NEW YORK (AP):Wall Street closed higher on Tuesday, partly recovering from its worst dive in years after the Federal Reserve said it was keeping interest rates steady amid a stunning upheaval in the American financial system that sent shock waves through the global market.
The Fed soothed fears of a worsening financial crisis, even as the market waited to learn the fate of troubled insurer American International Group Inc.
Stocks initially slumped on the Fed announcement, with the Dow Jones industrial average dropping by about 100 points. However, in late afternoon trading, the Dow was up then closed up about 141 as investors took heart that the central bank did not believe the economy was in as much trouble as many had feared.
All major market indexes finished higher, including Nasdaq and S&P 500.
Growing strains
In a statement accompanying its decision, the Fed noted the growing strains in the financial markets a day after the Dow Jones industrials plunged 504 points in reaction to continuing turmoil in the financial sector. The Fed also noted the ongoing weakening of the labour market. But it also sought to give some reassurance by saying it expected its policy moves to foster moderate economic growth over time.
Monday's dive came as investors grappled with the failure of Lehman Brothers, one of Wall Street's most venerable banks, and wondered who would be the next to fall. It was the steepest drop since the day the stock market reopened after the September. 11, 2001, attacks.
A person briefed on the talks said Tuesday that British bank Barclays PLC has agreed to buy at least some of Lehman's investment banking and trading operations. This person spoke on condition of anonymity because a final agreement had yet to be reached.
Wall Street was still focused on insurer American International Group Inc, the latest in a string of companies investors are worried could be undone by a shortage of cash. AIG is little known off Wall Street, but does business with almost every financial institution in the world.
The company, which insures US$88 billion worth of assets, plays an outsized role insuring mortgages and corporate loans, but what has Wall Street scared is that it's an integral player in the murky world of hedge funds and credit derivatives.
Investors worry its failure would pose an even greater threat to the US financial system than the collapse of Lehman. AIG stock was down as much as 60 per cent Tuesday.
AIG huddled with Fed officials to find the cash the huge insurer needs to stay in business and avoid igniting more financial turmoil.
Meetings at the New York Fed, which is the Fed's point bank on financial crises, were carrying on into the late afternoon. As talks went on, AIG shares rallied off intraday lows, though investors still remained worried there would be no assistance for the company.
Fed spokeswoman Michelle Smith said she could not make any comment on reports that the Fed was prepared to offer AIG a loan.
Still, shares of troubled banks Washington Mutual Inc and Wachovia Corp recovered as investors grew hopeful that AIG Inc would receive much-needed funding.
The uncertainty follows a tumultuous 24 hours that redrew US finance. Lehman Brothers, which predates the US Civil War and weathered the 1930s Great Depression, filed the largest bankruptcy in American history. A second storied bank, Merrill Lynch, fled into the arms of Bank of America.
Rotten mortgage loans
Monday was by far the most stomach-churning single day since a financial crisis began to bubble up from billions of dollars in rotten mortgage loans that have crippled the balance sheets of one bank after another and landed mortgage giants Fannie Mae and Freddie Mac under the control of the federal government. About US$700 billion evaporated from retirement plans, government pension funds and other investment portfolios.
Internationally, on Tuesday, France's benchmark CAC-40 index and Germany's DAX 30 index of blue chips were both down two per cent, and the FTSE-100 share index was 3.71 per cent lower in London. Earlier, Asian stock markets plummeted, catching up with other markets around the world after a holiday Monday kept Tokyo and Hong Kong bourses closed.
Earlier, the Fed pumped an additional US$70 billion into the financial system to help ease credit stresses
The Federal Reserve Bank of New York's Tuesday action came in two operations in which US$50 billion and then another regularly scheduled $20 billion were injected in temporary reserves.
The cash infusion was designed to help ease a spike in the overnight lending rate between banks. A sharp rise in such borrowing costs makes banks reluctant to lend to each other and to hoard cash, worsening already tight credit conditions. Harder-to-get credit has crimped spending by consumers and business, a factor in the slowing economy.
To help grease the financial plumbing on Monday, the Fed pumped a total of $70 billion into the system through open market operations.
The fallout was far from over as AIG continued its fight to stay alive. New York Gov David Paterson moved Monday to allow the company to tap one of its subsidiaries for an emergency loan to stay above water. Almost US$20 billion in AIG's shareholder value was wiped out Monday.
Late Monday night, all three major agencies - Standard & Poor's, Moody's Investors Services and Fitch Ratings - cut AIG's ratings at least two notches.
Steve Sachs, director of trading at Rydex Investments, contended that the market will not be able to move past its concern about the financial sector until it sees a resolution of its worries over AIG.
"I think the AIG issue needs to get solved and it needs to get solved today," he said.
Treasury Secretary Henry Paulson, who refused to toss a financial lifeline to Lehman, was unapologetic Monday as the Bush administration signalled strongly that Wall Street should not expect more rescues from Washington.
