Dow Drops 411 Points After Paulson Changes Bailout Plan

Wall Street had a bad reaction to Paulson's statement that the bailout funds won't be used to buy illiquid assets. Sales figures from Best Buy also worried investors

By Karyn McCormack and Ben Steverman

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Wall Street got some promised financial relief yanked away by Treasury Secretary Henry Paulson, sending stocks sharply lower on Wednesday. Paulson urged expansion of TARP funds, but said that money won't be used to purchase illiquid mortgage-related assets of financial institutions as originally planned.

This news gave jittery investors even more reason to keep selling stocks. The major indexes were already deep in the red before Paulson's morning announcement on news that retailers Best Buy (BBY) and Macy's (M) continued to show strain from the weak economy. Traders were also watching the fate of U.S. automakers being decided in Washington.

Selling picked up in the last half hour of trading on Wednesday. The Dow Jones Industrial Average finished down 411.30 points, or 4.73%, to 8,282.66. This level is still above the Dow's trading low of 7,773.71 on Oct. 10, and its recent closing low of 8,175.77 on Oct. 27.

The broad S&P 500 index fell 46.65 points, or 5.19%, to 852.30. And the tech-heavy Nasdaq composite dropped 81.69 points, or 5.17%, to 1,499.21.

In a major change, Paulson said the $700 billion government rescue program will not be used to purchase illiquid mortgage-related assets of financial institutions. He said the administration will continue to use $250 billion of the Troubled Asset Relief Program (TARP) to purchase stock in banks as a way to bolster their balance sheets and encourage them to resume more normal lending. He said the Treasury Dept. was considering a second round of capital injections to match private injections.

"He basically came out and said [buying troubled assets] was a bad idea," says Peter Cohan, author and management consultant at Peter S. Cohan & Associates in Marlborough, Mass. "I thought it wouldn't work because of the challenges of setting the prices of the troubled assets." Under the original rescue plan to purchase bad assets, there was no way to set a price that works for the taxpayer and the banks - so it was a nonstarter to begin with, Cohan says.

The Treasury has just $60 billion left in its rescue fund, and either the current or next administration will have to turn to Congress to request the second half of the promised $700 billion, according to the Wall Street Journal. So far, the Treasury has committed $250 billion to banks and is spending an additional $40 billion to buy preferred shares in American International Group (AIG), the WSJ reports.

The lingering worries about a recession aren't going away anytime soon and are likely to keep pressuring stock prices. Cohan notes that the market has gone from a volatile one with a lot of ups and downs to just big downs. "It's just maximum selling every day," he says.

Cohan notes that many hedge funds and endowments continue to dump stocks. "There's just a lot of big institutional selling pressure," he says, while smaller investors are already out of the market.