U.S. Stocks Drop as Lending Freezes Up Following AIG Takeover

By Lynn Thomasson and Elizabeth Stanton

Sept. 17 (Bloomberg) -- U.S. stocks tumbled as bank lending seized up in the wake of the government's takeover of American International Group Inc. and investors fled to the relative safety of Treasuries.

Goldman Sachs Group Inc. and Morgan Stanley, the two largest U.S. securities firms, plunged more than 9 percent after Oppenheimer & Co. analyst Meredith Whitney cut profit estimates. General Electric Co., the world's third-biggest company, fell 7 percent and U.S. Steel Corp., the second-largest U.S. producer of the metal by market value, slid 9 percent. Yields on three- month bills sank to a 54-year low and a measure of corporate borrowing costs surged to the highest since the crash of 1987.

``It's ugly,'' said Michael Mullaney, a Boston-based money manager for Fiduciary Trust Co., which oversees $10 billion in stocks and bonds. ``It's about the worst I've seen it in 25 years. You have to have free-flowing credit to lubricate the system. That's not happening right now.''

The S&P 500 lost 32.59, or 2.7 percent, to 1,181 at 10:52 a.m. in New York, its lowest in almost three years. The Dow Jones Industrial Average decreased 247.19, or 2.2 percent, to 10,811.83. The Nasdaq Composite Index sank 60.04, or 2.7 percent, to 2,147.86. More than 10 stocks retreated for each that rose on the New York Stock Exchange.

About $2.8 trillion of market value was erased from global stocks this week, triggered by Lehman Brothers Holdings Inc.'s bankruptcy. Russia halted stock trading for a second day and poured $44 billion into its three biggest banks in a bid to halt the worst financial crisis in a decade.

`Protracted' Battle

Morgan Stanley slid $3.97, or 14 percent, to $24.73. Whitney lowered her fourth-quarter profit estimate to 69 cents a share from $1 and cut the 2009 earnings forecast to $4.05 a share from $4.15, citing higher borrowing costs.

``We believe Morgan Stanley, along with its peers, will battle a protracted period of negative operating leverage,'' Whitney wrote in a note to clients.

Merrill Lynch & Co.'s Guy Moszkowski reduced his fourth- quarter profit estimate for Morgan Stanley by two cents to $1.04 a share and lowered his 2009 earnings forecast to $5.15 a share from $5.93. The lowered estimates come a day after Morgan Stanley reported profit that beat estimates.

Goldman slid $12.94 to $120.07. Oppenheimer cut its fourth- quarter earnings estimate to $2.60 a share from $3.45.

Whitney wrote in a note to clients that she expects ``material'' writedowns at U.S. banks into 2009 as the collapse of Lehman and the takeover of Merrill Lynch & Co. result in ``meaningfully less liquidity.''

TED Spread

The three-month London interbank offered rate, or Libor, rose 19 basis points to 3.06 percent, the British Bankers' Association said.

U.S. Treasury three-month bill rates dropped to as low as 0.233 percent and the so-called TED spread, the difference between three-month Treasury yields and three-month Libor, widened 64 basis points.

AIG lost $1.64, or 44 percent, to $2.11 and extended its decline over the past year to 97 percent. The insurer, which received the $85 billion loan from the U.S. government yesterday, is most likely to repay the loan by liquidating or selling assets, central bank staff officials told reporters on the condition of anonymity. The Fed will take 79.9 percent of the New York-based company's stock and replace its management because ``a disorderly failure of AIG could add to already significant levels of financial market fragility,'' according to a central bank statement yesterday.

The S&P 500 Financials Index slumped 2.3 percent as 70 of its 86 companies retreated.

Banks and brokerages also fell after the Reserve Primary Fund, the oldest U.S. money-market fund, became the first in 14 years to expose investors to losses after writing off $785 million of debt issued by Lehman. Investor redemptions will be delayed as long as seven days, the fund said.

`Massive Retrenchment'

``There's just a massive retrenchment in risk appetite,'' said Robert Stimpson, a money manager at Oak Associates Ltd. in Akron, Ohio, which oversees $1.1 billion. ``We've seen three cornerstones of Wall Street fall by the wayside in the last six months. Is anyone safe? It's a legitimate question.''

The Securities and Exchange Commission stiffened regulations against manipulative short-selling after the routs in AIG and Lehman. The new rules force traders to borrow shares before selling them short and make it a fraud for investors to lie to their broker about locating stock to close positions.

Housing Slump

Homebuilders across S&P industries slumped 1.2 percent after the government reported a 6.2 percent drop in housing starts to a 17-year low.

The S&P 500 gained 1.8 percent yesterday as expectations grew the Federal Reserve would rescue AIG and spare financial institutions from more losses.

The benchmark index for American equities started the week with a 4.7 percent tumble after credit losses forced to file for bankruptcy protection and Merrill to agree to be taken over by Bank of America Corp.

The S&P 500 has fallen almost 19 percent this year and is poised to post its first yearly retreat since 2002 after global banks racked up $516 billion in credit losses and asset writedowns stemming from the collapse of the subprime mortgage market.

Financial shares in the S&P 500 have lost 33 percent as a group this year, led by the tumble in AIG, an 83 percent drop for Washington Mutual Inc. and a 76 percent retreat in National City Corp.

The Federal Reserve kept its benchmark interest rate at 2 percent yesterday, citing risks to growth and inflation. Hours after yesterday's meeting, the central bank agreed to the AIG loan.

To contact the reporter on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net.