NEW YORK/LONDON (Reuters) – Shares of Wall Street firms Morgan Stanley and Goldman Sachs plummeted on Wednesday and the UK’s biggest mortgage lender, HBOS Plc, looked set to be bought in the latest signs of financial industry distress.
Tuesday’s $85 billion rescue of insurer American International Group by the U.S. Federal Reserve did little to calm investor nerves.
The move capped a week of bailouts, a bankruptcy on Wall Street, and central banks around the world flooding the financial system with money to prevent it from seizing up.
The result: a seismic shift in the financial industry, with some of Wall Street’s biggest names disappearing overnight.
But investors remained spooked, and U.S. stocks dropped as much as 3 percent in morning trading.
“The fear is who is next,” said John O’Brien, senior vice president at MKM Partners LLC in Cleveland. “It almost feels like people scour the books and say who is the next likely target that we can put a short on, and that spreads continuous fear.”
In the latest sign of regulatory anxiety, the U.S. Securities and Exchange Commission tightened enforcement of rules against abusive short-selling, or investor bets on declining share prices.
Shares of Morgan Stanley and larger rival Goldman and fell as much as 42 percent and 22 percent, respectively, even after both reported better-than-expected quarterly earnings on Tuesday.
“I’m assuming that Goldman Sachs and Morgan Stanley are lining up dancing partners. They don’t want to be … this week’s victim,” said William Larkin, fixed income manager at Cabot Money Management in Salem, Massachusetts.
The cost of protecting their debt spiked, reflecting investor fears that their debt issues are no safer than junk bonds. Both are currently rated investment grade.
“The credit crunch and credit contraction is intensifying,” said Peter Boockvar, equity strategist at Miller Tabak & Co in New York. “The action in Morgan Stanley in light of what was better-than-expected numbers last night is disconcerting.”
Other signs of distress had emerged earlier: The cost of borrowing overnight dollars spiked above 10 percent, indicating a deep lack of trust spooking the inter-bank lending market in Europe.
And Bank of Ireland became the latest bank to cut its dividend, causing a sell-off in Irish banking shares.
PROPPING UP THE SYSTEM
British bank Lloyds TSB was in advanced talks to buy domestic rival HBOS Plc to create a 28 billion pound ($50 billion) mortgage giant, marking another chapter in a dramatic financial industry shake-up.
The talks underscore how quickly authorities around the world are ditching long-held beliefs about free markets and competition as they seek to counter the credit crunch.
Lloyds, for example, was previously blocked from buying a smaller mortgage bank.
Then there was the shock British government decision in February take over troubled bank Northern Rock — the first major nationalization in Britain since the 1970s.
U.S. authorities also have moved to prop up the financial system.
The AIG rescue comes just over a week after the bailout of mortgage finance companies Fannie Mae and Freddie Mac, and six months after the Fed brokered the sale of failed investment bank Bear Stearns to JPMorgan Chase
AIG’s bailout brings to about $900 billion the total of U.S. rescue efforts to stabilize the financial system and housing market. Authorities may get much of that money back — if asset prices don’t slide further.
The week already saw two legendary firms bite the dust, with Lehman Brothers Holdings Inc’s filing for bankruptcy and Merrill Lynch throwing itself into the arms of Bank of America.
British bank Barclays Plc gave Wall Street a small boost on Tuesday by agreeing to buy Lehman’s Manhattan headquarters and investment bank for $1.75 billion and taking aboard 10,000 staff.
YARD SALE AT AIG
AIG’s newly appointed chief, former Allstate CEO Edward Liddy, was poised to hold a big yard sale to pay off the $85 billion loan from the Fed. There are plenty of interested bidders, AIG’s main regulator told business television channel CNBC.
AIG, which has businesses ranging from life insurance to airplane leasing in 130 countries, has a big incentive to raise cash: It is currently paying more than 11.4 percent interest on the loan.
Japan’s cash rich insurers and Australia’s top player are seen as potential buyers are among the potential; buyers analysts and fund managers said.
“Its a no-brainer,” said CLSA analyst Yuin Lim in Hong Kong. “If you have a non-growing mature market, excessive capital, you have a big war chest there.”
AIG faced a cash crunch after $18 billion of losses over three quarters, largely because of complex securities that are tied to mortgages, and which plunged in value as the nation’s housing crisis deepened.
AIG’s lifeline was meant to prevent a deepening of the credit crisis and sooth investors. The rescue kept AIG from surpassing Lehman as the largest corporate failure ever.
“Thank God,” exclaimed Daniel Fuss, an influential bond manager who oversees more than $100 billion at Loomis, Sayles & Co in Boston late Tuesday. “AIG is interwoven with so many people and touches many companies around the world.”
By Jack Reerink and Douwe Miedema
(Additional reporting by Jeffrey Hodgson and Kevin Plumberg; Editing by Ted Kerr and John Wallace)