* U.S., European stocks fall to lows last seen in May 2005
* Gold shoots higher on flight to safety, short covering
* Markets remain choppy, underlying banking fears persist
* Crude rebounds on inventory data, AIG rescue
(Adds close of European markets, updated price quotes)
By Herbert Lash
NEW YORK, Sept 17 (Reuters) - Investors scrambled for ultra
low-risk investments like cash and gold on Wednesday, amid a
global rout in equities sparked by a growing fear of financial
risk that drove down the shares of Wall Street titans Morgan
Stanley and Goldman Sachs.
The price of government debt soared and the U.S. dollar
rose versus the euro, reversing earlier losses, as growing
concerns about the health of the U.S. financial sector
increased risk aversion.
Gold futures shot 7 percent higher, while the yield on the
one-month U.S. Treasury bill -- which moves in the opposite
direction to the price -- briefly fell below zero on fear that
investors will be in desperate need of cash.
Investors were spooked. Broad market indexes in the United
States and Europe fell to levels last seen in May 2005; the Dow
has shed 700 points so far this week.
The U.S. government's $85 billion rescue of insurer
American International Group <AIG.N> failed to calm markets.
Investors instead wondered which company might next be strained
by tightening credit conditions around the world.
"The fear is who is next," said John O'Brien, senior vice
president at MKM Partners LLC in Cleveland. "It almost feels
like people scour the books and say who is the next likely
target that we can put a short on, and that spreads continuous
fear."
Morgan Stanley <MS.N> stocks plunged 37 percent and larger
rival Goldman <GS.N> fell 23 percent, even after both reported
better-than-expected quarterly earnings on Tuesday.
Some Morgan Stanley bonds traded at distressed levels as
concerns grew about the firm's ability to survive in a
deepening global financial crisis.
In the oil market, prices rose after U.S. data showed a
sharp draw in inventories due to Hurricane Ike and concerns
about starting up offshore rigs hit by the storm.
U.S. light sweet crude oil <CLc1> rose $2.40 to $93.55 a
barrel. Crude had fallen $10 to a seven-month low this week
amid the flight to safe havens.
Financial shares led stock market losses, with the DJS
banks index <.SX7P> down almost 11 percent in Europe and S&P
financials index <.GSPF> in the United States off 9.5 percent.
Only one stock, Johnson & Johnson <JNJ.N>, was ahead in the
30-component Dow. More than 15 shares declined for every
advancing stock on the New York Stock Exchange.
In early afternoon trade the Dow Jones industrial average
<> was down 295.39 points, or 2.67 percent, at 10,763.63.
The Standard & Poor's 500 Index <.SPX> fell 37.72 points, or
3.11 percent, to 1,175.87. The Nasdaq Composite Index <>
slipped 69.83 points, or 3.16 percent, at 2,138.07.
The sell-off threatened to go beyond the financial services
sector, hurting the corporate profit outlook and spreading
gloom among consumers who are increasingly overstretched.
Fanning fears that credit might be drying up in the global
financial system was the cost of overnight borrowing among
banks. The rate fell more than 1 percentage point on Wednesday
but the premium paid for dollars and sterling over three months
swelled.
"Every investor is now questioning each and every
investment they have anywhere on the planet," said John
Schloegel, vice president of investment strategies at Capital
Cities Asset Management in Austin, Texas.
"It's leading them to sell anything that has any type of
risk -- to sell first. It's an unusual situation we are in
right now."
The FTSEurofirst 300 <> index of top European shares
ended down 1.95 percent at 1,070.10 points. The benchmark has
fallen more than 8 percent this week and is on track for its
worst week in more than six years.
Banks were the top weighted European losers, with HBOS
<HBOS.L> slipping 19 percent and Royal Bank of Scotland <RBS.L>
10.4 percent.
"There's very little confidence in financial companies, and
it's likely to stay that way for a while. Investors can't
identify a strategy that will work," said Darren Winder, head
of macro and strategy research at Cazenove.
The benchmark 10-year U.S. Treasury note <US10YT=RR> rose
10/32 to yield at 3.40 percent. The 30-year U.S. Treasury bond
<US30YT=RR> rose 28/32 to yield 4.04 percent.
The dollar rose against major currencies, with the U.S.
Dollar Index <.DXY>, which measures its performance against a
basket of currencies, up 0.25 percent at 78.946.
Against the yen, the dollar <JPY=> fell 0.96 percent at
104.70. The euro <EUR=> fell 0.30 percent at $1.4162.
Prices for gold, seen as a safe-haven investment, were
boosted also by the notion that forced sales by investors in
need of liquidity would end soon after the AIG bailout was
announced, said Kitco senior analyst Jon Nadler.
Spot gold prices <XAU=> rose $59.80 to $837.35 an ounce.
Asian stocks rose overnight in response to the AIG bailout,
even as the cost of insurance against defaults soared and signs
mounted that banks were hoarding U.S. dollars.
Japan's Nikkei share average <> rose 1.2 percent, but
closed well off the day's highs. MSCI's Asia-Pacific ex-Japan
index <.MIAPJ0000PUS> also pared early gains, barely up 0.05
percent at 1530 GMT.
(Reporting by Richard Leong, John Parry, Lucia Mutikani, Nick
Olivari and Frank Tang in New York and Jane Merriman, Matthew
Robinson, Atul Prakash and Agnieszka Flak in London)
(Writing by Herbert Lash, Editing by Chizu Nomiyama)
