Credit fears swept Wall Street on Wednesday, pushing the blue chips to their second epic selloff of the week and overshadowing the Fed's emergency takeover of insurance giant American International Group. 

Today's Market

The Dow Jones Industrial Average slid 449.36 points, or 4.06% to 10609.66, the Standard & Poor’s 500 dropped 57.22 points, or 4.71%, to 1156.38 and the Nasdaq Composite lost 109.05 points, or 4.94%, to 2098.85. The FOX 50 fell 36.83 points, or 4.21%, to 838.16.

The losses pushed the Dow to its lowest level since November 2005 and the broad S&P 500 to a reading unseen since May 2005. 

“Just because the government gave an $85 billion life preserver to AIG doesn’t mean everything is fine. If anything, there is more concern. There are significant credit market fears," said Michael James, senior equities trader at Wedbush Morgan Securities. 

Wednesday marked the third consecutive day that opened with a triple-digit plunge, underscoring the level of anxiety that has slammed Wall Street this week. That nervousness led to the 504-point plunge on the Dow on Monday, the largest point decline since the aftermath of the Sept. 11. attacks. Sandwiched in between those losses and Wednesday's was a triple-digit rally on the Dow a day ago. 

The dramatic government takeover of American International Group (AIG) was aimed at avoiding a financial disaster and came just days after investment bank Lehman Brothers (LEH) filed for bankruptcy and financial giant Merrill Lynch (MER) was forced to sell itself to Bank of America (BAC).

“As soon as they put one fire out, another one starts. The degree of nervousness is at an all-time high, certainly [as high as] I've ever seen it,” said Anthony Conroy, head trader at BNY ConvergEx. “In the near-term, it's all fear and greed... But ten days from now when cooler heads prevail you can make a lot of money.”

As a reflection of the anxiety on Wall Street, commodities soared on Wednesday, including the largest one-day surge in gold prices ever and a $6 jump in crude oil prices. The flight to safety was also clear in Treasury prices, which soared. The VIX, which measures market volatility and investor fear, closed at the highest level since October 2002.  

AIG was easily the biggest loser on the Dow on Wednesday, closing down 46%. Citigroup (C) and American Express (AXP) also closed down double-digit percentages. 

The markets weren't helped by a report showing U.S. construction of new homes and apartments plunged last month to the lowest level since January 1991. 

Money-Market Fears 

Wall Street was clearly spooked by developments in the money market after Reserve Primary Fund, a $62 billion money-market mutual fund, fell below $1 a share due to losses tied to Lehman's debt. It was just the second time ever that a money-market fund "broke the buck," or exposed investors to losses. Money-market funds are considered extremely safe and typically offer low interest rates. 

That news, and worries of other fallout from Lehman's bankruptcy, sparked fears banks will stop lending to each other, or do so at an expensive rate. 

On Tuesday, the Libor rate, a widely-watched short-term lending rate, soared in the largest one-day jump on record, according to The Wall Street Journal. Also, the TED spread, another gauge of market stress, widened by to levels unseen since the stock-market crash in 1987. Higher spreads indicate unwillingness by banks to lend to each other.

“Those are the signs of the panic. When the uncertainty is so high, you just take to the sidelines. You don’t lend and it just locks up everything," said Marc Pado, U.S. market strategist at Cantor Fitzgerald. 

AIG's $85B Life Preserver

In the largest government bailout of a private company in U.S. financial history, the Federal Reserve provided AIG $85 billion in emergency loans to save the insurer from bankruptcy. The government provided the loan at a very high interest rate and it was contingent on AIG providing the entire company's assets as collateral. 

Also, the U.S. government received equity warrants that will effectively give the U.S. taxpayers a 79.9% stake in AIG. This action heavily dilutes AIG’s current stockholders but it does not wipe them out completely.

The decision to rescue AIG was a remarkable turnaround from what Treasury Secretary Henry Paulson and other government officials said just days earlier. AIG and its $1 trillion balance sheet has extensive ties to the already battered U.S. financial system. The need to come to AIG's help was caused by the insurer's inability to raise cash, something that was exacerbated after major ratings agencies cut AIG's credit ratings. 

"The federal government determined AIG needed to be rescued and it was too big to fail. That’s something we should be happy about," said Art Hogan, chief market strategist at Jeffries & Co.  

Financials Under Fire

Financial stocks were clearly the biggest drags on the markets on Wednesday, diving almost 10% as a group. 

Most disconcerting, perhaps, was Morgan Stanley (MS), which saw its shares plummet as much as 44% despite reporting significantly better-than-expected earnings late Tuesday, a day earlier than originally scheduled. Goldman Sachs (GS), the only other remaining independent investment bank on Wall Street, briefly fell below $100 a share for the first time since June 2005. 

"I imagine you'll see them (Morgan Stanley) be owned by a bank this weekend. You won't see them fail, but you could see more shotgun marriages," William Smith, president of Smith Asset Management, told Reuters. 

Financial stocks could receive a big boost after the SEC announced new rules aimed at curbing naked short selling, which is a way to bet a stock will go down without borrowing the shares first. The rules take effect Wednesday night. 

Crude Surge

Energy stocks attempted a rally but closed in the red despite oil prices rising sharply. 

After trading with modest gains for much of the day, crude jumped $6.01 to settle at $97.16 a barrel. On Monday, crude closed below $100 a barrel for the first time in weeks. 

Oil prices were pushed higher on Wednesday by a larger-than-expected decline in weekly crude supplies. The Department of Energy said crude stock piles declined by 6.3 million barrels last week, compared to consensus estimates of a more modest decline of 4.8 million barrels. Also, a sharply weaker greenback gave a boost to dollar-commodities like crude oil and gold. 

Data Dump

The day's economic data didn't give traders much of a reason to buy as the government said U.S. construction dove by a much larger-than-expected 6.2% last month. The Commerce Department’s report, which revealed construction fell to the lowest level in 17 years, had been expected to fall a more modest 1.6%.

Corporate Movers

Lehman Brothers (LEH) unloaded its North American investment banking and trading operations to Barclays (BCS), the third-largest U.K. bank, for $250 million. Barclays also agreed to acquire Lehman's New York headquarters and two data centers for an additional $1.5 billion. Lehman is reportedly in talks to sell its investment management business.  

Washington Mutual (WM) fell sharply again after Merrill Lynch cut its price target to $1 from $3 and predicted the nation’s largest savings-and-loan may soon have to sell itself. Merrill said it suspects WaMu’s board would seriously consider an offer, even if it was at a discount to what it believes the company is worth. WaMu’s retail-bank footprint remains attractive to potential suitors, Merrill said.

Lloyds TSB (LYG) is in advanced talks to acquire embattled U.K. mortgage lender HBOS, which confirmed the discussions on Wednesday. Lloyds is the fifth-largest British bank and HBOS has been under pressure due to subprime exposure in the U.S. The takeover discussions have been spurred by the British government, which hopes to avoid a repeat of its nationalization of Northern Rock earlier this year, The Wall Street Journal reported. HSBC (HBC) is not in talks to acquire HBOS, Reuters reported. 

Adobe (ADBE), the maker of Acrobat Reader and Flash software, reported better-than-expected quarterly results. Adobe posted adjusted-earnings of 50 cents per share in the third quarter, beating analyst expectations of 46 cents. The company's revenue rose 4% to $887.3 million, also exceeding expectations. 

Global Markets

For the second day in a row, Russia halted trading on its main stock markets, according to published reports.

Major European indexes closed sharply lower, with the FTSE 100 Index, London’s benchmark index, ending down 113.20 points, or 2.25%, to 4912.40. 

Asian markets were mixed with Hong Kong’s Hang Seng Index tumbling 3.63% to a reading of 17,673.