Credit markets begin to thaw

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By Patrice Hill and Jon Ward

An unprecedented $3 trillion of cash is being pumped into the banking system worldwide - potentially one-third of it from the U.S. Treasury - and it finally started to unglue stuck credit markets Tuesday.

The massive Treasury plan to bolster the nation's banks got near universal praise on Wall Street. Investors rushed from safe havens such as gold and Treasury bills, where they have sheltered money during the past month of market turmoil, and piled into other markets from commercial paper to municipal bonds.

Bond investors bailed out of Treasuries and dove into other credit investments in part because of a huge increase in Treasury issues needed to fund its $250 billion bank recapitalization plan - which some analysts think will help push the budget deficit and Treasury borrowing past $1 trillion this fiscal year.

"The great global banking crisis of 2008 looks over," said Hugo Dixon, analyst with Breakingviews.com, noting that the combined effort of European nations and the United States was massive enough to make a difference in credit and money markets that trade in tens of trillions of dollars each day. "It should be big enough to restore confidence, unfreeze money markets and get banks lending to each other again."

But the cost will be a ballooning federal budget deficit, which the White House said can be expected to rise from $455 billion in the year ended last month to $732 billion or more this year. Treasury borrowing could be even higher: The Treasury disclosed Tuesday that it already has borrowed an extra $300 billion in the past few months to fund bank rescue programs, and the obligations to fund banks will only widen this year.

In a sign of thawing, short-term bank lending rates dropped and California made headway selling $4 billion of short-term notes, although investors were demanding significantly higher interest rates that prompted Ohio, Massachusetts and other states to delay their offerings.

While the acute credit crisis may be ending, "the economic crisis is not," Mr. Dixon said. Analysts expect the economy to experience fallout from the Wall Street crisis for months to come, including thousands of job losses, business closings and consumer retrenchment as loans remain hard to get.

Brian Bethune, chief U.S. financial economist at Global Insight, said the Treasury plan came at a critical time when many banks had reached the end of their ability to raise funds on their own and faced the prospect of insolvency and failure without such "massive" assistance.

"The Treasury secretary and the chairman of the Federal Reserve have finally declared war on the financial crisis, and this may well represent a critical turning point," he said.

But the implications for the U.S. budget deficit and borrowing are immense, he said, predicting that the Treasury will return to Congress later this year or next to ask for more funds to aid banks. In addition, members of Congress are considering a second economic stimulus plan that could add another $300 billion to the deficit.