Lehman Worries Sink Stocks

As Lehman Brothers struggled to raise capital, indexes gave back virtually all of Monday's bailout-fueled gains

by Ben Steverman

Watch the Video…

What Paulson giveth, Lehman taketh away.

Stocks fell Tuesday, virtually erasing the gains from a rally one day earlier prompted by the federal government's takeover of Freddie Mac (FRE) and Fannie Mae (FNM).

A main culprit was Lehman Brothers (LEH). Shares of the investment bank plunged 45% on worries it couldn't raise needed capital. An investment deal with a South Korean state-owned bank was reportedly in doubt.

Also, U.S. pending home sales continued to slide.

On Tuesday, the Dow Jones industrial average fell 280.01 points, or 2.43%, to 11,230.73, following Monday's 290-point rise. The broader S&P 500 index lost 43.28 points, or 3.41%, to 1,224.51. And the tech-heavy Nasdaq composite index dropped 59.95 points, or 2.64%, to 2,209.81.

On the New York Stock Exchange, 28 stocks lost ground for every four in positive territory. On the Nasdaq, the ratio was 23 to 5 negative.

Monday's rally came as the Freddie and Fannie takeover bolstered some investors' confidence by removing doubt about the survival of the two important U.S. mortgage financiers. The plan was announced by U.S. Treasury Secretary Henry Paulson on Sept. 7.

Some technical strategists, however, noted the weakness of Monday's rally and questioned how much investors' moods had really changed. Richard Dickson of Lowry's Report successfully predicted the market reaction. "Chances are [Monday's rally] will be best used as an opportunity for additional selling," he wrote.

Wall Street spent all of Tuesday's session closely watching shares of Lehman Brothers after Dow Jones reported Lehman has ended talks with South Korean government officials. They were negotiating a possible investment by state-run Korea Development Bank in the troubled investment bank. One official declined to say what conclusion had been reached, but another anonymously told Dow Jones that KDB would not be making a deal.

Also Tuesday, S&P Ratings Services placed its ratings on Lehman and all related entities on CreditWatch with negative implications. "We now believe that [Lehman] incurred a substantial net loss" in the third quarter, S&P said. It blamed the company's problems on "persisting difficult conditions in the investment-banking trading markets and write-downs from deteriorating market valuations of its mortgages and mortgage-related securities."

Oil prices fell on Tuesday. On the NYMEX, October crude oil slid $4.23 to $102.11 per barrel. Hurricane Ike weakened and forecasters believe it won't affect most oil production in the Gulf of Mexico. Also, the Saudi oil minister said the oil market is "well-balanced," suggesting the Organization of Petroleum Exporting Countries will not cut production.