Last Sunday I stated,
"Market reaction to this [Fannie & Freddie bailout] will be something that should be watched very carefully. Previous reactions have been positive, but as I mentioned a few days ago, the market will eventually begin viewing these events as a negative."
Well, as of 8pm PT on Sunday evening "eventually" appears to be "now." Lehman brothers looks to be facing bankruptcy as no deal could be reached without direct government guarantees. Bank of America has bought Merrill Lynch for a 70% premium to Friday's close. AIG is asking for government protection. And the Fed has lowered it's standards to accept a wider range of collateral for it's emergency lending programs. Initial market reaction in overnight futures? - 44.10 points for the S&P.
Whether this is "the one" is hard to tell, but the initial reaction offers a departure from the regular "buy the news" reflex. To be sure, we will be inundated before the open tomorrow with "breaking news" to attempt a sharp reversal. The reaction to the news is what I'm watching, as the news is assured to be another "spread around the losses" scheme that only prolongs the pain rather than fixing the problem (which they can't).
My best guess (we never really know) for the reason markets are tanking overnight is that they see Lehman's bankruptcy as a "credit event." Something that will result in the liquidation of suspect assets and a "price discovery" scenario for other financials holding similar assets. Whatever price Lehman's creditors get for these assets is what they're worth to the other banks and this means more heavy writedowns.
This all goes without mentioning Hurricane Ike which is responsible for destroying 20% of US refining capacity and causing gasoline prices to rocket worldwide. This is likely not going to treat the airlines or consumer discretionary companies very well tomorrow. Damage in southern Texas is still being assessed, but will definitely have significant economic ramifications.
All in all, it's been a terrible weekend and investors are voting with their wallets. Whether this indicates the shift from migration to panic is taking place remains to be seen.
The always dire John Xenakis had a good summary in plain english of the issues at hand and what he thinks this means. (Warning: Keep sharp objects away from you while reading John's analysis)