Wall Street's Crisis: When All News is Bad News

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Richard Drew / AP

Trader Bradley Silverman works on the floor of the New York Stock Exchange, Tuesday, Oct. 7, 2008.

For about 30 minutes on Tuesday, the Dow Jones Industrial Index gained back close to half of yesterday's loss, which included the biggest point drops in more than 20 years for most of the world's major stock indices. But investors could not look past the struggling U.S. financial sector, nor the overleveraged European banks. Very quickly, they sent the Dow on a day-long 500 point plunge — with it and the S&P 500 hitting five-year lows.

The market had initially been buoyed by decisions that occurred before it opened — both the Fed's decision to buy the short-term debt, called commercial paper, that companies issue to fund expenses like payroll and inventory, and the Reserve Bank of Australia's surprising decision to cut its official interest rate by a full percentage point.

But even the unprecedented Fed decision was quickly discounted by the market. Chris Low, chief economist of FTN Financial, said buying commercial paper was a "very good move," but explained that "investors almost have to see things work now before they'll believe them." In particular, Low pointed out, investors may want to be sure that this year's bailout shows results — unlike last year's Master Liquidity Enhancement Conduit, which was an attempt to solve the subprime crisis by three private banks (Citigroup, JP Morgan Chase and Bank of America) using private money — essentially what Treasury Secretary Hank Paulson hopes to do now with public funds. Within months, however, the Conduit was abandoned when no investors were willing to buy the toxic mortgages. And so the government bailout was devised. "It's gotten to the point that Bernanke and Paulson have lost enough credibility," Low said. "They have to show results now." He added: "Even if all of these plans work, there's still going to be a pretty dramatic decline in growth. A recession is inevitable."

By the end of Tuesday's trading day, the Dow had plummeted 5% to 9,447.11. The other major indices declined as well with the NASDAQ down 5.8%, the S&P 500 down 5.74%, while investors retreated to traditional safe harbors such as gold, which was up $17.10 to $833.80, and oil, up $3.39 to $91.20 respectively.

Even hints from Federal Reserve Chairman Ben Bernanke, testifying on Capital Hill today, of a possible rate cut did not help. His prognosis that slow growth in the American economy, not inflation, is now the Reserve's primary concern only added bad news to a day that included fallout from yesterday's after-hours Bank of America announcement that it will need to cut its dividend and raise $10 billion in capital. The bank, which has acquired Countrywide Financial and plans to do the same with Merrill Lynch, dropped almost 25% on the announcement. Morgan Stanley shares also plummeted 25% on rumors, which the company denied, that Mitsubishi-UFJ may not take an expected 20% stake in the embattled firm. J.P. Morgan was down about 9.5% while Citigroup fell more than 12%.

All this took place a day after many of the world's major stock indices had experienced their largest percentage point drop since the October 1987 crash. American investors, it seems, are still worried about what may be on financial companies' balance sheets. The ad-hoc nature of the European response to its banking crisis has also raised concerns. Investors were clearly worried that even if a global financial meltdown is averted, a broad recession may be inevitable. And so, as governments attend to one crisis, the markets discover another to fret about — and the cycle of panic continues.

(Learn the latest financial buzz-words here.)

(See how the market meltdown happened here.)