Stocks and the U.S. dollar tumbled on Monday as Lehman Brothers was expected to file for bankruptcy, leading to grave uncertainties about other banks and shaken confidence in the financial system, and sending safe-haven Treasury debt and gold prices soaring.
U.S. stock market futures were down more than 3 percent, pointing to sharply lower open, while major European markets were set for falls of between 2 and 3.2 percent, according to one financial spread-betting firm.
The dollar plunged 2 percent against the yen, on track for its biggest daily fall in more than six years, as U.S. investment bank Lehman Brothers looked set on a path to bankruptcy in a massive blow to investors' willingness to take risks.
While a lack of confidence was sucking down Lehman, a lack of short-term funding was hurting one of the world's largest insurers American International Group Inc The firm was asking the Federal Reserve for a bridge loan of $40 billion, according to the New York Times, an unprecedented move that further battered the dollar and knocked down 2-year U.S. government debt yields to a five-month low.
Stock markets in Australia, Singapore and Taiwan all dropped 3 to 4 percent as investors tried to slice off any trace of risk in their portfolios, loading up on investment-grade debt as consolidation in the financial sector sent shockwaves through almost all asset classes.
Holidays in most major Asian markets kept volume thin though price action belied a desire to seek safety first and ask questions later.
"The exact ramifications of the liquidation process and the unwinding of positions pertaining to the Lehman situation remain unclear. Hence, over the next 48 hours at least, financial markets are likely to be volatile and tense," said economists with United Overseas Bank in Singapore in a note.
The Swiss franc and yen, currencies associated with stability in times of duress, strengthened, especially against the dollar, which reeled as some in the market speculated the Federal Reserve may have to cut interest rates on Tuesday to shore up the economy from financial fallout.
The U.S. dollar dropped 2.4 percent against the yen at 105.29 yen on track for the largest daily decline since March 2002. The dollar was off 2 percent against the Swiss franc to 1.1075 francs.
The euro rose by more than a cent against the dollar to $1.4460, up 1.6 percent from late Friday in New York.
In the spot market, gold rose 2.7 percent to $783.95 an ounce.
FED SUPPLIES LIQUIDITY, NOT CONFIDENCE
The Fed on Monday said it would begin accepting equities as collateral for emergency loans for the first time and would as it tried to ease the spiralling crisis.
The steps would likely help surviving financial institutions to find cash but may not do much to boost global confidence in the U.S. financial system.
"The mere fact that they are forced to do this and they may still yet do some more indicates the breadth and depth of the trouble that the system is in," said V. Anantha Nageswaran, head of investment research, Asia-Pacific with Bank Julius Baer in Singapore.
U.S. Treasury yields fell sharply in early Asian trade on Monday and Eurodollars surged as concerns about the stability of the U.S. financial system sparked talk of emergency liquidity measures by the Federal Reserve or even a cut in interest rates after it meets on Tuesday.
The yield on the policy-sensitive two-year Treasury note hit a five-month low of 1.96 percent. The 10-year yield was also at the lowest since April, at 3.57 percent compared with 3.72 percent late on Friday.
"It appears that Lehman will file for bankruptcy and the risk of an immediate tsunami is related to the unwind of derivative and swap-related positions worldwide in the dealer, hedge fund, and buyside universe," Bill Gross, the chief investment officer of Pacific Investment Management Co (Pimco), told Reuters. Pimco oversees more than $812 billion in assets.
Investors may have to adjust their views on the financial sector since the U.S. government refused to back a Lehman deal the way that it did with JPMorgan Chase's purchase of Bear Stearns six months ago. Events seemed to show the private sector will have to sort itself out.
Bank of America is in advanced talks to acquire Merrill Lynch & Co Inc, people briefed on the matter told Reuters.
"Presumably the most important reason to teach Wall Street this lesson is that they will change their behavior, and not take the decisions that are reliant on a public bailout," said Alan Ruskin, chief international strategist with RBS Greenwich in Greenwich, Connecticut. "For many, but not all, this is an impossible lesson to learn in the middle of the worst financial storm since the Great Depression," he said in a note.
Australia's benchmark S&P/ASX 200 index fell 1.4 percent, weighed by shares of the country's top banks such as Commonwealth Bank of Australia and Macquarie Group Ltd
Taiwan's TAIEX, the only stock market open in north Asia, dropped 4.2 percent to the lowest since November 2005.
Singapore's Straits Times index was at the lowest since October 2006, down 3 percent.
"The financial sector in the region is very volatile now and we don't expect investors' confidence to recover quickly in just a few days or one week," said Alex Huang, a vice president at Taiwan's Mega International Securities.
While the fate of the U.S. financial system loomed in investors' minds around the world, initial reports that the passing of Hurricane Ike through country's energy production centre had not severely damaged infrastructure in Texas saw benchmark oil prices fall to a six-month low below $99 a barrel.
Oil fell $2.06 to $99.12 a barrel after falling as low as $98.46 — the lowest since February 26 — adding to a steady downward trend in prices since mid-July's peak of over $147 a barrel as evidence mounts that high energy costs and a weakening economy are cutting into fuel consumption.
