By Renae Merle

Washington Post Staff Writer

Wednesday, September 17, 2008; 4:30 PM

U.S. stocks swooned more than 400 points today as nervous investors turned their attention from the government's seizure of American International Group to what firms are still in danger -- in particular major banks that seemed secure just days earlier.

The Dow Jones industrial average closed down more than 449 points, about 4 percent, at 10,610. The technology-heavy Nasdaq lost 109 points, nearly 5 percent of its value, to end the day at 2,099. And the Standard & Poor's 500-stock index fell 57 points, 4.7 percent, to 1,156.

Investor jitters persisted despite a government deal to loan AIG, the country's largest insurer, $85 billion and keep it from bankruptcy, and they grew on concerns about banks' growing unwillingness to lend to one another.

"Banks are hoarding their cash; that is a scary position as well," said Art Hogan, chief market analyst at Jefferies & Co, adding that such reluctance is contributing to investor anxiety. "Some worry about what is today's disaster going to be."

Even after reporting better than expected earnings results Tuesday, Goldman Sachs and Morgan Stanley, the two remaining large investment banks, have not been able to remove doubt about their stability. Goldman fell 19 percent in afternoon trading, and Morgan Stanley was down 31 percent.

Investors "are worried there is a lot more out there," said Robert MacIntosh, chief economist for Eaton Vance in Boston. "What other firms are going to collapse?"

At the White House, press secretary Dana Perino said positive and negative developments have led to "challenging times" for the U.S. economy.

"It's not clear-cut, in terms of all the -- is it all positive, is it all negative," Perino told reporters at the daily press briefing. "There's a mixed picture. But we do have the strength to be able to deal with it."

During the briefing, Perino also addressed the question of why Bush, an avowed free-market advocate, has now presided over a series of unprecedented federal bailouts with the backing of taxpayer money, including the takeovers of mortgage giants Freddie Mac and Fannie Mae and the rescue of AIG.

"I can understand why a lot of Americans would be confused as to why this company and not another company," Perino said. ". . . The president's economic advisers had determined that there were some -- some of these companies were so big that to allow them to fail would have caused even greater harm and damage to the economy."

The Federal Reserve effectively nationalized AIG yesterday by agreeing to a loan in exchange for nearly 80 percent of the company's stock. Although the loan might help ensure the company's survival, it gives the U.S. government control of the majority of its stock -- diluting the value of the shares held by current investors.

The lesson for investors is stark, said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, N.J. "If this is the new way of doing things, then you better be very careful about which institutions you own because if you are an equity owner you very well could get wiped out," he said.

AIG's stock fell 45 percent today to close at $2.05. The company's shares have lost most of their value during the past year, falling from a high of $70.13.

"This takeover of AIG forestalls, to some extent, the recent dangerous escalation of the crisis in the U.S. financial markets," Brian Bethune, chief U.S. financial economist for Global Insight, said in a research note. "However, the risks to the financial system and the economy remain massive, and downward pressure on financial asset prices -- and the value of their underlying collateral -- continues to mount."

AIG's near demise was just the latest in a series of fast-moving events that have reordered Wall Street and prompted governments and central banks around the world to act in hopes of steadying both the world financial system and their own markets. It follows the bankruptcy of Lehman Brothers Monday and a quick deal by Bank of America to buy Merrill Lynch for $50 billion, which sent tremors through global financial markets. The U.S. Treasury also announced today that it will expand its bond issues on behalf of the central bank to help finance the AIG deal.

Many banks are now charging high rates to lend to each other, and some institutions have closed their windows altogether -- a sign of how tight borrowing has become. The benchmark overnight lending rate for these banks, called the London interbank offered rate, or Libor, nearly doubled to 6.4 percent, the highest jump on record.

"The magnitude of what we're seeing today has never happened," said Hogan.

Investors appear to be running for safe ground. After tumbling earlier this week, oil prices shot up $6 a barrel today, or 7 percent, to $97.16 on New York Merchantile Exchange. The price of gold went up $88 today to $869 per troy ounce, the biggest one-day gain ever in dollar terms, according to Associated Press. "Fear. Fear of inflation," said Joseph Brusuelas, chief U.S. economist of Merk Investments LLC. "When gold jumps up like that it tells you that people are profoundly worried."

At the center of the current economic turmoil is the troubled housing market where rising foreclosure rates have resulted in growing losses for Wall Street. Commerce Department data released today indicated that the crisis is continuing.

Home construction fell 6.5 percent in August to 895,000 units, the slowest building pace since January 1991, according to Commerce Department data. It is down 33.1 percent compared to the same period a year ago.

"We're dealing with a level of construction we haven't seen in two decades," said Mike Larson, a housing analyst with Weiss Research Inc. based in Jupiter, Fla.

Builders are slowing new home construction to help sell off the homes already languishing on the market as they compete with foreclosure properties for buyers.

The continuing housing slump adds to the worries about the U.S. economy, which have been exacerbated by the upheaval in the financial sector, analysts said. Given current market conditions, for example, it could become more difficult for builders to secure loans, said Brusuelas. "Not only that, loans that they thought they had may not be consummated," he said. "Plans to build may be scaled back. That is a negative on the aggregate economic output going forward."

Meanwhile, at a House Financial Services Committee meeting today, Sheila Bair, chairman of the Federal Deposit Insurance Corporation said efforts to prevent foreclosures are essential to economic stability and should expand now that the government has seized control of Fannie Mae and Freddie Mac. "Minimizing foreclosures is important to the broader effort to stabilize global financial markets and the U.S. economy," Bair said in a prepared testimony.

In August, the FDIC said it would systematically restructure thousands of loans held by failed bank IndyMac. So far, about 1,200 of the 7,400 homeowners that been offered new loans have accepted, lowering their payments on average by more than $430 a month, Bair's statement said.

Those efforts could be expanded to includes loans owned by Fannie Mae and Freddie Mac, which have faced mounting losses. The government took control of the firms, which buy loans, last week. Regulators can now take review the loans to see which can be modified, she said.

"Our hope is that the program we announced at IndyMac Federal will serve as a catalyst to promote more loan modifications for troubled borrowers across the country," Bair said.

Staff writers David Cho and Dan Eggen contributed to this report.