Bail-out fears hit money markets

Money markets seized up once more on Wednesday amid deepening uncertainty about whether Congress will approve the Bush administration's $700bn financial rescue plan and whether revised proposals would succeed in restoring confidence.

The rates that banks charge each other soared as investors sought the safety of short-dated US government debt – and US officials struggled to address mounting objections to the rescue plan in Congress and beyond.

On Wednesday, John McCain, Republican nominee for president, said he would suspend his campaign on Thursday in order to return to Washington and join talks on the bail-out effort. The Arizona senator also asked for a postponement of Friday night's scheduled debate with Barack Obama, his Democratic opponent.

Ben Bernanke, Federal Reserve chairman, argued against suggestions that the scheme would pay too much for distressed assets, and the head of the Congressional Budget Office warned lawmakers of possible "chaos" if Congress does nothing.

"You would have a financial market meltdown that would cause very severe dislocations . . . maybe on the magnitude of the Great Depression," said Peter Orszag, the CBO chief.

The flight to safety drove the yield on three-month Treasury bills below 0.5 per cent, down from 1.45 per cent just two days before. The benchmark three-month London interbank offered rate jumped 26.5 basis points to 3.476 per cent.

New data showed existing home prices suffered a record drop in August, weakening the US dollar and deepening concern over a rising tide of home foreclosures and loan defaults.

"A confluence of fiscal pain has all hit at the same time," said William O'Donnell, strategist at UBS, highlighting "the swirling uncertainty over the Treasury rescue package" as well as after-effects from the collapse of Lehman Brothers and a traditional repatriation of funds due to the Japanese half year.

Although Democratic and Republican leaders, including the party's presidential nominees, have called for a bipartisan effort to address the financial crisis, they have all also expressed deep misgivings about the current proposal.

In a poll by the Los Angeles Times and Bloomberg, 55 per cent of respondents said they did not believe taxpayer dollars should go to rescue financial groups. John McCain, the Republican presidential nominee, has refused to commit himself to supporting it.

The Bush administration has signalled that it will accept more oversight of the programme than it had originally envisaged and has come under overwhelming pressure from both parties to include curbs on executive pay for companies assisted by the programme.

Mr Bernanke and Hank Paulson, US Treasury secretary, have also found it difficult to persuade legislators this week of the merits of the plan.

Speaking to the Joint Economic Committee of Congress on Wednesday, Mr Bernanke addressed legislators' concerns that the plan would buy toxic assets at artificially inflated prices.

"I am not advocating that the government intentionally overpay for the assets," he said, as a series of Congresssmen on the committee indicated unease.

Additional reporting by Reuters

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