Updated from 12:51 p.m. EDTStocks on Wall Street dropped sharply Tuesday afternoon as investors digested more testimony from Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson on the government's historic bailout of the U.S. financial markets. Bernanke's warnings that the economy may slip into recession prompted some pessimism in the jittery market. The Dow Jones Industrial Average was down 99 points to 10,916, and the S&P 500 lost 14 points to 1194. The Nasdaq dropped 18 points to 2161. On Monday, stocks suffered as traders attempted to assess the impact of Paulson's sweeping bailout of financial firms. Paulson's $700 billion plan would create a government institution to buy from banks the bad debt at the core of the credit crisis. Although the plan is a welcome boon to many investment firms with hard-to-value securities on their balance sheets, fear remains that the massive government-spending increase will drive up interest rates and weaken the dollar as new government debt floods the market. Speaking before the Senate Banking Committee Tuesday, Paulson emphasized the fragility of the financial system and said that last week's market turmoil spread into other segments of the economy. He also said that regulatory reform is needed, but that providing an immediate response to the financial crisis is critical. Bernanke agreed that swiftly dealing with the current crisis should take priority. Bernanke also said that failure to get a bailout package through Congress raises the chances of a recession. He said that without the bailout, businesses would stagnate, unemployment would rise, and the auto and housing markets would continue to suffer.
"If the deal gets passed, the stock market is going to react well because they believe that the plan can return liquidity to the markets," said Chip Hanlon, president of Delta Global Advisors. However, he said that the plan has inflationary implications, and commodities will also increase in price as a result of the plan. Hanlon said that the government could have offered financial firms a large boost, at no cost to taxpayers, by getting rid of mark-to-market accounting rules. Although much of the debt that's hurting institutions will have some value at maturity, firms currently have to mark those securities down to what they would sell for today. Because investors are so afraid of these securities, they are valued at next to nothing, which "completely wrecks their balance sheets," said Hanlon. Meanwhile, investment banks Goldman Sachs ( GS) and Morgan Stanley ( MS) over the weekend agreed to become bank holding companies . Many have speculated about whether the big brokerages, following their transformation, will buy small regional banks to build a base of retail deposits. Following an $85 billion emergency loan from the Federal Reserve, insurance firm AIG ( AIG) said it was preparing a list of properties it would sell as part of its effort to repay the government. Japanese securities company Nomura Holdings said it would buy European banking and investment banking businesses of bankrupt brokerage Lehman Brothers. Such a purchase would result in the preservation of 2,500 former Lehman employees, Nomura said. Oppenheimer analyst Meredith Whitney's reduced earnings outlook was providing drag on the financial sector. Whitney cut her view for Bank of America ( BAC), JPMorgan ( JPM) and Wells Fargo ( WFC). She also predicted quarterly losses from Citigroup ( C) and Wachovia ( WB).
As for corporate earnings, homebuilder Lennar ( LEN) reported a fiscal third-quarter loss that narrowed year over year on sharply declining revenue. On the merger front, Bristol-Myers Squibb ( BMY) raised its buyout offer for ImClone ( IMCL) to $62 a share from $60 a share. In the technology arena, T-Mobile, a unit of Deutsche Telekom ( DT), released its G1 phone , which uses Android software from Internet search company Google ( GOOG). Over in commodities, the price of crude oil was off $3.85 to $106.60. Gold was down $15 at $894. The price of longer-term U.S. Treasury securities was higher. The 10-year note was adding 10/32 to yield 3.8%, and the 30-year was up 14/32 to yield 4.39%. The dollar was higher vs. the euro, yen and pound. Overseas, European markets were taking some knocks, while Asian exchanges ended mixed. The FTSE in London and the DAX in Frankfurt were lower. The Hang Seng in Hong Kong finished with a loss. Japanese markets were closed Tuesday.