Credit crunch squeezes stocks

Signs of an increasingly severe credit crunch for home buyers and corporations yesterday sent the Dow Jones Industrial Average plummeting 281 points.

The market sell-off deducted more than 2 percent from major stock indexes, adding to a nearly 5 percent drop in stocks fed by credit troubles last week.

Helping to spur the sell-off this time was a comment from a top Bear Stearns executive, who said the sudden shutdown of credit for mortgages, corporate buyouts and other activities was the worst he has seen since the 1998 worldwide credit crunch after Russia defaulted on its debt.

“I’ve been out here for 22 years, and this is as bad as I’ve seen it in the fixed-income markets,” Bear Stearns Chief Financial Officer Samuel Molinaro said in a conference call with analysts. The Wall Street investment firm, which was one of the biggest financiers of the mortgage credit boom in the early 2000s, has been among the worst hit by rising defaults and the ensuing credit crisis. Three of its mortgage-related hedge funds have collapsed this year.

The developments showed that the credit debacle has spread well beyond the subprime market for mortgages. Wachovia Corp., Wells Fargo & Co. and other major home lenders yesterday said they were no longer offering mortgages to so-called “Alternative-A” borrowers, whose credit is nearly as good as prime.

A typical “Alt-A” home buyer is young with little credit history and a large amount of debt, or self-employed with no income documentation but a good credit rating. The flow of loans to these home buyers was a major force driving the housing boom between 2000 and 2005.

American Home Mortgage, a top Alt-A lender, shut down yesterday and laid off more than 6,000 employees after saying it could no longer get funding for loans. Such funding was freely available from hedge funds, insurance companies, pension funds, European banks and other investors as recently as June. The evaporation of the financing is why some fear the credit crunch is mounting into one of historic proportions.

“The list is getting long,” with new revelations of credit woes each day, said David Ader, U.S. government bond strategist at RBS Greenwich Capital. “The broader question still looms: Can consumption and the real economy survive the continued turmoil in the credit markets?”

In bond trading pits, where the credit crunch has been playing out in recent weeks, “we are engaged in the active discussion of ’When will the credit turmoil end?” ” he said. “We don’t sense that anyone has a clue.”

The news yesterday sent stocks into a tailspin. The Dow fell 2.1 percent, to 13,182, while the Standard & Poor’s 500 Index dropped 2.67 percent, to 1,433, and the Nasdaq Composite Index fell 2.5 percent, to 2,529.

Investors bailed out of stocks and fled to safe-haven Treasury securities.

Aggravating the market was a report of tepid job growth of 92,000 last month, held down by layoffs at construction and manufacturing companies as well as state and local governments. The unemployment rate for July rose to a six-month high of 4.6 percent.

Among lenders curtailing loans to Alt-A borrowers, First Horizon National Corp. said it has reduced the number of loans it is making and raised rates “significantly” in the past two weeks. Wells Fargo, the second-largest U.S. mortgage lender, said it is temporarily cutting issuance of Alt-A home loans through brokers. Wachovia has stopped offering Alt-A loans through independent brokers, but still offers them through its own bank offices and branches.

The pullback at Wells Fargo is notable because the bank has long prided itself on conservative lending standards therefore was spared during previous market turmoil.

IndyMac Bancorp Inc. Chief Executive Officer Michael Perry said the market for many mortgage-backed securities has become “very panicked and illiquid,” and that is pushing many lenders to quit subprime and Alt-A.

“The credit crunch is here,” said Keith Shaughnessy, president of Foundation Mortgage Corp.

Harm Bandholz, economist with UniCredit Markets, said the housing crunch and credit debacle have resulted in a mild pullback in consumer spending, but steep declines in housing prices and stocks could cause a bigger retreat.

“The recent developments in financial markets beg the question as to how robust the economy really is,” he said.