Caution looms over Wall Street

By Madlen Read

Sept. 22, 2008 12 AM PT

The Associated Press

NEW YORK — The Dow Jones industrial average may be almost exactly where it was a week ago, but Wall Street is a completely different place.

In a matter of days, Lehman Bros. Holdings Inc. went into bankruptcy, Merrill Lynch & Co. was snapped up by Bank of America Corp. and giant insurer American International Group Inc. was bailed out by the government. One big mutual fund broke the buck, and another was shut down.

And now, the government is planning to assume banks’ risky assets.

Overall, investors are relieved about the intervention. But they remain quite cautious about the outlook for the financial markets and the economy. Those who remember the savings and loan crisis of the late 1980s will recall that it was followed by about three years of recession, pointed out John O’Donoghue, co-head of equities at Cowen & Co.

“If we’re not in one, we will be in one,” O’Donoghue said, adding that a government rescue of the banks would not prevent them from tightening their lending standards further. When people and businesses have a hard time getting loans, that tends to stunt economic growth.

The belief among investors that the anemic economy could worsen before it improves could keep the stock market jittery until it sees real signs of strength.

No one is holding their breath for such signs this coming week, with the National Assn. of Realtors anticipated to post a decrease in August’s existing-home sales and the Commerce Department expected to report a decline in August’s new-home sales.

Gross domestic product supposedly grew at a healthy annual rate of 3.3% during the second quarter, the Commerce Department estimated last month. In the coming week, the department is expected to reiterate that figure, according to the median estimate of economists surveyed by Thomson Reuters.

Still, the figure has been met with disbelief by many market participants, who say it does not accurately reflect what is going on in the economy.

Last week -- after the Dow saw its worst percentage drop since 2001 and then its best percentage recovery since 2002 -- the blue-chip index ended the week down 0.3%. The Standard & Poor’s 500 index ended up 0.3%, and the Nasdaq composite index finished up 0.6%.

Tight credit markets and back-and-forth movements in the stock market have been the norm for more than a year, but last week’s patterns were extreme.

Lending in the credit markets virtually halted, sending institutions flocking to Treasury markets and gold for a safe place to put their cash. Worries about a potential collapse of the U.S. banking system hit a peak, driving money out of financials and the rest of the stock market as well.

It was shocking enough when Fannie Mae and Freddie Mac, which already had government ties, were bailed out and taken over by the U.S. Treasury two weeks ago. But the government’s decision to let Lehman go into bankruptcy and the ensuing bailout of insurer AIG sent Wall Street further into true tumult, with everyone asking: Who’s next to fall, and who’s going to be collateral damage?

The government alleviated those immediate worries with word of a plan to take on banks’ assets.

And the stock market’s performance was helped on Friday as well by a temporary ban on the short-selling of financial stocks.

Kim Caughey, equity research analyst at Fort Pitt Capital Group, called the short-selling ban, which is scheduled to end in early October, a positive development but “just a tourniquet.” The real core of the markets’ problems is the housing market.

“To make real estate sell, you need to get a mortgage,” Caughey said. The government’s assumption of risky debt should “improve, very slowly, the likelihood that there’s money out there for lending.”

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At a glance

oday

Weekly Treasury auction.

Quarterly earnings report due from CarMax.

Tuesday

Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson are expected to testify at a Senate Banking, Housing and Urban Affairs Committee hearing on turmoil in the financial markets.

Quarterly earnings report due from Lennar.

Wednesday

National Assn. of Realtors releases existing-home sales for August.

Bernanke expected to testify about the economy before the Joint Economic Committee.

House Financial Services Committee hearing on the financial markets crisis.

Quarterly earnings report due from Nike.

Thursday

Labor Department releases weekly jobless claims.

Commerce Department releases new-home sales and durable goods report for August.

Freddie Mac releases weekly mortgage rates.

Bernanke and Paulson to testify before the House Financial Services Committee.

Quarterly earnings reports due from Discover Financial Services, Research in Motion and Rite Aid Corp.