Financial System Suffers Relapse

"The economic news continues to be quite bleak," said Peter Cardillo, chief market economist with New York-based Avalon Partners. "We have a market that is pricing in a global recession that will probably last longer than most people anticipated."

And investors are coming to grips with the limitations of the government's response. Treasury secretary Henry M. Paulson Jr. said this week that he would not seek the remaining $350 billion of the $700 billion rescue package Congress approved last month, instead leaving the balance for the Obama administration to use come January.

Paulson also said last week that he would not be using any of the bailout money to buy up troubled assets from the books of banks, so hope has dissipated that the market for complex mortgage securities will start functioning soon. Investors had hoped that government purchases would jump-start that market by establishing new prices that could open the door for the return of regular buying and selling.

Wall Street interpreted Paulson's comments to mean that the financial rescue is on hold until President-elect Barack Obama's inauguration. And Wall Street was none too pleased.

"It's a complete loss of confidence," said Allen Sinai, president of Decision Economics, a consultancy. "We made our errors in the 1930s by letting the banking system go down. . . . We haven't done that. But history will write that we made a lot of other mistakes and left ourselves with a modern-day counterpart to the 1930s situation."

Bank lending, which increased steadily in October as financial firms became more confident that the rescue would work, has fallen recently, according to Federal Reserve data, suggesting that credit will remain constrained in the near future.

J.P. Morgan Chase is expected to lay off 10 percent of its investment banking staff, or about 3,000 people. Goldman Sachs shares fell to below the price at which they were first sold to the public almost a decade ago.

The simplest measure of the health of the financial system is the price the U.S. government must pay to borrow money by issuing bonds. When investors are fearful, they are willing to accept low rates to lend to the government just to guard against losses or the risk that they won't be able to access cash.

Yesterday, investors were petrified. Rates on all types of U.S. government debt fell to all-time lows; the Treasury can now borrow money for two years at a rate of less than 1 percent, and can borrow money for 30 years for less than 3.5 percent.

For 30-day Treasury bills, the rate is effectively zero, which means, with transaction fees, that investors are essentially paying for the government to take money out of their hands for a month.

Conversely, rates soared on all types of risky debt. Rates have spiked on "commercial-mortgage-backed securities," which are loans against office buildings and other commercial property, and on debt owed by companies that are considered uncertain bets.

"The market is hungering for stability, and it isn't getting it from the government. They're not getting it from the economy, and their only recourse is to sell," said Matt McCormick, portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel.

The Treasury said yesterday that it stands ready to buy assets from the Reserve Fund's U.S. Government Fund, a money-market mutual fund with $6.3 billion in assets, under a temporary program it initiated last month to bolster money-market funds. That would make it easier for the fund to handle redemption requests by its investors.

Also casting a pall on the broader market was uncertainty about the future of the U.S. automakers. With Congress struggling to reach accord on a rescue of General Motors, Ford and Chrysler, investors were weighing the prospect of further job losses among autoworkers and auto parts suppliers and of ripples through the financial system.

"The market is fearful of the consequences if Detroit is allowed to fail and what that would mean in terms of further economic decay," said Cardillo, of Avalon Partners.

The economic and financial distress continues to drive down prices of fuel and other commodities.

Crude oil closed below $50 a barrel yesterday for the first time since 2005, and has now has fallen more than 65 percent from its peak of $147 a barrel this summer. Some analysts are forecasting prices of $35 to $45 a barrel by year's end, levels that would have been unthinkable just this summer, reflecting sharply declining global demand.

Traders are ignoring triggers that would have traditionally sent prices up, including a Saudi-owned supertanker seized by pirates off Somalia, which could disrupt shipping routes, said Addison A. Armstrong, director of market research at Connecticut-based Tradition Energy. "There are bullish factors out there," he said, "but the market is just ignoring them because they are more focused on the collapse of the financial system."