Investors still kept a nervous eye on American International Group, the world's largest insurer, which huddled with the New York Fed in hopes of staving off a failure that would create even more financial turmoil.
The Fed, in its first unanimous decision this year, kept its closely watched federal funds rate unchanged at 2 percent - but noted that strains on the market have "increased significantly" and said it was ready to act if needed.
Stocks slumped immediately after the Fed announcement, with the Dow Jones industrial average dropping about 100 points. But the Dow finished the day up 141, and back over 11,000.
It was a breather from the chaos the shook the financial system Monday, when investment house Lehman Brothers declared bankruptcy and the Dow Jones industrials suffered their biggest point drop since the Sept. 11, 2001, terrorist attacks.
But AIG, a company that is little known off Wall Street but does business with almost every financial institution in the world, became the new star of the Wall Street soap opera.
The company, which insures $88 billion worth of assets, plays an outsized role insuring mortgages and corporate loans, but what has the Wall Street scared is that it's an integral player in the murky world of hedge funds and credit derivatives.
Investors worry its failure would pose an even greater threat to the U.S. financial system than the collapse of Lehman. AIG stock was down as much as 60 percent Tuesday.
Late Monday night, all three major credit rating agencies cut AIG's ratings at least two notches. While the new ratings are all still considered investment grade, they add pressure on AIG as it seeks tens of billions of dollars to strengthen its balance sheet.
New York Gov. David Paterson said Monday he would support a measure allowing it to use $20 billion of assets held by its subsidiaries to pay for its business - essentially giving it a bridge loan from itself.
A collapse of AIG would force Wall Street to untangle the complex credit derivatives markets and send the market scrambling to figure out who owes what to whom - or even who owns what.
"Regulators knew that if Lehman went down, the world wouldn't end," money manager Michael Lewitt wrote in an op-ed column Tuesday in The New York Times. "But Wall Street isn't remotely prepared for the inestimable damage the financial system would suffer if AIG collapsed."
As AIG teetered, central bankers around the globe scrambled to revive credit markets. The Fed injected $70 billion into the American financial system. The European Central Bank pumped one-day financing of nearly $100 billion into the 15-nation zone. The Bank of Japan added $24 billion, and England's central bank almost $36 billion.
Cash left world markets Monday like an outgoing tide. The interest rate banks charge each other for overnight loans soared as high as 6 percent - far above the Fed's target rate of 2 percent and a sign banks didn't trust each other enough to make even 12-hour loans.
Meanwhile, Lehman Brothers Holdings Inc., which filed the largest bankruptcy in American history on Monday, was reported to be frantically working to sell all or part of its business to British bank Barclays PLC. Lehman's creditors were set to meet Tuesday night to untangle the bank's $613 billion in debt.
Separately, Bank of America Corp., which in July bought battered Countrywide Financial Corp., began to work out how it would digest its $40 billion acquisition of Merrill Lynch after its shotgun wedding with the brokerage on Sunday.
In the wings, Goldman Sachs Group Inc., which began the year as one of five large investment banks and is now one of two, reported its worst profit drop since going public in 1999. Goldman's third-quarter profit dropped 71 percent to $810 million, while revenues plummeted 50 percent.
The only other investment bank left standing, Morgan Stanley, had better news. It reported solid quarterly profits - though down 7 percent from a year earlier - and surpassed Wall Street's expectations.
Earlier this year, the federal government engineered the sale of Bear Stearns to JPMorgan Chase, and earlier this month the government assumed control of mortgage giants Fannie Mae and Freddie Mac.
On the campaign trail, Republican presidential nominee John McCain called for a commission to study the economic crisis. Democrat Barack Obama laughed the idea off as "the oldest Washington stunt in the book."
"This isn't 9/11," Obama told a noisy crowd of more than 2,000 at the Colorado School of Mines, dismissing the idea of a need for study. "We know how we got into this mess. What we need now is leadership that gets us out. I'll provide it. John McCain won't."
McCain, campaigning in Florida, promised reforms, too, to expose and end the "reckless conduct, corruption and unbridled greed" on Wall Street that he said had caused the financial crisis.
To say that it is an unusual week in US finance would be a huge understatement. On Tuesday, the Web site Christianity Today even posted an e-mail from an evangelical leader asking Christians to pray for Wall Street.
"We may find it hard to pray for these bankers because they are insanely wealthy, true," it read. "A few of them can be terribly arrogant; and some can have little heart for the less wealthy. Yet, Jesus prayed for the rotten because he loved the rotten.
In this situation prayer could accompany a revival of the heart on Wall Street."
