Stocks plunge after Fed announces stimulus steps

NEW YORK - The Federal Reserve did what investors expected Wednesday - it said it would buy Treasury bonds to help the economy. But stocks fell anyway. The reason? The Fed made it clear that it thinks a full economic recovery is years away.

The Dow Jones industrial average lost 283.82 points, or 2.5 percent, and closed at 11,124.84. The Standard & Poor's 500 index fell 35.33, or 2.9 percent, to 1,166.76 The Nasdaq composite fell 52.05, or 2 percent, to 2,538.19.

Investors bought Treasurys because of concerns about the weak economy. The yield on the 10-year Treasury note fell to a record low of 1.86 percent from late Tuesday's 1.93 percent.

And the price of oil continued its slide on expectations that there'll be less demand for energy because of the economy. Crude fell $1 to $85.92 on the New York Mercantile Exchange.

The industries that fell the most Wednesday were the ones that have suffered amid worries about the economy this summer: financial and industrial companies and those that sell non-essentials to consumers. Retailers were among the biggest losers.

Wednesday's trading recalled the sharp losses the market has suffered this summer as investors feared that the country was heading toward another recession.

The Fed said after a two-day meeting that it would buy long-term Treasurys and sell short-term ones to help the economy regain momentum. It surprised investors when it said it would include more 30-year bonds in its purchases than expected.

"It's being viewed as perhaps an admission that this is a longer-term issue that the U.S. economy is facing and not one that's going to be solved over a couple of years," said Oliver Pursche, president of Gary Goldberg Financial Services.

The major indexes fluctuated as they often do after major Fed announcements. The losses accelerated in the last hour of trading.

The Fed said it would buy $400 billion in 6-year to 30-year Treasurys by June 2012. Over the same period, it planned to sell $400 billion of Treasurys maturing in 3 years or less. The move is intended to drive down interest rates on long-term government debt, and could lower rates on mortgages and other loans.

Those purchases are intended to send long-term rates down - Treasury yields fall when the bonds are in demand. The inclusion of more 30-year bonds than expected means the Fed saw the need to keep very long-term rates lower for an extended period. And that took investors by surprise, Pursche said.

"When the Fed decides to take this type of action, it's because things are serious," Pursche said.

The Fed had some bleak remarks about the state of the economy in the statement that accompanied its decision to buy more bonds.

The Fed said the economy has "significant downside risks." One of those risks is the volatility in financial markets around the world. It also listed a number of problems that won't be easily solved: high unemployment, a depressed housing market and consumer spending that is growing only at a slow pace.

There are also concerns about problems overseas, including the debt crisis in Europe that investors believe could affect the U.S. The International Monetary Fund said Wednesday the global financial system is in its most vulnerable state since the 2008 financial crisis. In a semi-annual report, the IMF said the risk to banks and financial markets has grown in recent months.

Stocks were already moderately lower when the Fed made its announcement shortly before 2:30 p.m. Eastern time. Within half an hour, the Dow was down 157 points. It then regained ground and fluctuated before beginning its plunge in the last 45 minutes of trading. Investors were digesting the Fed's plan, and began to see it as a statement that the economy is weaker than many people had thought.

"That is perhaps a recognition that the Fed is running out of firepower and resorting to some arcane techniques resurrected from the vault of history," said Lawrence Creatura, portfolio manager at Federated Investors.

Investors may also doubt the Fed's ability to drive down Treasury yields much more from their current levels.

"Let's face it: with a 10-year Treasury offering 1.90 percent, there's not a whole lot of room for there to be a major impact," said Mark Lamkin, the head of Lousiville, KY-based Lamkin Wealth Management.

While initial investor reaction to the decision was negative, it's common for stocks to change direction in the minutes, hours and days following an important Fed announcement, said Phil Orlando, chief equity market strategist for Federated Investors.

"It's not unusual for the market to drop a percent or two after the decision, then it may rally the next day, then it may fall again. People are confused, they don't really know how to settle it in," said Orlando.