Fear gripping Wall Street

WASHINGTON -- The promise of lower interest rates and new federal efforts to stem the financial crisis failed to dispel the fear gripping Wall Street on Tuesday.

Stocks sank within minutes of the session's opening and the selling intensified during the afternoon, even after Federal Reserve Chairman Ben Bernanke all but pledged to cut interest rates by the end of the month.

The Dow Jones industrial average plunged 508 points, or 5.1 percent, extending a months-long slide that has erased one-third of its value in a year. In the last five trading days, the Dow has lost 1,400 points.

With the flow of credit still tight, investors have fixated on the threat of a serious recession despite increasingly urgent attempts by policymakers to buttress the markets. Deepening problems in the European banking industry have compounded fears of a worldwide downturn.

"The Fed is just plugging holes in the dam and the water keeps rushing over," said Michael Darda, chief economist at the research firm MKM Partners.

In a somber speech, Bernanke acknowledged that the financial turmoil of the past several weeks had forced the Fed to downgrade its already gloomy economic forecast for the remainder of this year and reconsider holding its benchmark rate steady.

"Overall, the combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased," Bernanke told members of the National Association for Business Economics.

"In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate," he added. It was his strongest indication yet that the Fed will cut rates.

Fed policymakers are scheduled to meet Oct. 28 and 29, and investors had already been betting that the central bank would reduce the overnight federal funds rate by as much as a 0.5 percent, to 1.5 percent. Many analysts predict the Fed may act sooner.

In its latest tactic, the Fed announced on Tuesday morning a new program to buy up parts of the short-term financing market to unlock the flow of credit to businesses. The move marked the latest and potentially biggest in a series of unprecedented Fed efforts to combat the worst meltdown that financial markets in the United States since the Great Depression.

"These are momentous steps," Bernanke said, "but they are being taken to address a problem of historic dimensions." He said the outlook for inflation had "improved somewhat" and made it clear that worries about a recession had now trumped worries about rising prices.

While he noted that energy and commodity prices, a significant burden on American consumers, had declined from their recent peaks, he painted a bleak picture of an economy stalling on multiple fronts.

Bernanke made it clear that the latest round of market turmoil would depress growth for the rest of the year. He said he hoped for a gradual recovery in 2009.

"You are getting all the things that you would think the equity markets would respond very favorably to," Steve Sachs, director of trading at Rydex Investments, said. "But at this point it just doesn't seem to be doing it. It's the attitude of 'sell' -- regardless of what the news is."

Although investors fled stocks, there were signs that the Fed's latest plan did have a positive impact on the troubles in the credit market. The cost to borrow commercial paper overnight fell significantly, and yields on Treasury bills rose, a sign that investors were more willing to leave the safety of government notes.

But the Dow, which had lumbered downward from early in the session, accelerated its losses in the final hour and ended down 508.39 points, breaking below the 9,500 mark to close at 9,447.11. The broader Standard & Poor's 500-stock index fell by 5.7 percent, ending below 1,000 for the first time in five years. Shares of banks and financial firms shouldered the biggest losses by far, with Bank of America, Merrill Lynch and Morgan Stanley all losing about 25 percent.

The Nasdaq composite index fell 108.08, or 5.80 percent, to 1,754.88.

Fears about the health of the banking industry were stoked by a disappointing earnings report from Bank of America, which had been perceived as one of the few winners in the current crisis. The bank slashed its dividend on Monday and reported a sharp fall in profits.

Late in the afternoon, rumors flew across trading desks that a financing deal between Morgan Stanley and a Japanese bank had fallen through. Shares of Morgan fell more than 30 percent before officials at the bank reassured investors that the deal was, in fact, still on track.

In a sign of how the credit crisis is affecting ordinary Americans, the amount of credit provided to consumers in August dropped for the first time since 1998. Consumer credit declined by $7.9 billion, the biggest monthly drop in more than half a century, according to the Fed.

"Nobody trusts anybody right now," said Ryan Detrick, an analyst at Schaeffer's Investment Research.