Financial Worries Drub Wall Street

Updated from 4:10 p.m. EST

Stocks in New York tumbled Friday amid more trouble in the financial sector and a fresh stack of sour economic reports.

The Dow Jones Industrial Average slid 315.79 points, or 2.5%, to 12,266.39, pulled down by a 6.6% drop in component AIG (AIG Quote) following the insurer's report of record fourth-quarter losses. The S&P 500 sank 37.05 points, or 2.7%, to 1330.63. The Nasdaq shed 60.09 points, or 2.6%, to 2271.48.

The plunge erased all of the gains stocks reaped over the past week, when the major averages had a rare three-session win streak, and contributed to the market's fourth monthly loss in a row.

For the week, the Dow fell 0.9%, the S&P fell 1.7%, and the Nasdaq lost 1.4%, putting the indices lower by 3%, 3.5% and 5%, respectively, for the month of February.

Fred Dickson, senior vice president and market strategist with D.A. Davidson, said gains over the past week -- including last Friday's late-session reversal -- came about as "short sellers in the marketplace were reacting with laser trigger fingers at any signs of positive news in the credit market."

Today, however, "the news that was on the table, was on the table," he said.

The dismal report from insurance giant AIG raised new credit worries for investors. The company swung to a $5.29 billion loss in the fourth quarter, its biggest ever, largely thanks to the plummeting value of certain derivatives contracts. AIG disclosed earlier this month that the portfolio had deteriorated at a far worse rate than it had initially estimated, and now it puts total fourth-quarter writedowns on the investments at $11.12 billion, pretax.

Elsewhere, bond insurers were in focus after a report on CNBC said the Ambac (ABK Quote) rescue proposal has run into a "snag" and that rating agencies want a bigger capital infusion for the bond insurer from its potential bank saviors. However, the report said that doesn't mean the deal won't be completed. Ambac shares fell 5.6%.

Separately, fellow monoline MBIA (MBI Quote) said in documents filed with regulators that it expects further mark-to-market losses for January because of conditions in the credit market. The stock dropped 7.8%.

Bond insurer Assured Guaranty (AGO Quote), however, had a piece of good news, surging 12.6% after billionaire Wilbur Ross said he would invest up to $1 billion in the company, one of the rare firms in the sector that hasn't been struggling.

Those developments came as a UBS report said financial firms could wind up recording losses of as much as $600 billion because of rotting debt amid the uncertainty rippling through financial markets.

Dickson said he wasn't surprised the week ended on a down note. "What we continue to have is that dark credit cloud hanging over Wall Street -- a thunderstorm sending lightning bolts from above," he said. And today's big credit-crunch shocker, he believes, was AIG's massive writedown disclosure.

"If there were bullish investors somewhere in the Himalayas," he said. "They wanted to get a bit more of an all-clear signal. It was a whirlwind of bad news hitting the market all at once."

Indeed, a new batch of data signaling trouble for the economy worked to accelerate stocks' losses. Shortly after the open, the Chicago purchasing managers' index came in at 44.5, indicating the most severe contraction of the manufacturing sector in the Midwest since December 2001. The index's break-even point is 50, and last month the figure came in at 51.5, indicating slight growth.

Investors tend to view the Chicago PMI as a foreshadowing of nationwide manufacturing trends. The data come ahead of a report on national manufacturing activity from the Institute for Supply Management Monday.

Ian Sheperdson, chief U.S. economist with High Frequency Economics, said the reading represents one "awful" manufacturing report too many. He now expects the economy to shrink next quarter and said that the government's tax rebate plan is the only factor preventing another GDP drop in the following one.

"We'd better hope at least some people spend [the money]," he said.

Elsewhere, the Michigan Consumer Sentiment Index showed a 7.6-point decline in February from the prior month to 70.8, which hovers around the levels of 16 years ago, when the country was reeling from a recession.

Personal spending in January rose 0.4% -- a tenth of a point better than expected -- but stripping out the effects of inflation, the figure was unchanged from last year. That echoes results from December. Personal income added 0.3% year over year, missing the 0.5% consensus.

Meanwhile, Americans saved 0.1% less in that month than they did a year earlier. The core personal consumption expenditures index, the preferred measure of inflation by the Federal Reserve, was up 2.2% over last year, above the central bank's comfort zone of 1% to 2%.

Treasury prices spiked after the weak data. The 10-year note jumped 1-6/32 in price to yield 3.52%. The 30-year bond surged 1-16/32 in price, yielding 4.42%.