Several Factors Contribute To Dow's Decline

The Dow has fallen by nearly 450 points. A high London Interbank Offered Rate, the stock value of a money market fund that lost money in the Lehman Brothers collapse, and fears the government may be stretching itself too thin with the bailout of American Insurance Group may have all contributed.

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MICHELE NORRIS, host:

From NPR News, this is All Things Considered. I'm Michele Norris. First this hour, to the markets. If you want to know just how bad things were today, consider this. The price of gold took its biggest jump in nearly a decade. Investors were looking for safe havens. The government's 85-billion-dollar bailout of insurance giant AIG did nothing to reassure investors. The Dow Jones Industrials lost nearly 450 points. NPR's Jim Zarroli has been watching the markets, and he joins me now. Jim, it seems like Wall Street keeps losing ground. What's scaring off investors?

JIM ZARROLI: Well, there were several things today. There's something called the London Interbank Offered Rate. It's just like it sounds. It's the rate that banks in Britain charge when they loan each other money. And when banks are nervous about the economy, they tend to bid up the rate, and right now, it is very high. If it stays up, it's a big deal for the U.S. economy because it makes credit much more expensive. LIBOR is really widely used to set interest rates for credit cards and other forms of credit in this country. So stock market investors are nervous about that.

There was also a money market fund that lost a lot of money when the Lehman Brothers collapsed, and its shares fell below a dollar which, is the threshold past which investors get very nervous.

NORRIS: It was expected the government bailout of AIG might help calm the markets. Why didn't that happen?

ZARROLI: Well, it hasn't really worked. In fact, AIG was again down today, so were some of the other big financial stocks, too, Goldman Sachs and Morgan Stanley. Whenever the federal government has come out with one of these bailouts, you know, it seems to stabilize things for a while, but then investors start getting scared again.

NORRIS: People have had a little bit of time to think about this. What do people in the market think about the AIG bailout?

ZARROLI: I think a fair number of people think, you know, it was a necessary evil. You can't let a huge company like AIG fail. I think a lot of people in Wall Street dislike the idea of this kind of rescue, just on principle. I talked to one economist today. He said, all these bailouts have gotten people worried that the government is maybe overextended. You know, it keeps promising all this money.

One of the things that happened today was that the Treasury Department said it would sell Treasury bills on behalf of the Federal Reserve. It said the Fed needs the money to deal with the credit crunch. Now, this is the kind of thing that creates the perception that the government is running out of money, which isn't happening really, but people get scared. They pull their money out of stocks, and they put it in safer investments.

NORRIS: That's NPR's Jim Zarroli in New York. Thanks, Jim.

ZARROLI: You're welcome.

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Stocks Rise As Plan To Handle Bank Debts Is Aired

Stocks rallied at the end of the day Thursday as investors piled into the market on reports that Treasury Secretary Henry Paulson is considering setting up a credit facility that would resemble the Resolution Trust Corp. that helped end the savings and loan crisis.

The stock market's major indexes were up about 4 percent on the day. The Dow Jones industrials gained 410 points Thursday after losing 449 points Wednesday.

The Resolution Trust Corp. was an entity responsible for liquidating the assets of the savings and loan associations that went bust in the late 1980s.

Treasury would not confirm that it had decided on an RTC-like solution for this crisis, but it didn't knock the prospect down, either, providing only "no comment."

Even if there were such a solution in this case, it is unclear exactly how the entity would be set up or even how it would work. The RTC of the 1980s helped the Federal Deposit Insurance Corp. work with sick savings and loans and created an orderly process to deal with a staggering number of insolvencies.

Some analysts embrace the idea because it could take care of a number of problems weighing on the market now. It could, for example, free up banks to restore some liquidity to the markets if the entity took on the bad loans that are weighing them down now.

Some sort of RTC-like solution could also allow for an orderly sale of the bad mortgages and that, in turn, would provide a better chance for distressed securities to recover some portion of their value.

For homeowners unable to pay their mortgages now, that could provide some flexibility. It could give banks some breathing room, which would make it easier for them to modify the loans of customers who can't make their current mortgage payments.

Bush Cites 'Serious Challenges'

Earlier Thursday, President Bush hinted that something was in the works when he came out and said he would do whatever was necessary to stabilize the markets. He didn't offer any policy prescriptions, but he did assure investors that he was closely monitoring the unfolding situation.

"The American people are concerned about the situation in our financial markets and our economy and I share their concerns," the president said, after announcing he had canceled a scheduled trip out of Washington to keep on top of the financial crisis.

"Our financial markets continue to deal with serious challenges," he said. "As our recent actions demonstrate, my administration is focused on meeting these challenges."

The president was referring to a series of government bailouts that have rocked financial markets. On Sept. 7, the Treasury announced that it was taking control of Freddie Mac and Fannie Mae to prevent them from slipping into bankruptcy. It provided a $100 billion line of credit for both companies in return for control of them.

Then, earlier this week, the Federal Reserve said it would take a nearly 80 percent interest in the insurer American International Group in exchange for a two-year, $85 billion loan.

On Wednesday, White House spokeswoman Dana Perino said the administration had shored up that trio of companies because they were just too big to fail. That has some investors concerned that there are more bailouts — and more failures — ahead. They are worried that the Bush administration is now willing to use taxpayer dollars to save companies that find themselves on the wrong side of the subprime mortgage crisis.

Central Banks Move To Ease Credit Crunch

Ahead of the president's comments, the Federal Reserve moved to ease the credit crunch by pumping $55 billion into the nation's financial system. The Federal Bank of New York injected the money into temporary reserves hoping it would ease a spike in the overnight lending rate between banks.

A credit crisis could have been more perilous than a market fall. The whole global financial system depends on banks lending each other money. Cash flow is the grease that keeps the financial system functioning, and without it, like a car engine without oil, the system seizes up. Right now banks seem unwilling to extend credit to other banks out of concern that they won't get their money back or that they might need the cash to cover their own obligations.

Overnight there was a concerted effort by central banks around the world to inject more money into the financial system. The Federal Reserve almost quadrupled the amount of dollars central banks can auction, to $247 billion. Then it authorized increases in what are called swap lines, which are temporary reciprocal currency arrangements that allow banks to borrow dollars at lower rates.

It doubled the European Central Bank's swap line to $110 billion. The Swiss National Bank's line is now $27 billion, up from $15 billion. The Fed also established new swap lines for the Bank of Japan, the Bank of England and the Bank of Canada.

"The central banks continue to work together closely and will take appropriate steps to address the ongoing pressures," the ECB said in a statement.

Borrowing Money Gets More Expensive

Proof of that "ongoing pressure" was the spike in the cost of borrowing money: London's intrabank lending rate, or LIBOR, is at 3.02 percent. Banks have not had to pay this much to borrow dollars since 1999.

Michael Mussa, senior fellow at the Peterson Institute for International Economics, says the high interbank lending rates, if they continue, will hit the economy like a heart attack. "If that goes on for a significant period of time, it's very worrying," he said. "It is sort of the financial-market equivalent of ventricular fibrillation."

Short Sellers Draw Scrutiny

With all the volatility in the market, regulators are trying to find ways to smooth out the spikes. One place on which they are focusing: short selling — which is essentially making a bet that a share price will decline to a certain level by a certain date. Some observers think it has been contributing to the current market crisis as investors use short selling to bid down the price of stocks.

In a statement late Wednesday, Christopher Cox, chairman of the Securities and Exchange Commission, said that hedge funds and investors managing more than $100 million in securities would be "required to promptly begin public reporting of their daily short positions."

The SEC's Role

Five SEC commissioners have to approve the rule for it to become binding. That hasn't happened yet.

What the SEC has done is stiffen the rules against so-called naked short selling, a practice in which traders never actually borrow the shares they are betting against from their brokers. What that does is flood the market with sell orders that drive down stock prices. Short sellers say they are being made the scapegoat for the market declines.

Republican presidential candidate John McCain placed the blame for the market problems squarely at the feet of Cox, saying he had failed in his responsibility to provide oversight of Wall Street.

McCain also called for a new Mortgage and Financial Institutions trust to work with regulators and the private sector to strengthen financial institutions that are weak before they become insolvent.

"For troubled institutions this will provide an orderly process through which to identify bad loans and eventually sell them," McCain told a rally of supporters in Iowa.

Amid all this turmoil, investors are running toward what are seen as traditionally safe investments. Wednesday they were so worried about the state of the markets they bought three-month Treasury bills that had only minimal interest. Gold was pushed to its biggest one-day gain in nearly 10 years.

The Impact Of The AIG Bailout

The fear became palpable just hours after the government announced it would seize control of insurer American International Group. The Fed said it would provide the insurer with an $85 billion emergency loan in exchange for a 79.9 percent stake in the company.

Perino defended the Federal Reserve's decision to bail out AIG Wednesday but managed to rattle markets in the process by saying that the decision was made earlier this month to bail out Fannie Mae and Freddie Mac, and now AIG, because the companies were "so big that to allow them to fail would have caused even greater harm and damage to the economy."

Perino's comments seemed to play into the fears of some observers that the Bush administration is prepared to bail out other companies caught on the wrong side of the latest financial crisis.

Perino said that the administration remained "concerned about other companies and that's why the secretary of the Treasury continues to work with the team to see if we can stem any other losses." She said determinations would be made on a case-by-case basis.

Saving AIG

The Federal Reserve's move Tuesday night to save AIG from bankruptcy was unprecedented. Critics of the plan say the government is putting taxpayer money at risk to protect a company that made bad bets on the subprime mortgage market. Supporters say the government had little choice: Because AIG insures a vast array of securities for financial institutions, the fallout would have been monumental had it failed.

That's because AIG had sold large quantities of credit-default swaps to financial institutions around the world. The concern was that if AIG went under, companies that had insured their investments with the firm would have had to massively revalue their holdings. That could have created a frisson felt around the world.

Economist Sun Won Sohn of California State University at Fullerton told NPR that the U.S. can raise the money it needs to pay for the bailouts, but the bigger issue is one of perception. The U.S. financial system seems overextended, and that is causing foreign investors to pull their money out of the country.

"The Federal Reserve and the U.S. Treasury have always been the rock of Gibraltar," he said. "Now we're seeing that people are beginning to wonder, is it really as strong as we thought it was?"

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