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Stocks Dig Deeper Into Red

Mike Taylor

Stocks in New York hit fresh session lows Monday afternoon, as traders continued to assess the Treasury Department's massive weekend bailout plan for financial firms. Money flowed into crude-oil futures, prompting a sharp spike in prices.

The Dow Jones Industrial Average shed 256 points to 11,132, and the S&P 500 slipped 33 points to 1222. The Nasdaq gave back 64 points to 2210.

On Friday, the three major indices finished substantially higher. Financials led the rally after the Securities and Exchange Commission temporarily banned short-selling of 799 stocks in the sector. The Treasury announced over the weekend that it would iron out a plan to provide hundreds of billions of dollars to U.S. banks and brokerages to try to avert further damage from the credit crisis.

The New York Stock Exchange on Monday extended the short-selling ban to 30 more companies that have significant financial operations. The list includes General Motors (GM Quote) and General Electric (GE Quote).

The short-selling ban helped unwind the buy-commodities, sell-financials trade, Paul Nolte, director of investments at Hinsdale Associates, wrote in an email Monday. Friday's rally was largely due to a recovery from very low levels and illustrates recent market volatility. "As a result, it is hard to take the movements ... as much more than a bounce from severely depressed levels," he wrote.

Over the weekend, the Treasury Department drafted a plan to lift as much as $700 billion in bad debt from financial-sector balance sheets.

"Some of the tranches of these [securities] are radioactive," said Jack Ablin, chief investment officer at Harris Private Bank. However, some of the less-risky securities do have value, he said. He said that the $30.6 million in mortgage-backed bonds Merrill Lynch sold to Lone Star in July were actually very solid.

"The fact that no one wants to touch this stuff with a 10-foot pole is hurting the market value of stuff that no one wants to really understand," said Ablin. He said that if a bailout institution holds the troubled assets to maturity, there's reason for optimism.

Nevertheless, it's possible that a government bailout institution [would] actually overvalue the assets it buys. "There is a potential for conflict of interest there," said Ablin.

"While desperate times require desperate measures, this might be a bit too desperate," wrote Nolte. The government plan raises the limit of the national debt by $1 trillion, he wrote. "While there are few worries if the plan works, the proposal severely hamstrings the government to act on any other issue that may come up," and may increase government borrowing from creditors who already own a great deal of U.S. debt, he wrote.

Tony Crescenzi, chief bond market strategist at Miller Tabak and contributor to RealMoney.com, acknowledged the risk associated with a bailout of this size. "If global investors see little wisdom in the U.S. policy response and turn their backs on the U.S. then the U.S. will enter an extraordinarily dark period marked by rapid, massive and de-stabilizing deleveraging." However, he said that such an event is unlikely because the U.S. continues to produce innovative ideas, has a solid political system and a strong military.

In terms of the impact on fixed-income markets, Art Hogan, chief market strategist at Jefferies & Co., said that the yield curve for Treasuries will steepen as the government issues new debt to cover new obligations, driving bond prices down and yields higher.

On Sunday, the Federal Reserve said that Goldman Sachs (GS Quote) and Morgan Sanley (MS Quote) would become bank holding companies instead of investment banks. The change subjects the pair to increased government oversight and stricter capital requirements. Goldman and Morgan had been the final two large, independent brokerages after Lehman Brothers went bankrupt and Bear Stearns and Merrill Lynch (MER Quote) merged with large banks.

CNBC subsequently reported that Morgan Stanley would probably not be merging with Wachovia (WB Quote) following the Fed's announcement.

Separately, Japanese bank Mitsubishi UFJ (MTU Quote) announced early Monday it would buy a 10% to 20% stake in Morgan Stanley. Such an investment could be worth as much as $8.4 billion.

"It was a surprise to me," said Ablin of the end of the investment-banking business model. He said that Goldman Sachs is now in competition with Bank of America (BAC Quote) and Citigroup (C Quote). Ablin said that as Goldman and Morgan Stanley seek funding from wholesale deposits, their costs are going to be incrementally higher than those at Citigroup and Bank of America, which already have large deposit infrastructure and offset their costs with service charges.

The impact of the shift away from the investment-banking business model is deleveraging, said Jeffries' Hogan. "The boom and bust cycle ... is going to flatten out a little," he said. "We're going to get used to quieter profits and more stable profits. You're not going to see explosive growth, so we're not going to rocket out of the doldrums we've gotten ourselves into."

Outside the financial sector, software maker Microsoft (MSFT Quote) announced a $40 billion share buyback program and said it would raise its quarterly dividend to 13 cents from 11 cents.

Similarly, computer maker Hewlett-Packard (HPQ Quote) and athletic apparel developer Nike (NKE Quote) each announced their own share-buyback programs.

Shifting to commodities, crude oil gained $16.37 to $120.92 a barrel. Gold was adding $44.30 to $909 an ounce.

Longer-dated U.S. Treasury securities were falling in price. The 10-year was down 8/32 to yield 3.84%, and the 30-year was down 18/32, yielding 4.41%. The dollar was declining sharply vs. its major foreign competitors.

Abroad, European exchanges were ticking downward. The FTSE in London and the DAX in Frankfurt were both falling. The Nikkei in Japan and the Hang Seng in Hong Kong had earlier finished their sessions on the upside.