Stock fall sharply on Fannie, Freddie worries

Wall Street sank further into a bear market Friday as investors dumped stocks in response to troubles at mortgage companies Fannie Mae and Freddie Mac and oil's continuing climb into record territory. The Dow Jones industrials fell more than 200 points and slid below the 11,000 mark for the first time in two years.

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NEW YORK — Wall Street sank further into a bear market Friday as investors dumped stocks in response to troubles at mortgage companies Fannie Mae and Freddie Mac and oil's continuing climb into record territory. The Dow Jones industrials fell more than 200 points and slid below the 11,000 mark for the first time in two years.

Investors appeared unimpressed by a statement from Treasury Secretary Henry Paulson, who said the government's focus is ensuring that Fannie Mae and Freddie Mac remain as presently constituted to carry out their mission. Some investors had been hoping that the government would announce plans to take over one or both of the companies.

"There are rumors that the Bush administration is willing to essentially take over those two agencies," Mike Walden, an economist at North Carolina State University, said. "That would be a blockbuster announcement."

The government-chartered companies have fallen sharply in recent days on worries about their stability. Wall Street is worried that a collapse of the two financiers would cause further shock to the financial system, and trigger more losses to banks and brokerages with significant holdings of mortgage-backed securities.

"If there's some interruption in the operation of Frannie Mae and Freddie Mac, this could stall people's ability to get mortgages and houses to sell, which of course, is at the root of the problems we have in the economy right now," Walden said.

The well-being of Fannie Mae and Freddie Mac is crucial, because they hold or guarantee about $5 trillion worth of mortgages - roughly half the $9.5 trillion debt of the United States.

"One analyst said they provide the grease for the mortgage market," Walden explained. "They're in place to buy mortgages from banks and then sell them to investors; they enjoy an investment advantage.

"So if they shut down, we could have big, big, big kinds of problems in the mortgage and housing markets."

Walden said he expects that government action to save the companies is only a question "of how much and to what degree." If the federal government took over the companies, then their $5 trillion debt would be added to the national debt.

"One thing this could mean is a bigger national debt and more interest payments from the debt down the road," Walden said.

Fannie Mae and Freddie Mac's troubles are just the latest depressing turn in a year-old credit crisis that shows no sign of ending, disappointing some stock traders who thought just months ago that the worst was perhaps over.

Global banks and brokerages have scrambled to sell assets and raise capital in an effort to offset nearly $300 billion of write-downs linked to the credit crisis. Citigroup Inc. announced Friday it will sell its German retail banking operation to France's Credit Mutuel for $7.7 billion.

Investors also had little reason to shop for bargains Friday because many financial companies are reporting results next week and are expected to announce another round of big write-downs.

Meanwhile, oil continued its ascent on supply concerns. A barrel of oil vaulted to a record above $147, raising more concerns about the weight of higher prices on inflation and in turn, the overall economy.

The confluence of negative news offset a mostly positive quarterly report from General Electric Co. The conglomerate that owns everything from television network NBC to jet engine plants reported second-quarter profits that met analysts' expectations. However, the outlook across its business lines was mixed.

"You have two issues, crude popped back up $10 to $11 in the last few days, and that is causing some concern. The second point is the financial services sector, there is concern and speculation that Freddie, Fannie and Lehman won't be around on Monday. That's obviously causing worry," said Phil Orlando, chief equity market strategist at Federated Investors.

In late morning trading, the Dow fell 224.06, or 2.00 percent, to 11,004.96 after having fallen to 10,980.37. It last traded below 11,000 on July 25, 2006.

Broader stock indicators also skidded lower. The Standard & Poor's 500 index fell 23.29, or 1.86 percent, to 1,230.10, and the Nasdaq composite index fell 36.97, or 1.64 percent, to 2,220.88.

Friday's drop meant Wall Street moved squarely into a bear market, which is defined as a 20 percent drop from a recent peak. At its low today, the Dow was down 22.5 percent from the record high of 14,198.09 it reached in October. The S&P 500 was down 21.6 percent and the Nasdaq fell 22.6 percent.

Oil, meanwhile, extended its move into record territory, rising as high as $147.27. At midday, light, sweet crude traded up $2.44 at $144.09 a barrel on the New York Mercantile Exchange amid tensions between the West and Iran and the potential for attacks on Nigerian oil facilities.

Bond prices fell. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3.88 percent from 3.80 percent late Thursday. The dollar was mixed against other major currencies, while gold prices rose.

Orlando said investors are looking to Federal Reserve President Ben Bernanke and Paulson for guidance.

"It feels like that Friday before the big Bear Stearns/JPMorgan announcement, so you're wondering if Bernanke and Paulson are going to sit around on the weekend trying to figure things out," Orlando said, referring to the near-collapse and subsequent Fed-orchestrated buyout of Bear Stearns.

"It seems all the confidence in the market has dissipated in these key financial services companies. When you talk about too big to fail, the government has to step in to figure out a solution to the Fannie and Freddie confidence issue," he said.

Freddie Mac fell $1.75, or 22 percent, to $6.25, while Fannie Mae tumbled $3.31, or 25 percent, to $9.89 as investors worried about their stability. Piper Jaffray analyst Robert Napoli lowered his price targets on both companies, and said in a note to clients investors should "not be in a position that only two government-sponsored lenders are willing to make mortgage loans and, without them, our economy would collapse."

Lehman Brothers Holdings Inc. fell $3.20, or 18.5 percent, to $14.10 as traders fretted that the No. 4 investment bank will succumb to soured debt.

Citi slipped 41 cents, or 2.5 percent, to $15.87 after saying it will book a $4 billion gain from the sale of its German retail operation. The deal is part of a plan by Chief Executive Vikram Pandit to sell up to $500 billion in assets to help boost profitability.

Investors remain cautious about the entire financial sector, especially ahead of second-quarter reports due next week from major names like JPMorgan Chase & Co. and Merrill Lynch & Co. JPMorgan declined $2.09, or 6.1 percent, to $32.42 and Merrill fell $1.70, or 5.9 percent, to $27.01.

In economic news, the United States' trade deficit narrowed in May as exports - including industrial supplies and consumer goods - climbed to all-time highs. The Commerce Department said growing exports drove the trade gap down to $58.8 billion, a 1.2 percent decrease from April and the best showing since March.

Investors did get a better-than-expected reading on consumers. The Reuters/University of Michigan Consumer Sentiment index rose to 56.6 for July from 56.4 in June. It had been expected to decline.

Declining issues outnumbered advancers by about 4 to 1 on the New York Stock Exchange, where volume came to 722.6 million shares.

The Russell 2000 index of smaller companies fell 7.04, or 1.04 percent, to 663.46.

Overseas, Japan's Nikkei stock average fell 0.21 percent. Britain's FTSE 100 fell 1.54 percent, Germany's DAX index declined 2.41 percent, and France's CAC-40 fell 3.09 percent.