Stocks tumble on economy worries

NEW YORK (Reuters) - U.S. stock indexes tumbled more than 2 percent on Tuesday after Merrill Lynch warned that ailing credit markets will hurt bank profits, while reports showing eroding consumer confidence and falling home prices added to concerns about the economy.

The mood worsened late in the day after the release of minutes from the Federal Reserve’s August7 policy meeting.

The transcript showed growing concern among Fed officials about the housing market and its effect on consumers even before credit market turmoil picked up speed.

Reflecting unease that the fallout from the subprime debacle is spreading, shares of State Street Corp STT.N, the world's biggest institutional money manager, fell 4.3 percent on worries about the company's $20 billion-plus in commitments to asset-backed commercial paper programs.

Meanwhile, British bank Barclays Plc BARC.L denied a report that it has several hundred million dollars of exposure to failed debt vehicles structured by its investment banking arm.

Merrill Lynch MER.N downgraded Bear Stearns Cos BSC.N, Lehman Brothers LEH.N and Citigroup C.N to "neutral" from "buy" and lowered estimates for the banks' earnings due to turbulence in the debt markets, slowing takeover activity and upheaval in the mortgage sector.

“Merrill downgrading the banks and the housing and consumer confidence data were a fundamental package that took us down,” said Jim Paulsen, chief investment officer at Wells Capital Management, in Minneapolis.

And the market “smells of the stuff that hurt us a week or two ago -- rumors of other problems that could emerge,” he said.

The Dow Jones industrial average .DJI skidded 280.28 points, or 2.10 percent, to 13,041.85. The Standard & Poor's 500 Index .SPX dropped 34.43 points, or 2.35 percent, to 1,432.36. The Nasdaq Composite Index .IXIC tumbled 60.61 points, or 2.37 percent, to 2,500.64.

Traders work on the floor of the New York Stock Exchange August 28, 2007. REUTERS/Brendan McDermid

U.S. consumer sentiment took its sharpest plunge in nearly two years during August while home prices swooned in the second quarter, according to reports that show the housing crisis is taking its toll.

The Conference Board’s index of consumer confidence dropped in August to its lowest reading in a year, while a report from S&P/Case-Shiller showed house prices fell 3.2 percent in the second quarter compared with the same period last year. It was their worst decline in 20 years.

Adding to home builders’ woes, a survey by the National Association of Home Builders showed tighter lending standards in recent months have hurt business at two-thirds of the nation’s home builders that were already suffering from burgeoning inventories.

Home builders Centex CTX.N and Lennar LEN.N led the Dow Jones home builders index .DJUSHB down almost 5 percent. Centex dropped 7 percent to $28.15, while Lennar slid 4.7 percent to $27.23.

Stocks of the banks downgraded by Merrill Lynch dropped, with shares of Citigroup falling 3.5 percent to $46.14 on the New York Stock Exchange. Shares of Bear Stearns slid 3.4 percent to $108.42 and Lehman Brothers shed 6 percent to $54.28. The S&P financial index .GSPF followed suit, down 3.2 percent.

Merrill's move came a day after Goldman Sachs GS.N slashed its earnings forecasts on Bear Stearns, Lehman Brothers and Morgan Stanley MS.N.

“All the brokers are downgrading each other, which was a long time coming, but obviously, the market is a little jittery surrounding anything related to that stuff these days,” said Michael Church, senior portfolio manager at Church Capital Management, in Philadelphia.

Shares of State Street Corp, the world’s largest institutional money manager, fell 4.3 percent to $61.16.

Shares of Maxim Integrated Products Inc MXIM.O fell 5.6 percent to $29.39, after Banc of America downgraded the analog chip maker. <ID:nBNG274570>.

Trading was light on the NYSE, with about 1.40 billion shares changing hands, far short of last year’s estimated daily average of 1.84 billion, while on Nasdaq, about 1.58 billion shares traded, also well below last year’s daily average of 2.02 billion.

Declining stocks outnumbered advancing ones by a ratio of about 7 to 1 on the NYSE and by 4 to 1 on Nasdaq.