Fears on Lehman, financials send market into skid

NEW YORK (Reuters) - Stocks plunged on Tuesday, driving the benchmark S&P 500 to its worst day in one and a half years, as concern about Lehman Brothers' ability to raise much-needed capital reignited fears about the broader financial sector.

Energy shares tumbled as oil prices fell more than $3 a barrel to a five-month low, hit by news that Hurricane Ike would veer away from Gulf of Mexico production facilities.

Shares of Lehman, the No. 4 U.S. investment bank, skidded 45 percent and renewed worries about other financial firms' ability to contend with mortgage losses. The S&P financial index fell 6.6 percent.

Lehman's percentage slide was its biggest since it went public in 1994, and fears about its survival doused Monday's optimism on the government's bailout of home finance firms Fannie Mae and Freddie Mac in an effort to boost the slumping housing market.

The S&P 500 shed more than 3 percent, while the Dow and Nasdaq fell more than 2 percent each.

"I think the No. 1 issue today is Lehman. Everybody is starting to ask whether Lehman will be able to raise capital and survive," said Hugh Johnson, chief investment officer of Johnson Illington Advisors in Albany, New York.

"After yesterday's rally, one would have expected some profit-taking today, but it's been accelerated by what's happening to Lehman."

The Dow Jones industrial average was down 279.11 points, or 2.42 percent, at 11,231.63. The Standard & Poor's 500 Index was down 43.15 points, or 3.40 percent, at 1,224.64. The Nasdaq Composite Index was down 59.95 points, or 2.64 percent, at 2,209.81.

Standard & Poor's said the market value of the S&P 500 is down $3.1 trillion from its record closing high hit on October 9, 2007.

Lehman's slide began on news that talks about a possible investment into Lehman from Korea Development Bank had broken down, and it continued after Standard & Poor's rating agency said it could cut the investment bank's credit rating.

Lehman shares ended down 45 percent at $7.79. The slide was marked by a surge in volume, with more than 300 million shares changing hands in composite trading, the biggest volume surge since at least September 2002, said Cleveland Rueckert, market analyst at Birinyi Associates in Stamford, Connecticut.

"Lehman's been rumored to be in trouble for a while, and people were hoping the Koreans might bail them out, but now they're not sure that's going to happen," said Todd Leone, head of listed trading at Cowen & Co in New York.

State-owned Korean Development Bank on Tuesday declined to comment on its talks with Lehman over a possible investment.

Other financial shares also fell. American International Group, the world's biggest insurer, which also has substantial exposure to the mortgage market, fell 19.3 percent to $18.37, making it a top drag on the S&P 500.

HOUSING AND GROWTH WORRIES

A report showing a steeper-than-expected decline in pending sales U.S. homes in July added to the negative tone.

Shares of home builders also fell as the euphoria faded over the federal bailout of Fannie Mae and Freddie Mac.

Luxury home builder Toll Brothers dropped 8.4 percent at $24.26, while the Dow Jones home construction index was off 8.8 percent.

A more than $3 slide in the price of oil to settle at $103.26 a barrel weighed on energy shares, with Exxon Mobil Corp ending down 4.6 percent at $73.26. An S&P energy index fell 6.4 percent.

"The worry is that now when oil goes down the market no longer responds (positively), and that means the lower price is a reflection of global economic weakness," said Johnson.

Investors also sold off shares of big manufacturers, including Caterpillar, down 5 percent at $61.38. The firm is among the bellwethers whose fortunes hinge on domestic and overseas demand.

Earlier, the National Association of Realtors Pending Home Sales Index, based on contracts signed in July, was down 3.2 percent to 86.5 from an upwardly revised index of 89.4 in June.

On Nasdaq, shares of iPod maker Apple Inc were a top drag, falling 4 percent to $151.68. Apple Chief Executive Steve Jobs on Tuesday introduced new iPod nano and Touch music players. He also poked fun at reports of his alleged poor health, saying he's healthy but could stand to gain 10 to 15 pounds.

About 1.69 billion shares changed hands on the New York Stock Exchange on Tuesday, slightly below last year's estimated daily average of roughly 1.90 billion. On Nasdaq, about 2.58 billion shares traded, above last year's daily average of 2.17 billion.

Declining stocks outnumbered advancing ones by about 7 to 1 while on the Nasdaq, decliners beat advancers by about 5 to 1.

(Additional reporting by Ellis Mnyandu and Richard Leong; Editing by Leslie Adler)