NEW YORK/WASHINGTON (Reuters) - Fear-driven selling sent U.S. stocks plummeting to five-year lows on Thursday, the eve of a G7 meeting of economic powers to try to halt a global spiral of financial distress and slowing growth.
The Dow dived below 8,600 for the first time since May 2003 and the S&P 500 dropped 7 percent as credit markets buckled. Both the Dow and S&P 500 have now lost more than 20 percent over a seven-day down streak.
“The market is in a phase now that it doesn’t believe in anything,” said Sasha Kostadinov, a fund manager and analyst for Shaker Investments in Cleveland, Ohio. “I don’t know what will turn the sentiment.”
Both the U.S. and Dutch governments readied public funds to shore up the capital of banks, matching a similar move a day earlier by Britain.
At the center of a financial crisis now almost a month old, credit markets remained in deep distress. With banks desperate to protect capital, the interbank cost of borrowing dollars rocketed. Three-month interbank rates for dollar loans hit their highest level of the year.
The U.S. Treasury plans to start injecting capital in U.S. banks as soon as this month, according to a financial policy source familiar with Treasury Secretary Henry Paulson’s thinking.
That partial nationalization of American banks would represent an enlarged role for the U.S. government as the lender and investor of last resort.
The Dutch government also announced it was setting aside 20 billion euros ($27.5 billion) of capital to protect banks and said other European governments were planning similar measures.
The punishing decline in U.S. stocks added to pressure on policy makers to do more to stem the crisis -- even after approval of a $700 billion U.S. bailout fund and an emergency rate cut by central banks over the past week.
At its Thursday close of 8,579, the Dow Jones industrial average had lost 39 percent over the past year.
U.S. stocks have now lost $2.3 trillion this week and $8.3 trillion over the past year, according to the Dow Jones Wilshire 500, the broadest measure of U.S. equities available.
“It’s a self-feeding frenzy -- you go to sleep and hear Japan is down, you wake up and hear Europe is down, then you come in to work and markets here are down,” said Thomas Russo, partner at Gardner Russo Gardner.
There was no sign of an end to that grinding cycle of loss. Nikkei futures that are traded in Chicago closed down 7 percent from their close Thursday in Osaka. European stocks had lost more than 2 percent on Thursday.
“This is not the bottom yet. We need to have more bad news discounted in the marketplace, we need to officially hear we are in a recession, we need to have better visibility on company earnings and the credit market needs to show signs of relief before things get better,” said Keith Wirtz, chief investment officer of Fifth Third Asset Management.
Earlier, South Korea and Taiwan cut interest rates on Thursday following the coordinated cuts on Wednesday by major central banks including the U.S. Federal Reserve. Japan was considering other measures in the face of new recessionary signals.
Finance ministers and central bankers from the Group of Seven major industrial nations will meet in Washington on Friday amid expectations that the group will present a united front on policy to contain the crisis.
“Various countries have done bits and pieces. Nobody has done all of them,” said David Mackie, head of Western European economic research at JPMorgan.
“It’s not entirely obvious that these measures are turning the tide,” Mackie said. “At the end of the day, if you socialize enough of the financial system, it has to work.”
The Treasury’s bank recapitalization plan was an option included in the $700 billion rescue plan approved last week in which the government will buy bad loans from financial institutions in the hope that it will jump-start lending.
Until now, U.S. policy has focused on a contentious plan to buy up distressed assets from banks. But many analysts have said that a U.S. government move to shore up the capital position of hobbled banks would be a more direct way to break the logjam in credit markets that has shut down new borrowing for consumers and businesses.
The United States would be following the lead of Britain, which said on Wednesday it was prepared to inject 50 billion pounds ($87 billion) of taxpayer money into its banks.
In a sign of the escalating pressure on banks, direct borrowing from the Federal Reserve climbed to a record for a second straight week and has averaged $420 billion per day.
U.S. financial stocks also came under withering pressure. The S&P financial index dropped almost 12 percent.
In a resolution to talks that have included U.S. bank regulators, Citigroup said it had abandoned talks to divvy up the assets of Wachovia Corp with Wells Fargo.
Citigroup, Wells Fargo, and the Federal Reserve have been negotiating over the future of Wachovia, a regional bank hobbled by the credit crisis.
Citigroup agreed at the beginning of last week to buy Wachovia’s banking assets for about $2.2 billion with partial government assistance. But Wells Fargo on Friday said it had an agreement to buy all of Wachovia in an all-stock deal worth about $15 billion at that time.
Shares of both Wachovia and Citigroup bounced 15 percent in after-hours trade as a resolution to the contested deal after a week of uncertainty and legal skirmishing appeared near.
Earlier, shares in General Motors Corp shares fell to their lowest level since 1950 as concerns mounted that an industry decline that started in the United States was spreading to faster-growing markets overseas. The 31 percent drop in GM shares added to the gloom about a recessionary spiral in the U.S. economy.
“Part of it is continual fear of economic contraction, which is driving deflationary fears, and you take down General Motors and people are looking at the ripple effect,” said Greg Orrell, portfolio manager of the OCM Gold Fund in Livermore, California.
Additional reporting by Reuters bureaus around the world; writing by Kevin Krolicki; editing by Brian Moss, Steve Orlofsky, Gary Hill