(Adds close of U.S. markets)
* Oil prices drop to $140 a barrel level
* U.S. stocks slip on fears financial sector needs money
* Dollar reverses course as U.S. financial shares fall
By Herbert Lash
NEW YORK, July 7 (Reuters) - Wall Street closed lower on
Monday after a wave of concern over mortgage providers' capital
adequacy spoiled an early stocks rally triggered by a plunge in
commodity prices led by oil.
In volatile trading, investors bailed out stocks after a
brokerage report that Fannie Mae and Freddie Mac may need to
raise more capital. The report by Lehman Brothers sparked
weakness throughout the financial sector.
The dollar also at first rose but later it fell against the
euro and erased gains versus the yen on the concerns over the
health of the financial sector.
Crude oil fell below the $140 mark before settling down
almost $4 on profit taking from last week's record high and
signs that Iran may be more flexible in negotiations over its
nuclear program. A wide range of commodities fell, including
soy and corn, pushing the Reuters/Commodity Research Bureau
index down nearly 3 percent.
U.S. government debt rallied and erased early losses as a
stock reversal revived the bid for safe-haven U.S. government
debt. Government debt in Europe also rose as investors pared
bets the European Central Bank would raise interest rates again
after last week's long-anticipated hike in euro zone rates.
U.S. banking shares plummeted to their lowest level in more
than a decade after forecasts of soaring credit losses led
investors to fret that next week's quarterly earnings reports
could fall short of already low expectations.
Citigroup Inc <C.N>, Bank of America Corp <BAC.N> and
Wachovia Corp <WB.N> were among the decliners after analysts
predicted significant credit losses for large regional banks
including Marshall & Ilsley Corp, <MI.N> SunTrust Banks Inc
<STI.N> and Zions Bancorp <ZION.O>.
Analysts at Lehman Brothers said a pending change in U.S.
accounting rules could force Fannie Mae <FNM.N> and Freddie Mac
<FRE.N>, the largest providers of funding for U.S. home
mortgages, to raise a combined $75 billion in fresh capital.
Even though the Lehman analysts said such an outcome was
unlikely, investors were spooked.
A report from CreditSights also raised concerns about
Freddie Mac, which it said could suffer greater losses as the
mortgage insurance unit of Radian Group <RDN.N> could face more
downgrades and force it to wind down its existing business.
"Fannie Mae and Freddie Mac are ground zero for mortgages,"
said Steve Persky, chief executive at Dalton Investments in Los
Angeles. "They're the largest leveraged owners of mortgages out
there, and that's not a good position to be in right now."
Freddie Mac fell 17.6 percent and Fannie Mae fell 16.9
percent. The KBW Bank index <.BKX>, a broad measure of the U.S.
commercial banking sector reached its lowest level since 1997.
The broad market S&P 500 finished within 1 point of formal
bear market territory. Bear markets are defined by a 20 percent
fall from a peak.
The Dow Jones industrial average <> fell 56.58 points,
or 0.50 percent, at 11,231.96. The Standard & Poor's 500 Index
<.SPX> fell 10.59 points, or 0.84 percent, at 1,252.31. The
Nasdaq Composite Index <> fell 2.06 points, or 0.09
percent, at 2,243.32.
Tech stocks tried to rally after Microsoft <MSFT.O> said it
would be willing to reopen talks to buy all or part of the
Internet company. Yahoo <YHOO.O> shares rose more than 12
percent.
The decline in oil prices initially lifted the appeal of
beaten-down stocks in the wake of the market's recent sell-off,
while speculation on two deals, one new and the other involving
renewed talk about Microsoft and Yahoo, also buoyed stocks.
U.S. crude <CLc1> settled at $141.37 a barrel, down $3.92
and below Friday's low of $143.22. Brent crude <LCOc1> settled
at $141.87 a barrel, down $2.55.
In Europe, merger speculation about Spain's Iberdrola
<IBE.MC> lifted utility shares. Iberdrola rose 7.8 percent
after the company's No. 2 shareholder said it saw no
alternative to a merger between Iberdrola and Gas Natural
<GAS.MC> of Spain.
Rivals EDF <EDF.PA>, Centrica <CNA.L> and Suez <LYOE.PA>
gained between 3 percent and 5.5 percent.
Oil and gas producers were among the top performers in
Europe despite falling oil prices. Traders cited a rebound from
weakness last week.
"The fact that the sellers have been so persistent and
there's been nothing but selling over the last six weeks means
we are due a period of remission," said Mike Lenhoff, chief
strategist at Brewin Dolphin.
"If on top of that, we get something like some decent news
out of the commodities markets, oil in particular, that's
great," he said.
The FTSEurofirst 300 index of top European shares <>
ended 1.3 percent higher at 1,178.69 points.
After an initial decline, the euro rose.
"There is nothing on the FX front, everyone is looking at
equity markets," said Ron Simpson, director of foreign exchange
at Action Economics in Tampa, Florida. "Commodity and energy
stocks have all got smashed."
The relentless march high in oil prices took a pause from a
recent rally that has produced almost daily new record highs
and lifted by almost 50 percent this year.
Gold fell along with other commodity prices across the
board -- from metals to softs to grains -- as funds sold after
returning from the long U.S. holiday weekend.
"Copper's down, silver's down, crude oil is down. Gold was
holding support pretty well and when crude dropped $2.50, we
dropped," said Jonathan Jossen, an independent gold trader at
the COMEX division of New York Mercantile Exchange.
The benchmark 10-year U.S. Treasury note <US10YT=RR> rose
15/32 to yield 3.93 percent. The 30-year U.S. Treasury bond
<US30YT=RR> gained 17/32 to yield 4.50 percent.
The dollar rose against major currencies, with the U.S.
Dollar Index <.DXY> slight higher, up 0.04 percent at 72.732.
Against the yen the dollar <JPY=> rose 0.30 percent at 107.13.
The euro <EUR=> rose 0.08 percent at $1.5717.
Asian stocks rose, snapping a six-day losing streak, on
optimism that China's banking sector has thrived despite market
turmoil.
Japan's Nikkei share average <> finished 0.9 percent
higher, its first gain after 12 straights sessions of losses.
It was the longest losing streak since 1954.
Shares in the Asia-Pacific region traded outside of Japan
edged up 0.3 percent, according to an MSCI index <.MSCIAPJ>.
Spot gold prices <XAU=> fell $7.80 to $924.50 an ounce.
(Additional reporting by Richard Leong, Gertrude
Chavez-Dreyfuss, John Parry and Carole Vaporean in New York,
Alex Lawler, Kirsten Donovan and Amanda Cooper in London;
Editing by Richard Satran)
