Concerns that financials will need to raise fresh capital and again dilute their shareholders translated into sharp falls in the price of Fannie Mae and Freddie Mac, the government-charted buyers of mortgages.
The brittle mood was also fanned by Fitch Ratings warning that it might cut the credit rating for Merrill Lynch based on the anticipation of a fourth consecutive quarterly loss.
The S&P 500 closed down 2.3 per cent at 1,244.69 to settle in bear market territory, having fallen more than 20 per cent from its record high on October 9 2007. Ahead of many banks reporting their second quarter earnings this month, the S&P financials index slumped 5.2 per cent and the investment banking index fell 6.1 per cent.
The picture was markedly different in Europe, where the FTSE Eurofirst 300 index rose 1.7 per cent with a sharp strengthening of banking stocks following remarks on Tuesday by Ben Bernanke, the Federal Reserve chairman, on extending support for investment banks.
In London, the FTSE 100 was up 1.6 per cent.
The slump in US financials captured the attention of bond investors, prompting a flight to quality that pushed the yield on the two-year Treasury note to a low of 2.37 per cent from a high of 2.54 per cent yesterday.
The selloff saw Fannie and Freddie’s shares fall by 13.8 per cent and 26 per cent respectively. Merrill fell more than 9 per cent.
Freddie’s stock price briefly fell below $10 for the first time since 1992. Concerns surrounding the two companies forced Fannie to pay record interest rates to issue new two-year debt yesterday.
On Monday, Fannie and Freddie fell by as much as 18 per cent and 23 per cent respectively at the peak of a sell-off sparked by comments from a Lehman Brothers analyst who said an accounting change could, in theory, force the two biggest US mortgage financiers to raise an additional $75bn in capital.
The selloff continued on Wednesday in spite of attempts by the companies’ regulator on Tuesday to reassure investors that the two companies would be likely to be exempt from the rule, comments which had initially prompted a brief recovery rally on Tuesday.