WASHINGTON — The U.S. government this year has placed on its books the liabilities of a major investment bank in March, two mortgage-finance giants earlier this month, and this week, the nation's largest insurer.
The world of free-market finance as we know it is over.
Turmoil was the word of the day Wednesday as global stock exchanges plunged and investors flocked to safer havens. The Dow Jones Industrial Average finished down 449.36 points to 10609.66, while the S&P 500 shed 57.20 points to 1156.39 and the technology dominated Nasdaq lost a whopping 109.05 points to 2098.85. All three indexes were off by more than 4 percent.
Contracts for future delivery of gold, an ever-ready hedge against declining asset prices, rose $85 an ounce in trading before settling up $70, or 8.9 percent, at $850.50.
If the Federal Reserve's Tuesday night rescue of insurer American International Group was supposed to calm global financial markets, it didn't happen Wednesday. Russian markets were so volatile that authorities halted trading in stocks and bonds, and Brazil's Bovespa index fell almost 6 percent.
Adding to the fear on Wall Street and beyond were problems in money markets, usually considered among the safest places for ordinary investors. One of the giants in this field, Reserve Primary fund, which manages $65 billion, said late Tuesday that it would temporarily suspend some customer redemptions because of its exposure to Lehman Brothers, which filed for bankruptcy protection on Monday.
This led other fund companies such as Vanguard to issue statements that they had no such problems in their money-market funds, but the hint that any player in this market had problems added to the anxiety.
In a span of less than 10 days, the entire landscape of U.S. finance was turned upside down.
This week's shakeup followed the Sept. 6 seizure by the federal government of mortgage-finance giants Fannie Mae and Freddie Mac, which together finance about half the mortgages in America.
Wall Street was abuzz with rumors Wednesday that one, or both, of the remaining standalone investment banks might get hitched to a commercial bank.
Morgan Stanley's shares fell 26 percent, and shortly after the close of trading, reports surfaced that the company was in preliminary discussions over a potential merger with Wachovia, based in Charlotte, N.C. On Monday, Merrill Lynch agreed to sell itself to Wachovia's crosstown rival, Bank of America. Meanwhile, Goldman Sachs, once run by Treasury Secretary Henry Paulson, traded down more than 20 percent for much of the day before finishing down just under 14 percent.
The assault by investors on the golden temples of finance came just hours after the Fed shocked the financial world by stepping up with an $85 billion, 24-month loan to AIG, which effectively bought the government a controlling interest in the global insurer.
The Fed's move was bolstered by an announcement Wednesday that the Treasury Department will auction about $40 billion in new bonds for use by the Fed in helping AIG access capital and eventually pay off its loan by selling off some of its businesses.
One reason for the panic on Wall Street is fear of where the next shoe will drop. After the clobbering financial stocks have taken, investors are worried that troubled Seattle-based thrift Washington Mutual may be the next domino to fall. If it were to fail, it could test the Federal Deposit Insurance Corp., which insures up to $100,000 per depositor.
The FDIC special fund to insure deposits already is below a congressional limit after the July seizure of lender IndyMac Bank by federal regulators.
WaMu shares have fallen more than 85 percent since the start of the year and closed at $2.08 a share Wednesday. The company has assets in the hundreds of billions of dollars, and if were to fail, the FDIC would likely have to tap a special line of credit from the Treasury Department — something that hasn't happened since the early '90s.
Hoping to avoid the fate of Lehman, WaMu was widely believed to be shopping itself around, and news reports said it had hired Goldman Sachs to help arrange a sale.
On the campaign trail, Democrat Barack Obama and Republican John McCain both repeated their vows to enact regulatory changes to avoid repeating these events. Never mind that earlier this year Treasury Secretary Paulson sent Congress a proposal for just such changes that was widely ignored by lawmakers in both parties.
Now that there's little doubt now that new regulation is coming, the debate will be over what form it takes. In an interview with McClatchy, Rep. Barney Frank, a Massachusetts Democrat and the chairman of the House Financial Services Committee, said he expected that the days of market discipline, or allowing markets to police themselves, are over.
"We can rely on market discipline within a sensible framework," he said, noting that antitrust laws and securities laws can coexist with a degree of market policing, but "there needs to be regulation."
Frank expects that Congress will mandate higher minimum capital requirements of banks and some limit on the ability of lenders to leverage their investments. Overleveraging is one big cause of the current crisis, with banks and other players borrowing money to make big bets with insufficient cash on hand if those bets don't pay off.
Even Sen. Richard Shelby, an Alabama Republican and the former chairman of the Senate Banking Committee when Republicans controlled Congress, seemed ready Wednesday to accept greater regulation.
"I never advocated a lot of overregulation, but where the federal government and the taxpayer is involved . . . you've got to have oversight," he told CNBC, calling for more hearings on the matter. "We've got to find out what's wrong with our regulatory bodies."
The problems in the banking sector are now dwarfing the closest crisis in modern times, over savings-and-loans, which like today's mess had its origin in bad mortgage lending.
"There was nothing like this in the S&L crisis," said Bert Ely, a banking expert who closely studied that turbulent period in the late 1980s and early 1990s.
Today's financial crisis is far more complicated because of the many complex financial instruments and unregulated markets for which little information is available.
"The systemic risk pieces are much more complicated. We don't begin to see the full picture. With S&Ls you knew who they were, they had quarterly reports. Today we don't have that," Ely said.
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