Stocks tumble on financial woes

Stocks tumbled Tuesday afternoon, as relief about the government rescue of Fannie Mae and Freddie Mac vied with worries about a slowing global economy and the outlook for Lehman Brothers.

The Dow Jones industrial average (INDU) lost 0.6%, the Nasdaq composite (COMP) lost 0.7% and the Standard & Poor's 500 (SPX) index lost 1.3% with about 2-1/2 hours left in the session. All three major gauges had been on both sides of unchanged in the early morning, before turning soundly lower near midday.

In part, the day's decline was in reaction to the previous day's huge rally, when the Dow jumped 290 points after the government bailout of Fannie and Freddie.

"I think the initial market reaction was a relief rally or a reduction in uncertainty, but now we have a bit of a correction as investors are going through the fine print and the euphoria is fading," said Darin Pope, chief investment officer at United Advisors of Secaucus.

He said Tuesday's market response was a bit of a reality check.

"It's the day after, and yes, the ability of the consumer to get a mortgage is better," he said. "But the economy is still struggling, the consumer is still strapped and we still have more work to do on the housing and credit market mess."

A weak read on pending home sales in July demonstrated the persistent weakness in the housing market, while Lehman Brothers' battering reminded investors that the credit crisis is far from over.

Meanwhile, regional banks and insurers tumbled in the wake of the government takeover of the two mortgage giants. (Full story).

Financials get hit: Lehman Brothers (LEH, Fortune 500) skidded 34% on reports that talks with the state-run Korea Development Bank have ended, putting to rest bets that KDB could buy as much as a 25% stake in the troubled bank.

The stock has been sliding of late as investors worry about the brokerage's ability to raise capital, and whether it can sell some or all of its operations. Lehman has also been struggling in the shadow of Bear Stearns, which the government had to rescue early this year, and in the wake of Fannie and Freddie.

Lehman is a different situation than Bear Stearns in that it has more value, said Thomas Nyheim, portfolio manager at Christiana Bank & Trust Company, whereas with Bear Steans, the bad loans engulfed all of their other assets. But although the circumstances are different, the concerns are similar.

Additionally, Lehman is suffering in the wake of Fannie and Freddie because while the government intervention helped the mortgage giant's bonds, the stocks have been tumbling. There may be a similar bet about Lehman, he said.

"The thought is if the Fed comes in and takes action, Lehman bonds might be OK, like Fannie and Freddie, but Lehman equity holders are going to get hit," Nyheim said.

Among other financial stocks falling, Washington Mutual (WM, Fortune 500) lost 19%, AIG (AIG, Fortune 500) lost 12%, Wachovia (WB, Fortune 500) lost 9%, Merrill Lynch (MER, Fortune 500) lost 6%, Citigroup (C, Fortune 500) lost 4% and American Express (AXP, Fortune 500) and JP Morgan Chase (JPM, Fortune 500) each lost 3%.

The broad Philadelphia Bank sector index dropped 2.8% and the Amex Securities Broker/Dealer index tumbled 6%

Fannie Mae (FNM, Fortune 500) shares rallied after plunging in the previous session, while Freddie Mac (FRE, Fortune 500) continued its decline.

Economic reports: The number of pending home sales fell 3.2% in July after rising in June, according to a report from the National Association of Realtors released Tuesday. The report is a forward-looking indicator of the housing market, tracking contracts signed during the month. (Full story).

Wholesale inventories rose 1.4% in July, according to a government report released Tuesday. That topped forecasts for an increase of 0.7%, according to a consensus of economists surveyed by Briefing.com. June wholesale inventories rose a revised 0.9%.

Meanwhile, federal officials warned Tuesday that the budget deficit will be substantially higher this year, rising $246 billion to $407 billion, reflecting the tax rebates and an increase in spending. (Full story).

Fannie and Freddie: The Bush administration said Sunday that it was taking control of the two companies in an attempt to help stabilize the battered housing market and bring down mortgage rates.

The plan included putting the companies under a government conservatorship, and replacing both chief executives. Additionally, the Treasury Department will put up to $100 billion in each company to keep them afloat, in exchange for senior preferred stock. (Full story)

The two government-sponsored firms own or back about half the mortgage debt in the country and have lost billions in the housing market collapse. The plan should lower mortgage rates by lowering Fannie and Freddie's borrowing costs.

There's a certain level of risk that's been taken out of the market as a result of this plan, said Tom Sowanick, chief investment officer at Clearbrook Financial, but that doesn't mean it can stabilize the housing market.

(Why the bailout is not a quick fix for the economy)

What is more likely is that the plan means that "Wall Street will, at least for a while, be on good behavior," he said.

Companies will need to create structured products that will work, and there will be new regulation that will help better protect the investor, he said. "The way companies manage risk is going to be on the front burner for quite some time."

Company news: Dell (DELL, Fortune 500) founder Michael Dell bought $100 million of Dell shares last week, it was announced after the close of trade Monday. Shares of the PC-maker slipped in the afternoon, giving up morning gains.

McDonald's (MCD, Fortune 500) said August sales at its stores open a year or more rose 8.5% in the month, topping forecasts. Shares gained 2.5%.

Market breadth was negative. On the New York Stock Exchange, losers beat winners by three to one on volume of 800 million shares. On the Nasdaq, decliners topped advancers by eight to five as 1.37 billion shares changed hands.

Fuel prices: Oil prices fell as investors awaited the conclusion of an OPEC meeting in Vienna, in which it is expected that the cartel will hold production levels steady despite the recent price slide.

Also impacting oil prices: signs that Hurricane Ike is weakening and is less likely to cause severe damage to oil facilities in the Gulf of Mexico, which accounts for about 25% of U.S. oil production. (Full story).

U.S. light crude oil for October delivery slid $1.82 to $104.52 a barrel on the New York Mercantile Exchange.

Prices have fallen more than $40 a barrel from a record high of $147.20 in July, on bets that a sluggish global economy is cutting into demand.

Gas prices declined for a ninth straight day, according to a national survey of credit-card activity.

Other markets: In global trade, European and Asian markets both ended lower.

In the bond market, Treasury prices rallied, lowering the yield on the benchmark 10-year note to 3.61% from 3.67% late Monday. Prices and yields move in opposite directions.

The dollar fell versus the euro and the yen.

COMEX gold for December delivery fell $11.50 to $791 an ounce.