Geoff Rogow reports:

Black Monday 2008 could have been even darker without the specialists.

Proponents of open-outcry trading say that specialist market-makers on the New York Stock Exchange, faced with a flood of selling orders late Monday, took the buy side or aggressively solicited for buyers on several large financial companies that were selling off. By assuming the role of buyers or soliciting them, these specialists may have helped limit losses at the bell.

In this solicitation, specialists that represent some financial companies said they would take buy orders in a late crossing session - a move that helped create a floor to some of the selling and kept an even bigger decline from occurring.

“If this was purely electronic, it could have been down 1200 or 1300 on the Dow,” said Bernie McSherry, a senior vice president with Cuttone & Co., the largest independent floor operator at the NYSE.

For the session, the Dow lost more than 777 points as the defeat of a proposed $700 billion bailout package in the U.S. House of Representatives sent traders scrambling. At many Wall Street companies, traders reacted to live footage of the vote count on the floor of Congress around 2 p.m. EDT with heavy selling.

Going into the 4 p.m. close, brokers on the NYSE floor say specialists published huge sell imbalances in many financial names, but were actively looking to find buyers. Specialists surveyed their books to find brokers that had purchased the financials on their books at certain levels in the past and went asking again.

To solidify this negotiation, specialists made verbal commitments to settle up buy trades in a late crossing session, while continuing to execute sell orders. While this helped specialists pare some of the large positions they would have to keep on their books thanks to the trade imbalance, it also served to help create a floor on some of the trading.

“[Specialists] created trades that otherwise would not have occurred…when someone alerts a broker and says look at this, you create an interest. That facilitates trading that doesn’t happen in other markets,” said Dave Humphreville, president of the Specialist Association, which represents market makers on the floor of the NYSE.

Still, a trader at one leading Wall Street algorithmic firm said the volume of stock handled by the specialists was small compared with the overall listed volume, and may not have had a broad impact.

Overall, specialists executed 141.5 million shares on Monday, more than double the 63.4 million shares they execute on an average day year-to-date. Overall volume was high, however, with about 7.3 billion shares trading on the NYSE Composite, meaning that the specialists handled about 1.9% of the volume.

“The New York Stock Exchange floor in general is shrinking as things go more electronic,” the trader at the electronic-trading unit said. The dark pool, an electronic crossing network that is an alternative to stock exchanges, at this firm and others are seeing record volumes during the recent volatility. One such venue traded half a billion shares in a single session earlier in September.

As for who bought from specialists, representatives for two floor brokers say specialists disseminated information out to “anyone in the stock market community” that they would take these buy orders in an extended session.

The “specialist helps in price discovery, so if they slow the market down, there would be better price discovery,” said Tim Mahoney, chief executive of Bids Holdings, an electronic trading group that has partnered with the NYSE.

Among the names that changed hands in the crossing session were some of the large banks, including JPMorgan Chase & Co., Bank of New York Mellon Corp., and Morgan Stanley.

“The specialists performed an important function by soliciting contra-side buy interest and that helped cushion some of the downward move. It’s happened on a stock-by-stock basis over the years, but I haven’t really seen that happen on as broad a basis before,” said Mr. McSherry.

Nonetheless, the “selling imbalance” at the close of the session, when sell orders flooded in, meant that prices slipped steadily during the extended trade. After being down fewer than 600 points at the closing bell, by 4:15 p.m. EDT, when all orders were processed and closed, the loss was more than 777 points. The Standard & Poor’s 500 also took a long time to settle at its final close, ending down 8.8%. The Nasdaq Composite, which settled more quickly than the other two indices and had no specialist involvement, fell 9.1% — a comparable loss.

The TED spread, a key indicator of stress in short-term markets, has spiked. (Source: JP Morgan Chase)

Equity futures are down in the early going, but once again the focal point for markets is the funding arena, where conditions remain stretched. Overnight funding rates dropped dramatically Wednesday morning, with overnight LIBOR falling to 3.78375%, down from 6.875% Tuesday, a record, as banks rushed in to secure month- and quarter-end funding.

The quarterly dislocations had an impact on commercial paper markets as well, and some of the goings-on in these markets reflected distortions as a result of the quarter-end issues. With that behind the market, the sentiment in the commercial paper market has improved somewhat Wednesday morning.

Still, the key three-month U.S. LIBOR rate rose to 4.15% overnight, highest since Jan. 11, and the TED spread, the difference between three-month LIBOR and three-month Treasury bills, currently sits at 3.35 percentage points. That’s a key measure of market stress, and shows that there’s quite a bit of it right now. The difference between LIBOR and the anticipated federal-funds rate is about 2.445 percentage points, a bit better than Tuesday’s 2.47 percentage points.

Dow futures are down by about 75 points, and the S&P 500 futures are off by 13 points headed into the opening bell. The market received what may be construed as good news from Automatic Data Processing, which said non-farm, non-government payrolls decreased by just 8,000 in October, but ADP has generally underestimated payroll losses for the past several months.

The market has recovered more than half of Monday’s losses, and it’s a good thing: The decline may have cost consumers billions of dollars in spending cash at a time when they could really use it.

According to Miller Tabak bond strategist Tony Crescenzi, every dollar lost in the stock market hurts consumer spending power by 4 cents for the next 18 months. U.S. consumers lost about $400 billion of the $1.2 trillion in market capitalization that vanished yesterday, meaning they were left with about $16 billion less to spend in the next 18 months, according to Mr. Crescenzi’s estimate.

Not all economists agree that there is any effect on spending from such declines in wealth. And in any event, consumers got at least $8 billion of that back today, meaning the net effect of the past two days in the market will be negligible, at least in dollars and cents.

But combine the past year of stock-market turmoil with sinking home values, mounting job losses, high prices at the pump and grocery store and tightening credit, and the obstacles for consumer spending are high and rising.

The stock market is less fearful than it was yesterday, but this may just be a pause as traders move between rooms in the big haunted house of the credit crunch.

The Chicago Board Options Exchange’s Volatility Index, or VIX, a key measure of market anxiety, is off 13%, recently trading below 41. On Monday it jumped 34%, briefly crossing 48 before closing at a record high of nearly 47.

A falling VIX can sometimes be a sign the worst is over for the market – and falling from a very high perch can often herald a market rally. J.P. Morgan equity strategist Thomas Lee points out that one week and one month after past VIX spikes above 48, the S&P 500 has been up 7% and 11%, respectively. This could hint at “a big short-term buying opportunity,” Mr. Lee told clients.

But the fear gauge is still at nosebleed levels. In its 25-year existence, the VIX has cracked 40 only three other times — during the Long Term Capital Management crisis in the fall of 1998; on the day markets opened after the Sept. 11, 2001, terror attacks; and in 2002, when the post-bubble bear market was reaching its greatest frenzy.

Clearly, if Congress approves a bailout plan this week, the market could quickly retrace much of its Monday loss. But beyond the very short run, there is no telling how much the plan will help the credit market, meaning stocks might soon be sliding again.

“A longer rally…requires liquidity to improve in credit markets,” Mr. Lee wrote. “This is not apparent yet.”

Carolyn Cui reports.

Platinum and palladium are taking a beating Tuesday. Apart from the general concerns over a weaker global economy, these two precious metals are particularly weighed down by the imminent auto sales numbers — which are not going to be pretty.

Recently, platinum was down 6.5% on the Comex division of the New York Mercantile Exchange, while palladium lost 7.8%. Auto production is important to the two metals, as nearly 60% of each is used in auto catalysts, which are fitted in vehicles to reduce harmful emissions. (At right: palladium December contract on Comex.)

“These are the ‘industrial, precious’ metals, and they need industrial demand to keep them strong,” wrote Dennis Gartman in this morning’s The Gartman Letter, a daily newsletter. Platinum and palladium have suffered heavy losses since this spring, as the economic outlook started turning sour.

Another blow is in the offering: General Motors Corp., Ford Motor Co., Toyota Motor Corp. and other auto makers are scheduled to unveil their September sales results Wednesday. In light of the tighter credit and sluggish economy, analysts expect auto sales to continue to fall and extend into the 11th straight monthly decline. “Damage has been done and it shall be months before reasonable health can be restored to this market,” Mr. Gartman wrote.

Rob Curran reports:

Some of these companies are doing their own things, some of these companies just don’t belong (on the financial-stock short list).

The number of stocks protected under the Securities and Exchange Commission’s financial-stock short-sale ban is now about 975, with the New York Stock Exchange’s recent additions including jeweler Zale, car-dealer AutoNation, car-rental firm Avis Budget Group and moving-truck renter Ryder. They join a motley crew that already includes such notable “financials” as International Business Machines, Medco Health, General Motors and Ford Motor.

The rule, issued to help stabilize shares of banks, lenders and brokerages, now encompasses a range of other businesses with sometimes tenuous links to finance. For fiscal year 2008, the “All Other” part of Zale’s business, which includes its insurance unit, accounted for less than 1% of its overall revenue.

Last weekend, the SEC furnished exchanges with a set of criteria for additions to the original list of 799 companies, namely that a company is or owns a bank, savings association, insurance company, or various other entities. With that, the SEC passed along the responsibility for additions to the exchanges. The Nasdaq selected 66 companies at its discretion; the NYSE called for applications from eligible companies.

The NYSE and the Nasdaq, for their part, insist that all companies added to the list fit the “strict” criteria.

Zale’s financial unit markets insurance to holders of its store credit card, and contributed $12.4 million to overall revenue of $2.14 billion for the fiscal year ended July 31. Similarly, finance and insurance made up about $281 million, or roughly 3.6%, of AutoNation’s first-half revenue of $7.91 billion.

How Avis and Ryder qualify is not clear, and the companies didn’t immediately return calls for comment. Avis takes a small amount of derivative risk to hedge on rental rates.

These companies join International Business Machines Corp., which qualified thanks to a finance unit that contributed 4% of its second-quarter revenue; driller Atlas Energy Resources LLC, on the strength of a broker dealer that raises a minority of the money needed for its drilling operations; and drug-plan manager Express Scripts Inc., which described its insurance operations as “minute.”

Atlas Energy, added Thursday, says capital raising contributes about a quarter of its gross margin, but most of that capital isn’t raised by its broker-dealer unit.

“The regulators have offered stabilization for all companies that qualify,” said Brian Begley, spokesman for Atlas Energy. “We’re not a financial-services company, but what we do in syndication and fundraising is provide a financial service.”

Curiously, one of only five companies to opt out of the list so far is JMP Group Corp., parent of San Francisco broker and money-manager JMP Securities, a company in the center of the banking and brokerage crisis. The president of that company, Craig Johnson, said it opted out because of a belief that short-selling is a crucial function of financial markets.

Min Zeng and Mark Gongloff report:

If you only watch the stock market, where the Dow was recently up more than 250 points, you might get the mistaken impression all is well with the world on the Tuesday after the latest Black Monday.

But, as has often been the case during this crisis, credit markets are singing a different tune. Overnight dollar Libor rates more than doubled to 6.875%, as banks hoarded cash for the quarter end amid signs the financial crisis was spreading. It’s more than a little ironic that while investors are buying banks’ stocks — shares were up sharply across the sector — banks themselves were unwilling to buy each others’ shortest term debt. Banks are so desperate for funds that they paid 11% for $30 billion in overnight funds from the European Central Bank, up from 3% just Monday.

Sure, a second round of dollars from the ECB and a 28-day injection of funds from the Fed helped calm the worst panic (indeed, the ECB’s $50 billion offer drew just a bit more than $30 billion in bids, and the rate fell back to 0.50%; while fed funds are now trading at 3.0% rather than the 7.0% high we saw them at earlier), but we’re a long way from normal. Lena Komileva, economist at broker Tullet Prebon, notes the premium for overnight liquidity is “out of control,” making it hard for central banks to instill confidence in the future.

In short, credit is frozen, in part because institutions are hoarding liquidity for the end of the quarter. Monday’s Epic Fail on Capitol Hill would seem to be hurting too — except credit was worsening even before the $700 billion bailout bill died, notes Brian Reynolds, chief market strategist at WJB Capital.

Need more geeky proof just how little trust is around? The three-month Libor/OIS spread — which compares the rate at which banks are prepared to lend to each other to the expected benchmark interest rate set by the Fed — widened to a record 246.75 basis points from around 218 basis points Monday. And it isn’t just Wall Street. The commercial paper market, where companies raise short-term financing, also felt the pressure of tightening conditions. One trader at a primary dealer said volumes are holding up around Monday’s levels, but overnight rates on asset-backed commercial paper jumped to 6% to 7.5% from 2% for better-rated companies on Monday. It isn’t helping that today is the last day of the third quarter, bringing banks’ efforts to get their books in order to a head.

Aaron Lucchetti reports:

Being on an Amtrak during one of the toughest days the market has seen in years is tough. “This is the worst day to be out of the office,” says Tim Ghriskey, chief investment officer at New York-based Solaris Asset Management, who traveled to Philadelphia Monday to visit a prospective client. On the way there, he found out the meeting was postponed because the client was dealing with accounts he had with Wachovia Corp., which announced a government-assisted sale to Citigroup Monday morning. “He felt he had to deal with that,” Mr. Ghriskey recalled.

On the train, Mr. Ghriskey kept in touch with analyst and trader colleagues back in the office, getting the latest on the House of Representatives voting down the Bush administration’s bailout plan. Last night, he said the optimists feel Congress will forge a new plan after hearing from constitutents that they don’t want their 401-K plans to decline in value any further.

“But there are no guarantees when it comes to Congress,” says Mr. Ghriskey. “Bailout is an unfortunate term, and it’s going to be hard for a Congressman to change his mind unless it’s a radically different bill.”

Of course, a radically different bill might not be successful in stabilizing the system. “There’s certainly a lot of panic out there,” he says. “It appears that politics is more important than stabilizing the financial system.”

The Conference Board’s reading of consumer confidence defied expectations and rose in September, to 59.8 from an upwardly revised 58.5 in August. The Wall Street consensus was that confidence would fall to 55 — cut in half from its recent peak of 111.9 in July 2007. Though still closer to its all-time low of about 43, set in 1974, confidence is now at its highest level since April.

The big factor helping sentiment was the price of gasoline, which has fallen to $3.63 a gallon, on average, from a peak of $4.11 this summer. That generally pushes up the “expectations” component of the confidence index, says Ian Shepherdson, chief U.S. economist at High Frequency Economics.

Labor conditions weigh on the “present conditions” component, however, and that fell in September. Other readings of labor-market strength in the Conference Board report also faded in the month. And consumers felt a little less optimistic about their incomes six months hence.

Mr. Shepherdson, in a note to clients, suggests today’s confidence reading is still “consistent with real consumption falling about 0.5% year-over-year. Hardly good.” Consumer confidence, and spending, are still likely to retreat in the months ahead in response to the latest market turmoil and tightening of credit.

As the market rebounds, consumer discretionary stocks are rising with it. The Consumer Discretionary SPDR ETF is up nearly a full percentage point in early trade. Beaten-down shares of consumer-tech giants Apple and Google are up 4% and 7%, respectively. But investors are clearly bargain-hunting in a thinly traded market after Monday’s selloff, and the future path of consumer spending is still in doubt.

Rob Curran reports:

Memo to Congress: The Wall Street crisis has already arrived on Main Street – Main Street, U.S.A., Main Street, Reykjavik, and Main Street, Beijing.

The Wall Street crisis is rippling through the economy and the globe at an alarming rate, hurting commercial activity worldwide and thus the prospects for technology, commodity and manufacturing stocks.

It isn’t likely that the U.S. Treasury’s bailout plan can reverse this ripple effect.

“If the banks don’t trust each other, they’re certainly not going to trust even some of their longstanding clients,” said Joseph Battipaglia, equity strategist for the private-client group at Stifel Nicolaus. Even after a potential bailout, only “the best creditors will get money; if you’re a corporate officer, you’re looking to conserve cash. You cut capital-spending expectations.”

More so than in banking panics of the past, credit markets now operate worldwide, so adverse effects are already clear in commodity prices ranging from oil to fertilizer; in shipping rates; and in corporate warnings from conglomerate General Electric, BlackBerry maker Research In Motion and chicken processor Pilgrim’s Pride. Perhaps most worryingly, over the weekend, Toyota Motor warned of weakening demand in China, the last great hope for stimulating global growth.

“The last nine months of tougher and often unavailable credit will mean that capital spending will be soft and not just in the U.S., with clear indications of weak demand in Europe, Japan and even some emerging economies recently,” Tobias Levkovich, an equity strategist at Citigroup, wrote in a note. “We anticipate sharp downward adjustments to earnings estimates for late 2008 and the first half of 2009. To some degree, we got a taste of that when urea prices slipped for fertilizer stocks and when a major smart phone producer guided down numbers last week.”

Oil prices, one of the more reliable thermometers for economic activity in modern times, fell more than $10 a barrel to around $96 Monday.

Another indication that commerce is freezing along with the credit markets: the Baltic Dry Bulk Index has dropped sharply of late, with a 6.5% drop Monday on top of Friday’s 10% fall. That index reflects standard international shipping rates for commodities such as grain, metal and coal, and is often seen as a leading indicator of global economic growth. Some of the biggest decliners during Monday’s bust were coal miners, such as Consol Energy, and steelmakers, such as U.S. Steel.

Shares of erstwhile stock-market darlings such as Potash of Saskatchewan, Mosaic and Intrepid Potash are trading at fractions of their summer values, after reports last week that one grade of fertilizer, urea, fell sharply in price, mirroring losses for grains.

One company that’s suffering because it can’t get a loan on Wall Street, or anywhere else: Pilgrim’s Pride. Shares of the nation’s largest chicken processor are down 78% for September. The company warned last week that it could default on its loan covenants after wrong-way hedging bets in the grain markets.

Also last week, General Electric – a key company for U.S. employment and stock portfolios – shocked markets when it suspended a stock buyback program and indicated it may not boost its dividend in 2009 for the first time since 1976.

“GE is a diversified, broad-based company,” said Jeffrey Pavlik, head of hedge-fund firm Pavlik Capital Management. “They have their hand in a whole lot of different things. If GE is suspending buybacks, things like that, there’s something fundamental with the economy that they’re seeing.”

Financial stocks rose in premarket trading, although most were only able to erase a small margin of their declines Monday, which sent the Dow Jones Industrial Average plunging to its largest point drop in history.

The House’s rejection of the plan stunned investors, sending the stock market into a tailspin and adding to concerns that the U.S. faces a prolonged recession if the legislation isn’t revived.

Citigroup, which had dropped 12% Monday, rose 7% in recent premarket trading, while Wachovia climbed 8.7% to $2, erasing just a small part of its 82% plunge Monday. Wells Fargo, which had been rumored to be in discussions with Wachovia, rose 6.2% premarket activity following its 11% decline Monday.

The past month has seen a number of U.S. financial giants fall, either being seized by the government or sold off to stronger firms. Wachovia is just the latest of them.

AIG jumped 19% to $2.97, erasing most of its 21% decline Monday, while J.P. Morgan Chase rose 9.8% after falling 15% Monday.

Morgan Stanley, one of the two remaining large standalone brokerages, which are now being converted into bank-holding companies, rose 4.8% in recent premarket trading after falling 15% Monday. Mitsubishi UFJ Financial Group said Monday it sealed a deal to acquire a 21% stake in the company for $9 billion. Morgan Stanley is hoping the investment will boost the confidence of investors nervous about the firm’s bets with borrowed money.

Goldman Sachs Group, the other big independent brokerage, increased 5.2% premarket, erasing part of its 13% Monday drop. Morgan Stanley and Goldman have both lured new capital in recent days to reduce leverage, while converting to bank holding companies, a move that brings them under the supervision of the Federal Reserve.

Each time one giant has fallen, investors have turned their focus to locating the crisis’s next likely victim and fleeing its stock. Monday, they indicated Sovereign Bancorp might be next, as shares plunged 72%. The embattled regional bank, which has been inactive premarket, is expected to try to shore up confidence and stem its stock’s decline Tuesday by announcing a new chief executive, Paul Perrault. Perrault is a former CEO of Chittendon Corp., a New England regional bank that was acquired last year.

A slew of other regional banks also posted sharp drops Monday amid fears that smaller banks won’t be able to survive intact without support from the U.S. government. National City, which saw no premarket trading, fell 63% Monday. The bank has been on investors’ radar despite reiterations from the company that it is well-capitalized and the sell-off is unjustified. Fifth Third Bancorp has also been targeted despite the company also maintaining that it is well-capitalized. Its stock dropped 44% Monday and saw no premarket trading.

The bailout was designed in part to get financial institutions lending again by ridding the market of the toxic mortgage-backed securities and other holdings that lenders fear could cause borrowers to default.

If credit markets continue to seize, the impact on businesses and consumers could be widespread. Access to loans would be reduced, crimping spending and investment. Economists said the credit crunch could lead to increased layoffs in the U.S. and prompt a hefty rate cut from the Federal Reserve. – Donna Kardos

This was, needless to say, not what was expected. Investors late last week warned that if a plan wasn’t cobbled together over the weekend, the market “wouldn’t open” on Monday. This may, in a sense, be worse — a plan was cobbled together, even if investors had issue with it, and it still didn’t end up getting through.

Stocks are broadly lower, with selling across all industries. The Dow industrials recently hit an intraday low, down more than 700 points, as investors try to figure out where the market is going to go next.

MarketBeat has put together a few reactions to the failure of the House to pass the bill:

• “Some sort of legislation was vital. This may not have been ideal, but it was something. I’m really kind of shell-shocked that this bill would be put to vote and not actually have the votes. I’m concerned what’s going on here is there isn’t enough understanding of our credit markets and how they operate and how locked up they are right now. People are trying to get loans right now see that banks aren’t lending to them. From student loans to businesses, there’s just no liquidity.” — Chris Colarik, portfolio manager for Glenmede Investment Management in Philadelphia.
• “All of the usual investment disciplines get thrown out the window, and people look to see what the guy next to them is doing, and the guy next to them is selling. It’s not a pretty sight.” – Marc Groz, CEO/CIO of Topos LLC, a hedge fund in Stamford, Conn.
• “The consequences of no action by either the House or FASB are frankly unthinkable. Let’s pray for less principled outrage and more adult, common sense decision-making.”–Vinny Catalano, Blue Marble Research
• “Today, the government failed to govern as it should have. Compromise was thrown out the window and tyranny of the minority is the rule of the day. No one, least of all me, was thrilled with the bill. It’s often said that a camel is a horse designed by committee, and this bill is certainly a camel…but it is the best that a diverse group could come up with and it needs to be enacted in some form with dispatch.” — Daniel Alpert, Westwood Capital
• “I don’t understand why they’re playing Russian roulette with it. I’m not quite sure what aspect they don’t like.” –Andrew Wilkinson, Interactive Brokers
• The downside risks to global growth have intensified with the US House of Representatives having voted down the rescue plan – as of this writing – and the spreading of the financial crisis to Europe. Too much leverage still prevails and the necessary de-leveraging process will continue to pose a deflationary risk to the economy through the credit crunch and wealth destruction. –Kathleen Stephansen, Credit Suisse

The failure of the $700 billion bailout package in the U.S. House of Representatives has caused an explosion of fear in the marketplace, as stocks drop dramatically and investors retreat to the safety of short-term Treasurys.

The VIX, traded on the Chicago Board Options Exchange, was lately at 46.39, ramping higher as investors build more fear into the marketplace. It reached levels not seen since October 2002. According to Frederic Ruffy, options strategist at Whatstrading.com, more than 437,000 S&P 500 index puts have traded, compared with just 200,000 index calls.

“The key is that Washington needs to pass a bailout plan,” writes Len Blum of Westwood Capital. “As everyone has undoubtedly heard over the past several days, there are many reasonable bailout proposals. Most of them work – some more efficiently than others.”