Wall Street recoils after failures

Dow Jones falls more than 500 points, and more fallout is likely, after Lehman Brothers and Merrill Lynch throw in the towel

NEW YORK -- The upheaval in the American financial system sent shock waves through the stock market Monday, producing the worst day on Wall Street in seven years as investors digested the failure of one of its most venerable banks and wondered which domino would be next to fall.

The Dow Jones industrial average lost more than 500 points, more than 4 percent, its steepest point drop since the day the stock market reopened after the Sept. 11, 2001, attacks. About $700 billion evaporated from retirement plans, government pension funds and other investment portfolios.

The carnage capped a tumultuous 24 hours that redrew U.S. finance. Lehman Brothers, an investment bank that predates the Civil War and weathered the Great Depression, filed the largest bankruptcy in American history. A second storied bank, Merrill Lynch, fled into the arms of Bank of America.

It was by far the most stomach-churning single day since a financial crisis began to bubble up from billions of dollars in rotten mortgage loans that have crippled the balance sheets of one bank after another and landed mortgage giants Fannie Mae and Freddie Mac under the control of the federal government.

"We are in the middle of a deep, dark recession, and it won't end soon. Here it is, and it is pretty nasty," said Barry Ritholtz, who writes the popular financial blog The Big Picture and is CEO of research firm FusionIQ.

And the fallout is far from over. American International Group, the world's largest insurer, is fighting for its very survival: New York Gov. David Paterson moved to allow the company to tap one of its subsidiaries for an emergency loan to stay above water.

"AIG still remains financially sound," Paterson said, even as the company's stock tumbled almost 60 percent. Almost $20 billion was wiped off AIG's balance sheet on Monday.

In Washington, Treasury Secretary Henry Paulson, who refused to toss a financial lifeline to Lehman, was unapologetic as the Bush administration signaled strongly that Wall Street shouldn't expect more rescues from Washington.

The result was one of the most momentous days in Wall Street history since legendary banker J. Pierpont Morgan helped broker the rescue of financial markets during the Panic of 1907.

'Once in a century'

Former Federal Reserve Chairman Alan Greenspan called the unraveling financial mess a "once-in-a-century" crisis, and experts say the most likely result will be further tightening of credit and lending standards for consumers and businesses.

"We're already in a precarious situation with the credit crunch and the economy in bad shape and this is just going to make a bad situation worse," Kenneth H. Thomas, a Miami-based economist and independent bank consultant, told McClatchy Newspapers.

The decision by the Federal Reserve not to help Lehman Brothers has its pros and cons. But in letting the company fend for itself, the Fed is sending a message that the next faltering financial institution cannot expect a taxpayer bailout.

That alone adds greater risk to credit markets, which could make home, retail and business loans more expensive and harder to secure.

"So all of a sudden the guy that needed a business loan for a new plant may not get his money because a bank decides to put a hold on it and reconsider their position," Thomas told McClatchy. "The same for somebody buying a house. They think they have a good price and are ready to buy, but if they can't get the credit, there's no deal. I think what we're going to see is the credit crunch getting worse."

Lehman workers pack