Stocks plummeted yesterday amid signs of a widening housing slump and credit crunch that threatens to throttle Wall Street’s acquisitions craze, with the Dow Jones Industrial Average plunging as much as 450 points before ending down 312.
The rout was worldwide as investors broadly reassessed the risks and vulnerability of stocks and bonds to rising defaults, and punished shares in housing, finance and other industries threatened by tighter lending standards. Safe haven investments such as U.S. Treasuries and gold benefited from the exodus from stocks and worries about rising credit losses.
The Dow ended down 2.26 percent at 13,474 in a wild day of trading, while the Standard & Poor’s 500 Index lost 2.33 percent. Britain’s FTSE 100 closed down 3.15 percent, Germany’s DAX dropped 2.39 percent, and France’s CAC-40 fell 2.78 percent. Benchmark stock indexes in Argentina, Brazil, Mexico, Turkey and Sweden dropped more than 3 percent.
The drubbing was set off by news from the Commerce Department of a 6.6 percent drop in U.S. new-home sales, confirming fears that the U.S. housing market remains mired in recession with no end in sight. New orders for big-ticket machinery at U.S. factories — which had been fueling economic growth in recent months — also disappointed in June with a weak 1.4 percent gain that did not recoup May’s 2.3 percent loss.
The discouraging economic news came as Wells Fargo & Co., the second-largest mortgage lender, announced it no longer will provide subprime mortgage loans through independent brokers, and Wall Street investment houses said they were having trouble arranging the loans needed to finance a takeover of automaker Chrysler, among other planned buyouts that have been boosting stocks and creating a market boom all year.
“With the debt markets quickly moving to ration credit, the probability of companies being ‘taken out’ is plummeting,” said Merrill Lynch & Co. chief investment strategist Richard Bernstein, calling for a pullback by investors betting on further buyouts.
Treasury Secretary Henry M. Paulson Jr. said the broad repricing of risky securities triggered by the subprime mortgage meltdown was needed.
“I do believe this is a wake-up call that lenders need to be very careful with the way they price risk, structure securities,” he told Bloomberg News. “As we get a broad reassessment of risk, we are getting volatility,” he said, adding “I don’t think it poses any threat to the overall economy.”
Citigroup Inc., the biggest financial company, fell 4.1 percent, leading declines in financial shares. Exxon Mobil Corp., the biggest energy company, tumbled 3.9 percent after profit fell for the first time in more than three years.
Mark Zandi, chief economist with Moody’s Economy.com, said mortgage defaults will get significantly worse in the months ahead, and now pose a threat not only to housing but to the broader economy. The credit problems originally seen with subprime borrowers are starting to appear among prime borrowers who took out interest-only loans, big mortgages with no downpayment, and “payment option” loans that allowed them to skip some principal and interest payments.
“Mounting mortgage delinquencies and defaults now pose the most serious threat to the global financial system and economy,” he said in a report this week. “If there is a fault line” in the global economy, “it runs through the U.S. housing and mortgage markets.”
Though it’s not likely, he said it is possible that cascading mortgage defaults could “be the catalyst for a global financial crisis” like the one that swept global markets in 1998. During that tumultuous period, Russia’s default on its bonds and the collapse of a major hedge fund forced the Federal Reserve and other central banks to rush to the rescue with deep interest-rate cuts.
“The preconditions for such a crisis are seemingly in place today,” Mr. Zandi said, particularly the complacency investors have shown in buying risky stocks and bonds with little compensation for the risks.
During the 1990s crisis, the U.S. markets were viewed as safe havens and benefited from the flight from Asian, Latin and Russian markets, but any meltdown today would be quite different, he said. “Global capital would likely flow away from U.S. markets, not to them, as the genesis of the crisis lies within the U.S. financial system.”
Bernard Connolly, analyst with Banque AIG, said foreign investors worry that the mountain of debt the U.S. economy is resting on — which has been financed largely by Europeans and Asians — will collapse like a “Ponzi scheme” and leave them with worthless holdings.
“Claims on U.S. borrowers are very risky … yet risk premia have been abnormally low,” he said. “If the Ponzi game implodes, forcing up [interest rates] for U.S. firms and household debt, then either the U.S. economy or the dollar must crash.”
Lawrence Kudlow of Kudlow & Co. said the market’s pessimism was overdone yesterday. The U.S. economy is fundamentally sound, he said, while corporate earnings have been robust and U.S. stocks remain cheap compared to those overseas.
“The moral of the story is that intelligent investors should be shorting toxic bonds — whether they are corporate or mortgage backed — and buying valuable stocks as they correct lower,” he said.
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