Markets Shaken as Two Big Banks Falter
By MICHAEL M. GRYNBAUM
Published: September 15, 2008
Investors braced for sharp declines in stock markets worldwide on Monday morning after waking up to a financial landscape vastly different from the one they left behind last week.

The major European stock exchanges sank more than 4 percent and Wall Street was anticipating similarly sharp losses in the American markets, in the first wave of investor reaction to some of the most dramatic developments in the history of high finance.

Lehman Brothers, the 158-year-old investment bank, is in liquidation; Merrill Lynch, one of the world’s most recognizable brokerage brands, has been subsumed into rival Bank of America. One of the world’s largest insurance companies, American International Group, in a dash to shore up confidence, is bracing for a sharp decline in its stock price, which fell nearly 40 percent in premarket trading.

Investors were betting that the Dow Jones industrial average could fall nearly 400 points after the opening bell, and futures for the broad Standard & Poor’s 500-stock index were down 4 percent, though stock index futures are unreliable predictors of subsequent moves in the market.

Yields on Treasury notes plummeted as investors scrambled to hide their cash in ultra-safe government notes. The dollar also weakened against several foreign currencies.

In another surprise development, the price of crude oil dropped more than $7 a barrel in electronic trading, nearing the $94 mark, as investors appeared to bet that a global downturn would cause a sharp drop in demand for energy.

Central banks around the world moved to stem a sharp sell-off, injecting enormous amounts of capital into the financial system in an attempt to restore investors’ confidence. The European Central Bank distributed 30 billion euros to major banks; the Bank of England issued ￡5 billion or about $9 billion in loans.

The Federal Reserve said it would accept a broader array of collateral in exchange for large loans to securities firms. And a group of 10 banks that includes JPMorgan Chase, Goldman Sachs and Citigroup gathered a $70 billion fund to help ensure market liquidity.

The major stock markets in Japan, South Korea, Hong Kong and China were all closed for holidays on Monday, granting some reprieve to investors in those areas. But other Asian markets slid, with the benchmark Taiwan index down 4.1 percent and the BSE losing 3.6 percent in Mumbai.

Analysts interviewed on Monday morning stressed that the atmosphere stopped short of panic.

“Investors are wandering around in a daze,” Stephen Lewis, head of research at Monument Securities in London, said. “It’s not a panic by any means, but there is a sense that we’ll see a few more weekends like the last two and then we’re looking at a long, long convalescence.”

In the Lehman talks Sunday, the United States government was worried about the precedents that it had set in bailing out the investment bank Bear Stearns and the de facto takeover of the mortgage finance giants Fannie Mae and Freddie Mac the previous weekend. Washington wanted Wall Street to collectively take on the risk that Lehman’s assets were worth far less than the firm claimed.

The bankruptcy of Lehman, combined with the potential insolvency of the giant insurer A.I.G. threatens to saddle financial institutions with new losses. Investors in Europe said it was still unclear exactly what Lehman held on its books over the weekend and how long the unwinding would take.

Mr. Lewis said the only parallel that he could remember was the banking crisis in Britain in the 1970s, which peaked around 1975, but was not fully resolved until about 1980.

In Europe, the FTSE index in London lost more than 4 percent and the CAC-40 in Paris lost 4.7 percent. The German DAX exchange was down 3.4 percent.

Peter Redwood, the director of Asian currency and economic research in the Singapore office of Barclays Capital, said in the longer term, the latest difficulties in the United States were likely to hurt Asian markets. “This is an increase in risk globally,” he said, adding that this was, “unambiguously negative for Asia and for capital outflows from Asia.”

Bond prices, meanwhile, rallied as investors sought the safer waters of fixed income investments. Treasuries surged, sending two-year notes up the most since January. The yield on two-year notes dropped 37 basis points, to 1.8 percent. The 10-year German bund yield fell 19 basis points to 3.98 percent. Japanese government bonds did not trade.

The Financial Services Agency of Japan, the main regulatory agency there, said late Monday that it was reviewing the exposure of Japanese banks, brokerages and other financial institutions to Lehman.

Some analysts expressed fears that the financial turmoil would dent already faltering economic growth, especially in Europe.

Ken Wattret, chief euro-zone economist at BNP Paribas said: “There is the possibility of intensifying financial problems that will impact the U.S. economy and then spill over into Europe and other markets.”

“We’ve seen business confidence collapse and the likelihood is that what happens will further enhance the downturn. The momentum downward is building.”

He added there was “increasing pressure on central banks to act” but that the Fed was more likely to cut interest rates than the central bank.

The Macquarie Group, the biggest Australian investment bank, slumped 10.3 percent to 39.46 Australian dollars after The New York Times reported that American International Group was seeking a $40 billion bridge loan from the Federal Reserve.

Centro Properties, the shopping mall owner facing a deadline at the end of the month to repay some of its debt, plunged 31.4 percent to 72 cents after a planned asset sale fell through.

In European equity markets, the main focus was on banks and insurers amid fears that they will face more write-downs and the possible need for government support.

“Confidence has really collapsed,” said Yann Azuelos, fund manager at Meeschaert, an asset manager in Paris. “With the rescue of Fannie and Freddie, we thought the worst had passed. Now we know it hasn’t.”