Wall Street plunged Monday in its worst performance since the Sept. 11, 2001, attacks as financial markets around the world absorbed the blow of the largest bankruptcy in U.S. history and worried that other American financial giants might also fail without the cushion of government bailouts.
The Bush administration sought to portray the bankruptcy of the Lehman Brothers brokerage as a necessary correction to years of Wall Street excesses, making clear that it never even considered a federal bailout of the storied investment house. Behind the scenes, regulators in Washington and New York tried to stave off another massive failure, this time in the insurance industry.
World markets reacted with shock. The Dow Jones Industrial Average plummeted 504 points to 10,918 - its largest point drop in seven years - as investors tried to sort through an estimated 100,000 claims against Lehman, one of the country's largest and most esteemed investment banks. With $639 billion in assets and $613 billion in debts, Lehman's bankruptcy filing far eclipsed the bankruptcy filing of WorldCom in 2002.
The Lehman filing was just one element of a trifecta of huge financial shocks yesterday. The nation's largest insurer, American International Group, went to the Federal Reserve and other regulators for help on getting a cash infusion to keep it from going under. In addition, the recently reeling Merrill Lynch was bought by Bank of America for $50 billion in stock.
The combination sent Wall Street whirling. Worries mounted that the renewed stress in stock and credit markets would imperil an economy already flagging under a deep slump in housing and auto production and sharp spike in energy prices. Several prominent economists said the Federal Reserve may cut interest rates when it meets Tuesday in an effort to limit the damage to the economy.
"The final cathartic rehabilitation of the financial industry has begun. Yes, it is violent and palpable," said Bernard Baumohl, managing director of the Economic Outlook Group. "After years of excessive risk-taking, cheap credit [and] a sense of invincibility, many large financial institutions are now paying the price."
The turning point came when the U.S. Treasury told potential buyers of Lehman over the weekend that it was not willing to bail out yet another financial institution on the rocks - something it had helped to do earlier this year with investment bank Bear Stearns as well as the mortgage finance giants Fannie Mae and Freddie Mac, Mr. Baumohl said.
Treasury Secretary Henry M. Paulson Jr. said Monday he never even considered providing government guarantees or cash to save Lehman.
President Bush sought to maintain a sense of calm amid the financial turmoil, proceeding with a long-planned state dinner with the president of Ghana and portraying Monday's events as a necessary correction.
"I know Americans are concerned about the adjustments that are taking place in our financial markets," Mr. Bush said in the Rose Garden. "In the short run, adjustments in the financial markets can be painful. ... In the long run, I'm confident that our capital markets are flexible and resilient, and can deal with these adjustments."
On the campaign trail, the men seeking to succeed Mr. Bush struggled to gain the upper hand on the politics of the economic crisis with neither offering many new ideas. Republican John McCain argued that his lengthy experience left him best suited to combat the greed of Wall Street and bring about change while Democrat Barack Obama blamed the crisis on years of Republican policies.
The fallout from the Lehman bankruptcy was far-flung and profound on Wall Street.
The stock market sell-off started with a 300-point drop in the Dow and worsened at the end of the day, credit markets swooned, and an unraveling of Lehman's energy bets helped fuel a stunning $5.47 drop in oil prices to well below $100 a barrel.
The biggest surprise of the day was the abrupt sale of Merrill Lynch, a deal that was cobbled together over the weekend as a way to insure that the huge brokerage would not bethe next in line to succumb to mounting credit losses and market pressures.
Still, investors punished Merrill's acquirer Bank of America with a 21 percent drop in its stock price on concern that the bank was taking on too much debt in the transaction.
American International Group, the big insurer whose enormous balance sheet is also weighed down by big credit and mortgage losses, got some government help: New York regulators approved a quick cash infusion through borrowings from its subsidiaries.
But that did not prevent AIG's shares from nose-diving 61 percent to $4.76 on fears that it still might face a death spiral from a cash crunch and possible credit downgrade.
Late Monday, word emerged that the Fed was urging Goldman Sachs and JP Morgan Chase to help AIG plug a $70 billion financing gap.
Now that the government has decided to step aside and let the chips fall, "the credit and financial markets are beginning to distinguish between institutions that are viable and those that aren't, making it more likely that the latter won't survive," said George Feiger, chief executive of Contango Capital Advisors.
He said that the credit markets are also in shock as thousands of Lehman's counterparties in credit deals awoke on Monday morning to the unpleasant news of the company's downfall. The event prompted bond investors to pile into Treasury bonds in a big rush to safety.
The stock of Washington Mutual, the nation's largest savings and loan with extensive subprime investments, fell 27 percent to $2 amid fears that it will soon be taken over by U.S. banking regulators.
Lehman shares, delisted from the New York Stock Exchange, plunged 94 percent to 21 cents.
Among the remaining Wall Street giants, Citigroup sank 15 percent to $15.24, Goldman Sachs shed 12 percent to $135.50 and Morgan Stanley dropped 13.5 percent to $32.19.
Analysts predicted that the fallout in financial markets - especially the complex credit markets that were Lehman's specialty - will be long and painful.
"What people fail to understand is that because of the complicated legal instruments by which these subprime loans were packaged and sold, the risks are widespread and even now not fully assessed," said Talcott Franklin, author of a recent book on litigation and the credit crisis.
"The first waves of the collapse came on the front lines, with borrower defaults and lender and broker bankruptcies. The second wave is hitting the investment banks who securitized the loans and the insurers who issued policies on the securities. Another wave is starting to hit investors, who are widespread and largely unknown," he said.
"The shocks to each of these players in the securitization markets will reverberate throughout the U.S. and world economy and will play out over a significant period of time. The overall result is easy to project: more defaults, more bankruptcies, and more economic pain."
Several prominent economists said the Fed should call off its fight against inflation for now and slash interest rates to limit the economic damage.
"The sudden bankruptcy of Lehman Brothers over the weekend has led to another dangerous escalation of the crisis in the U.S. financial markets - a crisis that has been seriously harming the performance of the economy for over a year now," said Brian Bethune, chief economist of Global Insight.
"Without supporting moves by the Fed to buffer the fallout in the form of an emergency rate cut, the risks to the financial system and the economy are massive," he said.