Fear the two largest US mortgage finance companies are in such poor health they need a government bailout pushed financial markets lower today, although stocks pared losses as officials began to talk of safety-net moves for the ailing sector.
In a wild trading day fueled by speculation of whether the US government will rescue troubled housing giants Fannie Mae and Freddie Mac, equity markets sagged, slumped and staged a short-lived rally on hopes a esolution was near.
But the weight of a credit crisis that has slowed world growth and threatened to push the US economy into recession since a US housing slump began more than a year ago reminded investors more pain than relief in the short term lay ahead.
Contributing to the pessimism was a $5 jump in oil prices to a new record above $147 a barrel on supply lingering worries over Iran's nuclear aspiration and a potential strike by Brazilian oil workers next week.
In fact, oil's rally could run further if the troubles at Fannie and Freddie feed into the commodities boom by reducing the chances of an interest rate hike by the Federal Reserve.
Investors fear a protracted financial crisis would hit the already weak US economy and markets. The US stock market, bonds and the dollar all fell, with equities hit the hardest.
The blue-chip Dow at one point fell below 11,000 for the first time since July 2006. The Dow and broad market S&P 500 closed down more than 1 per cent.
Fears that Fannie and Freddie could require massive capital infusions rattled investors in Europe as well, where an index for the top 300 European shares closed at three-year lows and are now down 25 per cent so far this year.
Gnawing at investor unease was a New York Timesreport that said the US government was considering a takeover that could trim or eliminate the value of the mortgage companies' stock.
"The bottom line is that we're in the middle of a financial Tsunami. This is a storm the likes of which this country hasn't seen," said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.
Wall Street opened weak and extended its losses after US Treasury Secretary Henry Paulson said his department's chief aim is to back Fannie and Freddie in their "current form" -- comments that failed to soothe investors' concerns.
The two government-sponsored entities, which hold more than $5 trillion in mortgage assets and were established to finance home ownership, are pillars of the US economy.
US Treasury prices slipped on fears a bailout would require a massive capital infusion and flood markets with more government debt. Yet the bonds of the two finance companies soared as investors bet the government would back their debt.
Senator Chris Dodd, chairman of the Senate Banking Committee, said the Fed and the Treasury Department are considering opening the discount window to the two companies.
"Both the Fed and the Treasury are looking at various options ... like the discount window," he said.
The stock of the two companies fell to 50 per cent of their day-earlier levels, but then cut their losses in half after Mr Paulson downplayed the likelihood of a near-term bailout.
Fannie closed down 22 per cent and Freddie just 3 per cent after a source said that Fed Chairman Ben Bernanke told Freddie's chairman and chief executive his company and Fannie could obtain emergency funding.
Some investors held out hope the weekend would relied to Fannie and Freddie.
"People are cognizant that some plan could develop over the weekend. They don't want to be too short," said Nick Kalivas, equity market analyst at MF Global Research in Chicago.
The Nasdaq and S&P 500 racked up their sixth weekly decline; for the Dow it was the fourth straight decline.
The Dow Jones industrial average closed down 128.48 points, or 1.14 per cent, at 11,100.54. The Standard & Poor's 500 Index was down 13.88 points, or 1.11 per cent, at 1,239.51. The Nasdaq Composite Index was down 18.77 points, or 0.83 per cent, at 2,239.08.
The dollar fell against major currencies, with the US Dollar Index off 0.73 per cent at 71.965. The euro rose 0.89 per cent at $1.5924.
Among other big declining shares, Lehman Brothers shares slid 16.6 per cent to $14.43, a day after dropping more than 12 per cent on unsubstantiated rumors of clients pulling back their exposure to the investment bank.
There were some bright spots. Shares of Anheuser-Busch soared 8.6 per cent to $66.50 after a source said the maker of Budweiser beer and Belgian-Brazilian rival InBev NV have begun negotiations for a friendly merger.
Financial stocks led losses in Europe, with Credit Agricole down close to 10 per cent after newspaper Le Monde reported the French bank's chief executive and chairman could resign over losses tied to the credit crunch.
Royal Bank of Scotland fell 8.6 per cent after Zurich Financial pulled out of the bidding for RBS's insurance unit. The Swiss company's stock rose 4.2 per cent.
The FTSEurofirst 300 index closed down 2.6 per cent at 1,126.39 points - its lowest close since June 9th, 2005, according to Reuters data.
Euro zone and US government bonds briefly pared losses Mr Paulson's statement gave no hints of a bailout for Fannie and Freddie, whose shares plunged more than 40 per cent each.
Those shares began to tumble in pre-market trade after The New York Timesreported the US government was considering a takeover - a move that would guarantee the mortgages the two lenders hold, but that could leave shareholders with nothing.
European shares initially rose on the report, with investors relieved that Washington looked ready to step in to save the two massive lenders. But shares later fell sharply to three-year lows after Wall Street opened lower.
In Europe, the slide in equity markets more than offset modest gains for heavyweight energy shares on the back of record oil prices.
US Treasury debt prices slipped on fears the government would need to sell more debt to back a potential takeover, and sparked a rally in Fannie and Freddie debt.
US crude oil settled at $145.08 a barrel, up $3.43, after climbing as high as $147.27 earlier in the day, adding to gains of $5.60 from yesterday. London Brent crude settled at $144.49 a barrel, up $2.46.
Overnight in Asia, stocks rose and government bond prices fell as investors initially believed efforts to bolster Fannie and Freddie would stem further fallout from the global credit crisis.
Japan's Nikkei share average closed down 0.2 per cent and shares elsewhere in the Asia-Pacific region rose 1.3 per cent, heading for the first weekly gain since mid-May.
Fannie and Freddie have been hit hard by the US housing crisis, seeing borrowing costs rise and suffering billions of dollars of losses as many investors lose confidence they can raise sufficient capital to stay afloat.
If they failed it would make it far more difficult and perhaps impossible for people to obtain home loans, which could cause the already hard hit housing market to grind to a halt.
"The credit crisis is getting more intense, the run-up in oil is getting more intense, and of course the potential for military conflict (with Iran) is intensifying," said Marc Pado, US market strategist at Cantor Fitzgerald & Co in San Francisco
"There isn't anything out there that's good. Nobody wants to be a long holder of stocks over the weekend. For the most part people are at their most defensive levels."