Stocks Drop Sharply and Credit Markets Seize Up

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By VIKAS BAJAJ and JACK HEALY

As a new bout of fear gripped the financial markets, stocks fell sharply again on Thursday, continuing a months-long plunge that has wiped out the gains of the last decade.

The credit markets seized up as confidence in the nation’s financial system ebbed and people rushed to put money in Treasuries, the safest of investments. Some markets are now back to where they were before Congress approved the $700 billion financial rescue in October.

The Dow Jones industrial average fell nearly 445 points, or 5.6 percent. The broad market sank to its lowest level since 1997 — before the dot-com boom, the Nasdaq market bust and the ensuing bull market that drove stocks to record heights.

With Thursday’s rout, $8.3 trillion in stock market wealth has been erased in the last 13 months.

Investors are growing increasingly worried that big banks like Citigroup, JPMorgan Chase and Bank of America, which have all received billions of dollars from the government to bolster their finances, are still too weak. The price of Citigroup’s shares plunged 26.4 percent on Thursday and other financial shares fell to fresh lows.

Citigroup, which is under pressure from some investors to split itself or sell businesses, plans to hold a meeting on Friday to update executives on the company’s condition.

The Standard & Poor’s 500-stock index fell 6.7 percent, leaving that benchmark down about 52 percent from its peak in October 2007. The Dow Jones industrial average closed at 7,552.29, barely above its low in October 2002 during the depths of the last bear market. The Nasdaq fell 5 percent, to 1,316.12.

“This is a response to real fear,” said Marc D. Stern, chief investment officer at Bessemer Trust, an investment firm in New York. “We each have to look inside and say, is the fear warranted?”

The fear was reflected in a stampede for the safety of government securities. The Treasury’s benchmark 10-year bill rose 2- 22/32, to 106- 10/32 and the yield, which moves in the opposite direction from the price, was at 3.01 percent, down from 3.32 percent late Wednesday.

The sell-off in equities gathered force over the last several days and brought an abrupt end to what had been a modest improvement in financial markets. After the Federal Reserve began making short-term loans directly to businesses last month, a semblance of normalcy returned to credit markets, and the stock market, although volatile, held above its old lows.

But investor confidence, which has been shaky since the bankruptcy of Lehman Brothers, was dealt a severe blow when the Treasury Department announced last week that it would not buy troubled mortgage assets using the $700 billion that Congress approved in October. Economic reports showing rising unemployment, falling consumer prices and disastrous retail sales compounded the damage. The risk that one or all of the Detroit automakers might go bankrupt added to the gloom.

“The profit drag on corporate America is widening and deepening, and this is leading to more layoffs and cutbacks in capital spending, which is extending and deepening the recession,” said Stuart Schweitzer, global markets strategist for J.P. Morgan Private Bank. “We’ve gotten into a full-blown, self-feeding downturn.”

More bad economic news arrived on Thursday morning the Labor Department reported that new claims for unemployment benefits rose to a seasonally adjusted 542,000 last week, the highest level since July 1992. Unemployment is also climbing at a rapid clip in Europe, and the once-sizzling economies in Asia and Latin America are starting to sputter. Early on Friday, Singapore reported that its third-quarter gross domestic product fell at a 6.8 percent annualized pace.

In Asian trading early Friday, stocks were down nearly 3 percent in Japan, Australia and New Zealand. On Thursday, most European markets closed down more than 3 percent for the day.

The global nature of the slowdown is a reason that oil prices have fallen spectacularly in recent months. On Thursday, oil futures, which had touched $145 this summer, settled below $50 a barrel for the first time since 2005.

The sell-off in markets has been all the more severe because of forced selling by hedge funds, mutual funds, insurance companies and banks, all of which are being compelled to sell at the same time because of pressures from investors, lenders, regulators and rising insurance claims.

There have been spectacular declines in investments like commercial mortgage-backed securities, which are collections of loans backed by shopping malls, office buildings and apartments. Prices of those securities have fallen 20 percent just this month, mostly in response to a report about anticipated defaults on just two loans. The price of insuring against a default on commercial mortgages has more than doubled in less than a week.

“Where the credit markets are trading, it’s all but implying a 1929 scenario,” said Joe Balestrino, fixed income strategist at Federated Investors, who added that he thought prices had fallen too far in many cases.

The troubles in the credit market are not limited to risky assets. The mortgage finance companies Fannie Mae and Freddie Mac, which the government took over in September, have had to pay a steep premium over rates at which the Treasury borrows because policy makers have not explicitly guaranteed their debt.

Investors said the weak condition of many large banks had exacerbated the pain in the financial system because those institutions served as critical intermediaries in the trading of securities, particularly in the credit markets, where securities do not trade on exchanges. Because they need every spare dollar to shore up their own health, those banks are not as willing to make markets in securities that may be even slightly risky.

Shares of Citigroup, for instance, have fallen more than 50 percent this week, to $4.71. Earlier in the week, the bank said it would nearly double previously announced layoffs to 52,000, or 14 percent of its total staff. Other big institutions like Goldman Sachs and Morgan Stanley have been reducing their reliance on borrowed money because they have decided to become bank holding companies subject to regulation by the Federal Reserve.

“They are the middleman, and they have just gotten killed,” Andrew Feltus, a bond fund manager at Pioneer Investments, said about big banks and securities firms.

Still, in a sign that some investors have not lost all faith, two dozen stocks in the S.& P. 500-stock index rose, albeit barely, and among them were two of the American’s troubled automakers.

General Motors and Ford had a rare positive day on Thursday after Congressional leaders left open the door for federal aid to them and for Chrysler, which is privately held. Still, Democratic leaders criticized the executives of the companies and said they needed to make a more persuasive case that they would be responsible stewards of government money. G.M. and Ford were up slightly, though still close to their lowest levels in decades.