Treasurys soar, credit pipes frozen

Bond prices jump as stock market tumbles on defeat of House bailout vote. Investors lose faith in credit thaw.

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By Catherine Clifford, CNNMoney.com staff writer

Does the bipartisan bailout proposal do enough to protect taxpayers?
  • Yes
  • No

NEW YORK (CNNMoney.com) -- Treasury prices soared Monday after a $700 billion economic rescue bill failed to pass in the House of Representatives, sending stocks into a tailspin.

Jitters about the depth of the credit crisis and whether the government would come to the rescue pushed investors toward the perceived safety of Treasurys, sending bond prices sharply higher.

Meanwhile, banks have the tap screwed down tightly on lending, keeping credit in a choke-hold.

Bailout: The House defeated the rescue bill Monday afternoon, following four hours of heated debate. The next steps were not immediately clear, but supporters were scrambling to put it up for another vote.

The proposed bailout plan would have pumped $700 billion into the economy in stages, with $250 billion available immediately. Lawmakers' goal was to jump-start the credit pipelines, facilitating lending between banks and to consumers.

But some market watchers wondered whether the plan was enough to fix the fundamental problems with the economy. "This bailout package is addressing the symptoms of the marketplace," said Andrew Brenner, senior vice president at MF Global. "It is not addressing the root," - the drop off in housing prices. As home values have plummeted, financial institutions that were built on mortgages have buckled.

Before the U.S. markets opened, U.S. regulators said Citigroup (C, Fortune 500) will acquire the banking operations of Wachovia (WB, Fortune 500), the nation's fourth-largest bank. As part of the deal, Citigroup will acquire Wachovia's massive deposit network, as well as over $300 billion worth of Wachovia's loan portfolio and the company's debt.

Treasurys: Treasury prices soared Monday as investors looked for a safe-haven for their assets. After lawmakers rejected the bailout bill, investors pushed prices on the notes higher.

"We have a flight to safety from the stock market to the bond market," said Michael Cheah, senior portfolio manager at AIG SunAmerica. The Dow industrials were down more than 500 points, having plummeted more than 700 points earlier in the session.

The benchmark 10-year note rose 1 31/32 to 103 3/32, while its yield dipped to 3.62% from 3.85% late Friday. Bond prices and yields move in opposite directions.

The price on the 30-year bond jumped 3 27/32 to 105 29/32, and its yield fell to 4.15% from 4.36%.

The price on the 2-year note rose 25/32 to 100 17/32, while the yield fell to 1.71% from 2.12%.

The yield on the 3-month note fell to 0.39% from 0.85% Friday as prices on the short-term notes jumped. Yields on 3-month Treasurys have remained at very low levels as demand for the notes has increased amid the uncertainty in the financial markets.

The 3-month note is a popular asset for money markets looking for stability because it offers a safe place to park cash on a short-term basis.

In order to pay for a costly rescue plan, the government would need to sell a lot more debt. Last week, the Treasury Department auctioned $34 billion in 2-year notes - the largest government debt auction in history - and $24 billion worth of 5-year notes. Both auctions attracted far more investor bids than there was debt made available.

Banks not sharing: Skittish investors have been holding onto their cash or hiding their assets in Treasurys, and nervous banks have been unwilling to lend money to other banks or to individuals.

"Banks are not willing to lend money," said Cheah.

When banks don't loan money to each other readily, businesses and consumers see higher prices on loans, including mortgages and cars, and some can't get a loan at all.

If banks do decide to lend, the borrower, be it a bank or consumer, will be slapped with a high premium.

For example, the Federal Reserve's key interest rate for banks lending to each other is at 2% but banks have been charging other banks nearly 4% to borrow money, said Cheah. Those high rates trickle down to customers, both individuals and companies.

Many companies will be able to draw on their lines of credit in the short term, said Cheah, but when that capital dries up, companies may find borrowing to be a challenge if the credit pipelines remain frozen.

Banking weakness: Banks were hesitant to lend to each other, since the government's bailout plan revealed just how weak many of the institutions are, according to Robert Brusca, economist with FAO Economics in New York.

"Two weeks ago we thought that Wachovia was a potential suitor for Morgan Stanley, now we find out they're going to be bought by Citigroup for $2.2 billion," said Brusca.

Washington Mutual fell apart last week Thursday and was quickly snapped up by JPMorgan Chase (JPM, Fortune 500). Investors were worried that more banks could fail.

Treasury buying will likely continue until the the banking system can find its legs again, added Brusca.

It's a situation that had been hinted at by the rising London interbank offered rate, or Libor, he said.

Market gauges: Two market indicators of the price of borrowing, the Libor-OIS, and the TED spread, showed a surge in the price of lending as banks have seized up.

The difference between the Libor and the Overnight Index Swaps rose to a new record high of 2.20%, according to data reported by Bloomberg.com.

The Libor-OIS "spread" measures how much cash is available for lending between banks, and is used by banks to determine lending rates. The bigger the spread, the less cash is available for lending.

In fact, the Libor rate on its own has been trending higher for some time as the European economy has stalled. The rate has stayed above 3% consistently during the past month - a level not seen since the start of this year.

"The problems in Europe are much worse than they are in the U.S.," said Andrew Brenner of MF Global.

And Europe is behind the U.S. in crafting its own rescue plan, which means a turnaround is likely still a ways off, according to Brenner.

"The international marketplace has recognized that the U.S. is way ahead in terms of addressing the problems," said Brenner. "Over the weekend, you had 5 credit events in Europe where they had to step in and defend 5 different" financial institutions.

Dutch-Belgian bank and insurance giant Fortis and British mortgage lender Bradford & Bingley were bailed out by governments, and Germany's Hypo Real Estate Holding AG secured a credit line from several other banks.

Further evidence of the squeeze, the "TED spread," showed high prices of loans between banks. The TED spread measures the difference between three-month Libor and the three-month Treasury borrowing rates. By midday Monday, it reached the widest margin since at least 1982, topping 3.44%, according to Bloomberg.com. However, the measure had retreated to 3.16% later in the day.

The retreat was partly due to the Federal Reserve's move to bolster its access to liquid funds, which relieved some pressure, said Brenner.  To top of page

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