Stocks Plunge, with Dow Falling Below 7,000

Major indexes tumbled 4% or more Monday in another dismal session, paced by a record loss at AIG and downbeat comments on the economy from Warren Buffett

By Will Andrews

U.S. stocks closed sharply and broadly lower Monday, depressed by investors' ongoing worries about the global economy and financial sector. News of a record loss from American International Group (AIG) and downbeat comments from investing icon Warren Buffett sparked the latest round of selling.

Monday's slump sent the Dow Jones industrial average below the 7,000 level for the first time since 1997. Other key market indexes were at multi-year lows as well, with the S&P 500 index barely holding above the 700 level.

On Monday, the 30-stock Dow Jones industrial average lost 299.64 points, or 4.24%, to 6,763.29. The broad S&P 500 index shed 34.27 points, or 4.66%, to 700.82. The tech-heavy Nasdaq composite index was lower by 54.99 points, or 3.99%, at 1,322.85. Sentiment was overwhelmingly negative, with 29 stocks lower in price on the New York Stock Exchange for every two that gained. Nasdaq was breadth was 24-3 negative.

Treasuries were higher, as was the dollar index, on flight to safety buying. Gold futures fell. Crude oil futures slumped on demand worries.

The seemingly unending stream of bad news from the financial sector continued Monday. This time, it was word that American International Group (AIG) posted the largest loss in U.S. corporate history -- red ink amounting to $61.7 billion -- and will receive $30 billion in government aid.

Meanwhile, legendary investor Buffett said the U.S. economy is in a "shambles"; his Berkshire Hathaway (BRKA) operating company posted a huge fourth-quarter loss.

The deepening recession and Buffett's comments on the economy "lead S&P to believe [the] bear market has a way to go," according to a note on S&P MarketScope.

Richmond Fed President Lacker Monday questioned the efficacy of government lending programs, and especially the use of the Fed's balance sheet, amid the recession and credit crisis. He said he believes the Fed should focus on monetary policy and separate that from credit policy, and thus should transferring the authority for most government lending to the Treasury. That would help the Fed's independence, and would also help Congress legislate a framework for a government safety net, he said.

Boston Fed President Rosengren said troubled assets should be removed from balance sheets as soon as possible, as banks holding them on their books focus on avoiding further losses, which depletes capital. He also warned that governments are not the best managers of bad assets and says that we need to make banking problems less pro-cyclical, potentially modifying policies related to loan loss reserves.

Investors paid little heed Monday to some better than expected economic reports: January personal income rose 0.4%; personal consumption surprisingly rose 0.6%; the nation's savings rate rose 5.0%; and the ISM manufacturing index rose to 35.8 from 35.6. February construction spending fell by a more than expected 3.3% to a five-year low.

American International Group, the insurer deemed too important to fail, will get as much as $30 billion in new government capital in a revised bailout after posting a record $61.7 billion fourth-quarter loss, Bloomberg reported. The loss widened from $5.29 billion in the year-earlier period, the New York-based insurer said in a statement. The government will also exchange its $40 billion in preferred stock for new shares that "resemble common equity," the Treasury and Federal Reserve said. AIG was paying a 10% dividend on the preferred stock.

In addition to providing up to $30 billion in additional capital to AIG in return for preferred stock, the Treasury said it would convert its existing $40 billion of preferred shares into new preferred shares that more closely resemble

common stock. The Wall Street Journal said under the new terms, the Treasury is to get a 77.9% equity interest via preferred stock.

"The company continues to face significant challenges, driven by the rapid deterioration in certain financial markets". The additional resources will help stabilize the company, and in doing so help to stabilize the financial system," the Treasury and Federal Reserve said in a statement. The steps by the Treasury will be coupled with changes to the Fed's existing $60 billion resolving credit facility for AIG. The Fed and the New York Fed plan to take up to a $26 billion preferred interest in two AIG life insurance subsidiaries -- American Life Insurance and American International Assurance -- as well as make $8.5 billion in new loans to benefit the domestic life insurance subsidiaries of AIG. In addition, the interest rate on the existing credit facility will be modified to reduce the existing floor. The Fed and Treasury said steps are meant to provide "tangible evidence" of the government's commitment to an orderly restructuring of AIG, and that the cost of not helping the company was judged to be too high.