Small caps fall as rally fizzles

The Russell 2000 (NYSE: IWM) has fallen far below the flat line as the morning rally on Wall Street goes into reverse. At 2:16 p.m. ET, the small-cap index had fallen 7.04 points, or 0.94%, to 743.29. The Dow Jones Industrial Average (INDU) was down 56.49 points, or 0.44%, to 12,901.95.

At about 12 p.m. ET, small-cap stocks abruptly lost steam and nosedived into negative territory, where they have since been joined by the other major U.S. indices.

The apparent reason for the sharp drop is a decline in financial stocks as investors once again turned their attention to the credit problems stemming from the meltdown in the subprime mortgage sector.

Before the start of trading today, Freddie Mac (NYSE: FRE), a government-chartered company that buys U.S. mortgages, reported a record quarterly loss and warned that it may have to cut its dividend.

A number of financial institutions have taken a hit in recent months as declining house prices and a wave of foreclosures and delinquencies made securities backed by subprime mortgages essentially worthless.

Morning trading was dominated by the bulls following news of a report from the U.S. Census Bureau that housing starts surprisingly increased 3% in October, after a fall of 11.4% in September.

Elsewhere, the price of oil has added $3.39 to $98.03 a barrel.

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