The Week That Broke Wall Street

A shocking series of events that forever changed the financial markets

Sunday – Trouble Brews

News that Lehman Brothers was on the brink of collapse and scrambling for a buyer first surfaced on Friday. But by Sunday, there were still no suitors for the 158-year-old investment bank, and bankruptcy seemed inevitable. Indeed, just after midnight, in Monday’s early hours, the firm officially announced its intention to file for Chapter 11. Equally as staggering, just hours after reports surfaced that Bank of America broke off talks to buy Lehman, BofA unleashed the news that it would pay $50 billion to scoop up Merrill Lynch, another iconic Wall Street name. As if that weren’t enough, American International Group, the nation’s largest insurer, said that it planned to sell some of its troubled assets in order to raise cash and boost investor confidence. Concerns about the credit crisis grew increasingly dire, even though the government had already pledged to backstop Fannie Mae and Freddie Mac up to $200 billion just one week ago, and months earlier engineered JP Morgan’s purchase of Bear Stearns with a $29 billion guarantee. But it looked like that wouldn’t be enough, so Sunday afternoon the Federal Reserve, along with 10 banks, announced a $70 billion pool of funds to aid troubled financial firms. The U.S. central bank also loosened its lending restrictions.

Monday – The Collapse

As traders sold off stocks on the weekend’s sour news, rumors began to circulate that AIG was struggling to raise enough capital to fend off a downgrade. As a result, New York Governor David Paterson bent intra-corporation lending rules, allowing the company to loan itself $20 billion from a subsidiary. In the worst day on Wall Street in seven years, the Dow Jones Industrial Average tanked more than 500 points after Lehman Brothers’ epic collapse and the buyout of Merrill Lynch. By Monday night, AIG was in fact hit with a downgrade, as Fitch bumped the insurance group down a notch. With $1.1 trillion in assets and 74 million clients in 130 countries, investors feared AIG’s collapse would severely hurt consumers and further tighten already strangled credit. Also Monday, news cropped up that the nation’s largest savings bank, Washington Mutual, was in search of a white knight.

Tuesday – The Fed Steps In

Stocks saw another sharp drop on Tuesday morning as worries mounted that the financial system was broken beyond repair. Investors poured money into bonds, and the yield on the benchmark 10-year Treasury note fell to a 5-year low. Next, several rock-solid money market funds began to falter, dipping below the $1 per share benchmark. Meanwhile the Fed was scheduled to meet on Tuesday afternoon. Wall Street analysts, who just a week ago expected the Fed to hold rates steady, began to anticipate a rate cut. But the central bank chose not to succumb to panic and unanimously decided to hold rates steady at 2%. Markets cheered the decision, and the Dow jumped 140 points at the close. After the bell, British bank Barclays agreed to buy up $2 billion worth of Lehman’s brokerage assets and real estate holdings, and Morgan Stanley reported better-than-expected earnings. But the big news came later that night when the government announced that it would stage a staggering $85 billion bailout of AIG, and take an 80% stake in the company.

Wednesday – Another Free Fall

Investors gave an enormous thumbs-down to the AIG news, sending stocks plummeting, while traders piled funds into safer havens. Gold rose $70, a new record. Oil rose $6, its second-largest jump ever. And the yield on the three-month Treasury sank to 0.02%, the lowest level since 1940. The Dow dropped 450 points by the end of the day, dragged down by bank stocks in a tail-spin. Despite reporting better-than-expected results, Goldman Sachs shares dipped below $100 a share for the first time since 2005. Morgan Stanley took a tumble as well, as rumors circulated that it would merge with troubled bank Wachovia. Many Wall Street analysts blamed the stock market’s collapses on so-called "naked" short sellers, who short stocks without ever buying the security. Subsequently, the U.S. Securities and Exchange Commission stepped in and banned naked short selling.

Thursday – The Bailout

With a crisis on its hands, the Fed convinced five other central banks around the world to invest a total of $180 billion in global financial markets. Meanwhile, AIG was tossed out of the Dow Jones Industrial Average and replaced with food giant Kraft. The stock market soared towards the close of the session, with financial stocks rebounding. The Dow added more than 400 points on rumors that an even more extensive federal bailout of the banking industry was in the making. Investors cheered these early reports that the Treasury would create an independent federal agency to take bad loans off of bank balance sheets. Late Thursday night, Treasury Secretary Henry Paulson met with Congressional leaders to hammer out the details of a large-scale bailout.

Friday – The Confidence Boost

As Wall Street eagerly awaited the details of Secretary Paulson’s plan, the SEC took what it called "emergency action" Friday morning and temporarily banned investors from short-selling 799 financial companies. The Treasury also said it would insure up to $50 billion in struggling money market fund investments at financial companies, guaranteeing that the funds’ value will not fall below the standard $1 a share. The Fed also said it would make unlimited funds available to banks to finance purchases of asset-backed commercial paper from money market funds. In a press conference, Treasury Secretary Paulson outlined the government’s plan to put up hundreds of billions of dollars to help stem the crisis, saying "the financial security of all Americans … depends on our ability to restore our financial institutions to a sound footing." Later, President Bush held a separate press conference, flanked by Paulson, SEC Commissioner Christopher Cox and Fed chief Ben Bernanke, saying it was "essential" that the government step in to save the economy. Investors cheered the moves, sending stocks soaring throughout th e day.

Although the U.S. government had set various bailouts in motion to the tune of roughly $1 trillion, investors finished the week with renewed confidence that Wall Street may be broken – but not beyond repair.