Stocks Plummet on Historic Wall Street Shakeup

Stocks plunged Monday after U.S. government officials let Lehman Brothers (NYSE: LEH) fail rather than stage another financial rescue, and Merrill Lynch (NYSE: ML) agreed to be acquired by Bank of America (NYSE: BAC).

The weekend’s historic shakeup left just two major Wall Street firms standing — Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS) — after a 14-month credit crisis that is shaping up to be the worst in decades for U.S. financial markets. It also left the major stock averages with their worst one-day decline since the aftermath of the Sept. 11, 2001 terrorist attacks.

And it’s not over yet, as insurance giant AIG (NYSE: AIG) is rushing to find funding before it follows suit. No Dow stock has ever filed for bankruptcy in the index’s 111-year history; AIG could be the first if the company can’t boost its financial reserves quickly, and the financial repercussions could make Lehman’s pale in comparison.

Even if AIG can find funding — and it has enough valuable holdings so that remains a possibility — the weekend’s financial market disruption and continued weakness in the housing market will likely set off another round of write-downs and capital raising by financial firms. Indeed, some on Wall Street are calling for suspension of year-old “mark-to-market rules” that require unrealized losses to be accounted for at a fair market value, at least until financial markets stabilize.

It will also take time to unwind Lehman’s derivatives positions, which has set off a scramble for liquidity that led to $70 billion in collateralized loans, or “repos”, from the Federal Reserve today. An AIG bankruptcy would compound those problems.

The biggest question remains how hard the turmoil will hit the real economy, which has already been showing signs of a sharp slowdown in recent weeks. If the Wall Street shakeout curtails lending and credit markets even further, the economy could feel the effects for some time to come.

The turmoil hit the tech sector hard, with the Nasdaq falling 3.6% on the day.

Take-Two (NASDAQ: TTWO) lost a quarter of its value after Electronic Arts (NASDAQ: ERTS) dropped plans to buy the company.

But Naspter (NASDAQ: NAPS) shares soared 86% on news that Best Buy (NYSE: BBY) will acquire the company.

Slowdown fears hit shares of Apple (NASDAQ: AAPL), Research In Motion (NASDAQ: RIMM), SanDisk (NASDAQ: SNDK), Dell (NASDAQ: DELL), Sun (NASDAQ: JAVA), VMware (NYSE: VMW) and Nividia (NASDAQ: NVDA), all of which lost 5% or more on the day.

After the close, HP (NYSE: HPQ) added to the economic uncertainty when it announced it will cut 24,600 jobs as part of its acquisition of EDS (NYSE: EDS).

The Nasdaq tumbled 81 to 2179, the S&P fell 59 to 1192, and the Dow plunged 504 to 10,917. Volume rose to 8.31 billion shares on the NYSE, and 2.72 billion on the Nasdaq. Decliners led by a 33-2 margin on the NYSE, and 25-4 on the Nasdaq. Downside volume was 96% on the NYSE, and 94% on the Nasdaq. New highs-new lows were 22-723 on the NYSE, and 33-346 on the Nasdaq.

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