Fear index sinks Dow by 449

And this is how markets react after the government saves American International Group Inc. instead of letting the insurance giant sink into bankruptcy?

If financial markets had such a thing as a fear index, it would have jumped off the charts yesterday. Investors ran from any kind of risk and stuffed their money in the safest possible places short of a mattress. That was after the Federal Reserve had agreed to loan AIG up to $85 billion to keep the business and its obligations afloat Tuesday evening.

Simple fear may only be part of the story. Financial dominos tumbling out of the Lehman Brothers Holdings Inc. bankruptcy earlier this week and the AIG fiasco also appeared mixed up in yesterday's events. They had a grip on all kinds of markets around the world.

Start with the US stock market, which bounced around all day but plunged in the last half hour of trading to lose more than 4 percent for the session. The Dow Jones industrial average sunk 449.36 to 10,609.66. The index is down 813 points for the week.

Shares of the last big brokers standing, Morgan Stanley and Goldman Sachs Group Inc., fell hard yesterday despite profit reports earlier in the week. Morgan Stanley was reportedly fielding calls from commercial banks interested in buying the company.

Step over to the government securities desk: US Treasury three-month bill rates dropped to their lowest level since World War II yesterday, pressing buyers to accept 0.036 percent interest. That's not a misprint. Treasury bill interest rates go down when demand from buyers pushes prices up. Demand, to put it mildly, was sky high.

On to the commodities pits: Gold, the ultimate safe investment, soared the most in nine years by gaining an astonishing $70 to settle at $850.50 per ounce. Silver jumped 11 percent to $11.675 per ounce, its biggest one-day advance since 1979. Even oil prices, which had been falling earlier this week, moved higher.

What about loans between banks? Don't ask. Banks hoarding cash drove those rates sharply higher. The so-called TED spread, which measures the difference between borrowing rates for banks and the Treasury, jumped to its widest gap since Oct. 20, 1987. That was Black Monday, when stock prices around the world collapsed.

Finally, there was the performance of other stock markets around the world. Most are having even worse years, if you can believe it, losing about 30 percent of their value and falling hard this week. Russia halted stock trading for a second day yesterday and pumped $44 billion into the country's three largest banks to head off its own financial crisis.

Put all those grim facts together and you can grasp just how much anxiety was rushing through financial markets yesterday. At this moment, it's probably the most fearful world market since the crash of '87.

But some of the day's events are surely connected, even if it's hard to say exactly by how much. Consider the amazing demand for short-term US Treasury securities.

The ultralow rate on three-month Treasury bills had a lot to do with one money market fund breaking the buck, losing money on investments that drove the fund's price below a constant $1 per share. The $62 billion Reserve Primary Fund became the first money market fund to do that in 14 years on Tuesday. Its problem investments: Securities issued by Lehman.

Where do investors go if they fear their money markets are no longer rock solid? Individuals might put their cash in a bank deposit, but that's not a practical option for most businesses. Those companies will put their money into short-term Treasuries and accept pathetic interest rates in return for safety. That's what they did yesterday, moving like a stampeding herd.

Soaring gold prices are certainly a reflection of investment fear. But who is trading and what threat drives them to act? Events in Russia probably had as much impact on precious metals prices as anything that happened at AIG and Lehman.

Other problems, like the reluctance of banks to lend each other money, are a recognition that no one knows how financial failures are going to shake through the world. Who had money on the line with Lehman, or got hurt with Freddie? It's not all obvious right away and banks would rather wait than take a chance.

Governments have a limited playbook when they try to calm financial markets gripped by fear. Liquidity, pumping money into the financial system, is the most important thing they can provide. But the Federal Reserve has backstopped so many collapsing financial giants, it needs to draw more cash itself from the US Treasury.

Investors and bankers will get over their anxieties eventually. But the fear index is sky high for now.

Steven Syre is a Globe columnist. He can be reached at syre@globe.com.