to plunge Tuesday on a report that a consortium that includes the New York Fed wants to force Bank of America to buy back $47 billion of mortgage bonds.
The market had already been down when the news hit, as technology stocks followed Apple and IBM lower after disappointing news in their earnings results. A rise in the dollar pressured materials and commodities stocks.
TheDow Jones Industrial Average fell more than 170 points, led by a nearly 5 percent drop in shares of Bank of America.
Alcoa and IBM also led the blue-chip index lower. Coca-Cola was the only Dow component to rise.
The S&P 500 Index and the Nasdaq also tumbled. TheCBOE Volatility Index, widely considered the best gauge of fear in the market, soared to above 21.
All of the major S&P 500 sectors fell, led by energy, materials and health care.
CNBC confirmed Tuesday that the New York Fed is part of a consortium that is suing Bank of America over failures related to mortgage securities.
The Bank of America report, initially reported by Bloomberg, said that Pimco, BlackRock and the New York Fed want the financial institution to repurchase mortgage bonds.
Pimcoand BlackRock had no comment when contacted by CNBC.
Only handful of financial stocks were higher after the news, including Goldman Sachs , which earlier had reported earnings and revenue resultsthat were better than expected thanks to net revenue gains from its investment banking business. Capital One , which reported a doubling in third-quarter profits as loan-loss provisions dropped from last year, also rose.
Earlier, Bank of America hadreported earnings per share of 27 cents for the third quarter, excluding a goodwill charge, better than expected, although revenue fell just short of forecasts.
Meanwhile, custody banks Bank of NY Mellon and State Street , released better-than-expected resultsfor the third quarter on earnings from managing client funds. Both, however, were trading lower.
Citigroup's earnings lifted bank stocks on Monday after the bank reported third-quarter figures which beat analyst expectations, although shares traded lower on Tuesday.
Financial stocks had been among the few bright spots earlier in the session, while tech stocks slid.
Kevin Kruszenski, head of listed trading at KeyBanc Capital Markets, said tech had led much of the recent rally in stocks, and Tuesday's more than 1 percent fall in the sector was a case of "sell on the news," that wasn't too surprising.
What's notable is that industrial companies "in a variety of different markets are seeing various degrees of economic strength," Kruszenski said, adding that many cyclical, industrial companies are leveraged to an economic rebound.
In one indication of strength among industrials, Parker Hannifin tripled its profits in the third quarter and raised its earnings forecast for fiscal 2011. The industrial controls company saw a 29 percent boost in orders and a 26.5 percent increase in sales.
"A lot of corporate managers have done a good job managing through these choppy times," Kruszenski said.
Stocks also had been rattled by the dollar, which rose against a basket of currencies after The People's Bank of China said it wouldraise interest rates for the first time in three years to curb domestic inflation. China plans to raise its benchmark one-year lending and deposit rate by 25 basis points.
The rising dollar also hurt gold, which was heading for its biggest one-day fall since July. Gold futuresfor December delivery fell about $31.
While several companies reported positive earnings Tuesday, investors remained focused on results from IBM, which disappointed with its tech services business, and Apple, which had slower sales of iPads than expected.
S&P Equity Research downgraded IBM to "buy" from "strong buy," saying earnings came in below the research firm's estimates. S&P lowered its 2010 estimate to $11.45 a share from $11.50 a share and maintained its estimate of $12.60 for 2011. Several brokerages, however, raised their price targets for the tech giant.
IBM, however, has contributed 13 percent to the Dow's gains since late August, more than any other component of the blue-chip index.
Several brokerages also raised their price target for Apple, which was still trading above $300 a share.
In other earnings news, Dow components Coca Cola reported strong third-quarter earnings of 92 cents a share, against an expected 89 cents a share and Johnson & Johnson beat expectationswith a 2 percent gain in profit on lower sales of $14.98 billion.
New York Times shares fell after the newspaper publisher posted larger-than-expected third-quarter revenue declines, and a narrower third-quarter loss. Stocks of other media companies also declined, including Media General , Gannett and WashingtonPost .
Shares of Lockheed Martin , meanwhile, slumped after the defense contractor posted lower-than-expected results, and lowered its forecast for 2010.
Also falling were shares of Harley Davidson , which reported strong third-quarter earnings, but said sales of motorcycles slipped. CEO Keith Wandell said the "economy has yet to turn around in a convincing way and many consumers remain on the sidelines," according to Reuters.
Yahoo will release quarterly numbers after the close.
The energy sector slumped asoil prices fell due to the rising dollar.
Occidental Petroleum slid despite reporting a 28 percent jump in third-quarter earnings, beating expectations, due to a rise in commodity prices and strong production levels.
But shares of Massey Energy soared to among stocks leading the S&P 500 Tuesday after a report in the Wall Street Journal that directors of the coal company are considering alternatives, including a sale of the company.
Shares of mining companies were mixed after UBS downgraded ratings for Lundin Mining , Equinox and ThompsonCreekMetals . The brokerage raised its price target for Alcoa to $14.50 from $13.25.
Shares of Abercrombie & Fitch fell more than 3 percent after Brean Murray Carret cut the teen retailer to "sell" from "hold."
In economic news, the Commerce Department reported a surprising rise in housing starts, but a sharp decline in permits for future home construction. U.S. housing starts rose 0.3 percentto a five-month high of 610,000 units, better than the 580,000-unit rate expected by analysts polled by Reuters. Permits for new construction fell 5.6 percent to a 539,000 unit pace, instead of the expected 580,000-unit pace, due to a decline in multi-family units.
Earlier Tuesday, Atlanta Federal Reserve President Dennis Lockhart said on CNBC that he favors quantitative easing — or increasing the nation's monetary supply by buying long-term securities — and said the amount of asset purchases needs to be significant to make a difference.
"It doesn't make sense to do a small portion of QE," Lockhart said. "It has to be enough to make a difference. Something along the lines of $100 billion a month would be in range."
On the Calendar Next Week:
TUESDAY: Grant's Conference, CFTC Open Meeting on Dodd-Frank; Chicago Fed President Evans speaks; after-the-bell earnings from Yahoo, Sallie Mae and Western Digital.
WEDNESDAY: Mortgage applications, oil inventories, Beige book; Apple Mac Event, Richmond Fed. President Lacker speaks, Philadelphia Fed President Plosser speaks; before-the-bell earnings from Abbott Labs, Boeing, BlackRock, Morgan Stanley, United Technologies, Wells Fargo, M&T Bank, US Airways; after-the-bell earnings from eBay, E*Trade, Netflix and Seagate Technologies.
THURSDAY: ECB Meeting, jobless claims, leading indicators, natural gas inventories, money supply, Kansas City Fed President Hoenig speaks, CBO Director Elmendorf speaks; before-the-bell earnings from AT&T, Caterpillar, Credit Suisse, Eli Lilly, Novartis, Travelers, UPS, Continental Airlines, PNC Bank, Southwest Airlines, and Xerox; after-the-bell earnings from American Express and Amazon.
FRIDAY: G20 Finance Ministers & Central Bank Governor's Meeting; before-the-bell earnings from Verizon, Exelon, Ingersoll-Rand and Schlumberger.
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