* U.S., European stocks fall to lows last seen in May 2005
* Gold rises 9 pct in biggest percentage gain since 2000
* Crude rebounds $6 a barrel on rising U.S. inventory data
(Adds close of U.S. markets, updated pricings)
By Herbert Lash
NEW YORK, Sept 17 (Reuters) - Investors scrambled for ultra
low-risk investments like cash and gold on Wednesday as growing
fear of financial risk sparked a global rout in stocks, which
was marked by a plunge in the shares of Wall Street titans
Morgan Stanley and Goldman Sachs.
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 be hit by
ever-tightening credit markets 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."
Amid a wild rush for the safest and most liquid havens
available to investors, the cost of insuring against U.S.
Treasury debt default rose to record levels.
The price of government debt soared on both sides of the
Atlantic and gold futures shot 9 percent higher in their
biggest one-day percentage gain since February 2000.
Yields on one-month U.S. Treasury bills briefly fell below
zero in anticipation of heavy redemptions from investors
spooked by deep losses in money market funds, a rare
development.
The scramble for short-term debt was sparked by troubles at
the Reserve Primary Fund, whose net asset value fell below $1 a
share due to losses on its holding of securities issued by
Lehman Brothers, which filed for bankruptcy on Sunday.
"When the $1 value of money funds is questioned, that's as
scary as it gets," said David Riley, director of portfolio
strategist at Rydex Investments.
Investors were spooked. Broad market indexes in the United
States and Europe fell to levels last seen in May 2005; the Dow
has shed more than 800 points so far this week.
Morgan Stanley <MS.N> stocks plunged 25 percent and larger
rival Goldman <GS.N> fell 17 percent, even after both reported
better-than-expected quarterly earnings on Tuesday.
Both stocks pared earlier losses that pushed Morgan Stanley
down more than 40 percent at one point. Some Morgan Stanley
bonds traded at distressed levels as concerns grew about its
ability to survive in a deepening global financial crisis.
In the crude oil market, prices shot up $6 a barrel, the
largest one-day percentage gain in three months, as a U.S.
government report showed nationwide energy inventories fell in
the aftermath of two Gulf Coast hurricanes.
The gains followed oil's steepest two-day sell-off in four
years as investors fled to safer havens like bonds and gold.
"Crude oil prices have rebounded, having fallen sharply to
near $90. At that level, I think the bear market near-term
correction has run its course," said Tom Knight, a trader at
Truman Arnold in Texarkana, Texas.
U.S. crude oil prices <CLc1> settled at $97.16 a barrel, up
$6.01, while London Brent crude oil <LCOc1> settled at $94.84 a
barrel, up $5.62.
In stock markets, financial shares led losses. Europe's DJS
banks index <.SX7P> closed down almost 11 percent and the S&P
financials index <.GSPF> in the United States fell 9 percent.
All stocks in the blue-chip Dow Jones industrial average
<> fell, with declining shares outpacing advancing shares
by 13 to one on the New York Stock Exchange.
The Dow fell 449.36 points, or 4.06 percent, to 10,609.66.
The Standard & Poor's 500 Index <.SPX> slid 57.20 points, or
4.71 percent, to 1,156.39. The Nasdaq Composite Index <>
shed 109.05 points, or 4.94 percent, to 2,098.85.
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.
U.S. government debt shed earlier gains. The benchmark
10-year U.S. Treasury note <US10YT=RR> rose 6/32 to yield 3.41
percent. The 30-year U.S. Treasury bond <US30YT=RR> added 1/32
to yield 4.08 percent.
The dollar fell against major currencies, with the U.S.
Dollar Index <.DXY> down 1.39 percent at 78.041. Against the
yen, the dollar <JPY=> fell 1.11 percent at 104.55.
The euro <EUR=> rose 1.64 percent at $1.435.
The $70 rise in the benchmark U.S. gold contract for
December delivery <GCZ8> was gold's biggest one-day rise in
absolute terms since 1980. Spot gold <XAU=> rose more than 10
percent to $866.10 an ounce by New York's last quote.
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)
