With Wall Street already reeling from the demise of one storied investment firm and the rushed takeover of another, investors are bracing for more turbulence as the housing crisis continues to hammer the nation's financial system.
The Dow Jones industrial average plummeted 504 points Monday -- the most since the aftermath of the Sept. 11, 2001, attacks -- after investment bank Lehman Bros. Holdings Inc. became the biggest company to file for bankruptcy protection and Bank of America Corp. announced it was acquiring Merrill Lynch & Co.
The market's direction today could hinge in large part on what happens with insurer American International Group Inc. -- the latest financial titan struggling to stay afloat -- and on the outcome of a Federal Reserve meeting on interest rates.
Like Lehman and Merrill, AIG has recorded large losses on mortgage-related debt. Its stock price plummeted 61% on Monday as the company scrambled to borrow as much as $75 billion to tide it over.
And, as with Lehman, investors fear that a collapse of AIG would ricochet through the financial system and prompt another wave of selling in the stock market.
"You could crater the market on Tuesday with no resolution of AIG," said Joe Battipaglia, market strategist at brokerage Stifel, Nicolaus & Co. in Florham Park, N.J.
The Fed, meanwhile, is under increasing pressure to come to Wall Street's aid by cutting interest rates, a move that only a few days ago seemed a remote possibility.
The depth of the crisis had analysts making comparisons to the aftermath of 9/11, the dot-com bust and the 1987 market crash -- if they were making comparisons at all.
"There's unprecedented turmoil among the largest financial institutions in the country, and that predictably has everyone on edge," said Jeffrey Bronchick, chief investment officer at Reed Conner & Birdwell in Los Angeles. "No one has seen this before, and it's going to take some time to see how it plays out."
The Dow ended the day down 504.48 points, or 4.4%, at 10,917.51. It was the worst one-session point drop since the blue-chip index plunged 685 points, or 7.1%, on Sept. 17, 2001 -- the day markets reopened after the terrorist attacks. It was the biggest one-day percentage decline since a 6.4% plunge in July 2002.
Stock prices also tumbled in Asia and Europe, and were down again in Asia early today.
The planned takeover of Merrill Lynch by Charlotte, N.C.-based Bank of America did little to reassure investors. Shares of Bank of America, which two months ago bought the largest U.S. mortgage lender, Countrywide Financial Corp., dropped 21% on Monday, slicing the value of its all-stock offer for Merrill to about $40 billion.
Likewise, statements by President Bush and Treasury Secretary Henry M. Paulson failed to calm investors.
In fact, the selling in the stock market accelerated after Paulson's remarks, which seemed designed to reassure investors but also make clear that the government had no plans for further intervention in the troubled financial system.
"We're working through a difficult period in our financial markets right now as we work off some of the past excesses," Paulson told reporters at the White House. "But the American people can remain confident in the soundness and the resilience of our financial system."
The Treasury chief also said that he "never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Bros." In March, the Federal Reserve, with the Treasury's endorsement, provided financial support for the sale of tottering investment bank Bear Stearns Cos. to JPMorgan Chase & Co., a move that stabilized markets for a while but was criticized by some experts as merely postponing an eventual day of reckoning for U.S. financial firms.
The downfall of 158-year-old Lehman, combined with the unexpected deal by Bank of America to acquire Merrill, marked the most dramatic reshaping of the Wall Street landscape since the Great Depression, analysts said. Lehman, mortally wounded by loss-ridden securities tied to real estate loans, filed Monday for protection from creditors who hold more than $600 billion of the firm's various IOUs.
In its bankruptcy petition, Lehman reported assets of $639 billion and liabilities of $613 billion. It listed 30 unsecured creditors to whom it owes about $158 billion. The markets are likely to remain on edge for weeks, experts said, until the extent of Lehman-related losses at other firms becomes clear.
A collapse of AIG could be an even bigger problem for the country's financial system, Bank of America Chief Executive Kenneth Lewis told CNBC. "I don't know of a major bank that doesn't have some significant exposure to AIG," he said.
Part of AIG's business is to provide a way for big investors to hedge against potential market losses in their portfolios by essentially taking the other side of the investors' bets.