Investors give $700B rescue plan cool reception

Wall Street gave Washington's $700 billion rescue plan for banks, brokerages, credit unions, thrifts and insurance companies a mediocre grade on Monday.

As the House prepared to vote on the package that was finalized late Sunday, stocks were poised to open lower on concerns that the measure, aimed at prying open credit markets, would not pass.

Stock futures fell sharply and demand for safe-haven Treasuries drove yields lower. The dollar was mixed, gold prices rose and oil fell.

President Bush urged Congress Monday morning to pass the banking system bailout bill, saying it is needed to "keep the crisis in our financial industry from spreading" across the economy.

Failure could lead to severe market disruptions, analysts said. But even if credit markets start to stabilize, the realities of a weak economy are likely to weigh on markets, they said.

Just after Bush spoke, the FDIC said Citigroup Inc. would acquire the banking operations of Wachovia Corp.

The move came only days after the government seized Seattle-based Washington Mutual Inc., the largest bank failure in U.S. history, punctuating the urgency of passing the plan.

"When you start thinking of the broader issues, a lot of this is very troubling," said Joseph Battipaglia, chief investment officer at Ryan Beck & Co. "We have in front of us a recession in the general economy, the consumer is dramatically retrenching their habits by cutting spending, and our financial system has sputtered. This isn't necessarily a confidence builder because now everybody knows how precarious the financial system really is."

In electronic trading early Monday, U.S. stock index futures were down, suggesting Wall Street would decline when trading opened. Dow Jones industrial average futures fell 166, or 1.49 percent, to 10,981. Standard & Poor's 500 index futures fell 20.40, or 1.68 percent, to 1,194.10, and Nasdaq 100 index futures fell 28.50, or 1.70 percent, to 1,646.25.

The yield on the 3-month Treasury bill, considered the safest short-term investment, fell to 0.63 percent from 0.87 percent late Friday. The yield on the T-bill falls as demand grows; investors are at times willing to take the slimmest returns to safeguard their principal. The yield on the benchmark 10-year Treasury note fell to 3.78 percent from 3.84 percent late Thursday.

Light, sweet crude dropped $4.40 to $102.49 in premarket electronic trading on the New York Mercantile Exchange.

Asian markets declined as investors remained wary about the time it would take to rectify the bad debt mess. Tokyo's Nikkei 225 index fell 1.3 percent while Hong Kong's Hang Seng index slid 4.3 percent.

And in Europe, stocks fell on worries about the plan's effectiveness and about the spreading contagion of banking system problems.

Dutch-Belgian banking giant Fortis NV was partially nationalized with a $16.4 billion rescue from the governments of Belgium, the Netherlands and Luxembourg, after investor confidence in the bank disappeared last week.

The British government nationalized mortgage lender Bradford & Bingley, taking over the bank's $91 billion mortgage and loan books. The Icelandic government bought a 75 percent stake in Glitnir, the country's third largest bank, for $878 million to ensure broader market stability after it suffered liquidity issues.

In Germany, the country's second biggest commercial property lender, Hypo Real Estate Holding AG, said it had secured a multibillion euro line of credit from several banks.

Meanwhile, eyes turned to Washington as the House prepared to vote on the compromise bill that lawmakers and regulators hope will set the U.S. economy on the road to recovery.

The plan would allow the government to buy toxic mortgage-backed assets from embattled financial institutions, giving them fresh cash to bolster lending. It would permit the Treasury to immediately spend $250 billion to buy banks' risky assets, provide another $100 billion at the discretion of the president, and a final $350 billion unless Congress has a change of heart and the president decides not to veto the decision.

Even if the bailout is passed — the Senate votes on it later this week — the economy remains balanced on the edge of a recession. Unemployment has been rising; it's now at a five-year high of 6.1 percent and is expected to rise as high as 7.5 percent by late 2009.

With worries running high about recessions around the world, global stock market volatility should remain elevated. And while anxiety about financial institutions could keep boosting demand for Treasury bills, pushing short-term rates down for U.S. government debt, a glut of new issues with longer maturities that must be sold to finance the rescue plan could weaken the dollar over time.

There are also plenty of U.S. banks still in trouble, and it may take time before the plan helps them.

Banks and brokerages wrote down about $400 billion worth of toxic mortgage investments since last year. Analysts believe write-downs could reach $1 trillion as rising home foreclosures further erode the values of mortgage-backed securities.

In the second quarter, the Federal Deposit Insurance Corp. estimated there were 117 banks and thrifts in trouble, the highest level since 2003. The threat of more banks failing in the U.S. and abroad forced the government to act swiftly.

"Without this rescue plan, the costs to the American economy could be disastrous," President Bush said in a statement late Sunday after the bill was completed.

Stocks have been volatile and the credit markets have been tight for over a year. The turbulence escalated to unprecedented levels a few weeks ago.

T-bill yields fell to zero for the first time since 1940 as investors pulled their money out of money-market funds and turned to the safest assets out there even if they offered no returns. The difference between those T-bill yields and bank-to-bank lending rates — a key measure of banks' willingness to lend — rose to the highest levels since 1982. And the Dow Jones industrial average swung violently, dropping to its lowest point since November 2005.

The proposed $700 billion bailout is aimed at reviving a market for mortgage-backed securities that has all but disappeared as credit has tightened.

"This gives us a much stronger background to work in compared to the past three weeks," said Ned Riley, chief investment officer of Boston-based Riley Asset Management. He added, however, that "we're still not out of the woods relative to all the other problems facing the economy, and there will be doomsayers who predict this package won't work."

The plan gave no details about how the government will buy banks' troubled assets, leaving it up to the U.S. Treasury Department to come up with the fine points. The government could price the assets very conservatively, which will mean further losses for institutions with souring debt on their books. Pricing the assets too high might leave taxpayers on the hook.

After the events of the past few weeks, analysts believe Americans are even angrier and more distrustful of the U.S. financial system. Many have watched their stock portfolios and nest eggs plummet in the past few weeks, and are going to be more unwilling to take risks.

"Who is going to want to borrow to buy a new home in this environment?" Battipaglia said.

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