WASHINGTON – The flow of money through critical parts of the financial system all but stopped Wednesday, prompting the stock market to plunge again as banks lost faith in one another and investors rushed to U.S. government securities to protect their savings.
Goldman Sachs and Morgan Stanley, the only major investment banks still standing amid the wreckage of Wall Street’s old order, tottered.
In one of the most tumultuous days ever for financial markets, the Dow Jones industrial average fell 449 points, or 4 percent, and so much money fled into safe U.S. debt that buyers were at one point willing to accept interest rates for Treasury bills of only 0.2 percent, the lowest since World War II.
The financial toll continued to mount despite a series of escalating steps taken by the government in recent weeks. As one investment bank failed Sunday and another was taken over, the Federal Reserve loosened its lending to troubled institutions. Then, in its most dramatic step yet, the government Tuesday took over the enormous insurance company American International Group and extended it an $85 billion emergency loan. None of these measures succeeded in stopping the accelerating troubles.
Investors “are worried there is a lot more out there,” said Robert MacIntosh, chief economist for Eaton Vance Management in Boston. “What other firms are going to collapse?”
The seizure in the credit markets made it difficult for corporate giants of American industry to raise money through the short-term debt they use to make their payroll and extend credit to customers. Ordinary Americans by the millions invest in that short-term debt, called commercial paper, through money-market mutual fund accounts.
On Wednesday, those money-market mutual funds were trying to unload commercial paper on fears of further problems, making it hard for all but the best-rated companies to borrow the money they need. That, in turn, led banks to hoard cash, which sharply raised borrowing costs for ordinary Americans.
The panic in credit markets made for tough sledding for the two remaining independent investment banks, which fund themselves with short-term borrowing. Both companies’ stocks experienced their steepest single-day drop ever: Goldman Sachs down 14 percent and Morgan Stanley down 24 percent.
Government leaders scrambled to consider their options, with officials at the Treasury Department and Federal Reserve calling contacts in financial markets and counterparts around the world to weigh any further intervention. As of last night, neither agency had any public comment on the distress.
The Securities and Exchange Commission instituted new rules to combat the “naked short selling” of stocks, a way of betting on their declines without having borrowed actual shares first.
The ban could make it harder for hedge funds to make big bets against the shares of troubled companies. Last night, SEC Chairman Christopher Cox announced that he was asking the commission to urgently consider new rules requiring hedge funds and other large investors to disclose their short positions.
The Treasury Department, meantime, auctioned $40 billion in new debt to put the Federal Reserve in a stronger position to make future emergency loans, like those extended in the AIG takeover and the rescue of the failing investment bank Bear Stearns in March.
The Treasury also established a procedure allowing it to auction off more debt if the Fed requires.
The turbulence was widespread through markets in the U.S. and abroad. Crisis deepened abroad, too, especially in Russia, where the government halted trading in stocks for the second straight day because of steep declines. There, the global financial crisis is compounded by a reliance on petroleum wealth, which is threatened by the severe drop in the price of oil over the past few months.
Oil prices did rise Wednesday, however, by $6 a barrel, as investors looked for places other than the debt markets to place their money.