The immediate costs of bailout plan

Pessimism rules the day on world markets

Investors who had the weekend to think over Washington's $700 billion financial bailout plan came back to work worried yesterday.

The stock market sank, the dollar fell hard, and commodity prices moved higher. Taken together, the world's markets were painting a pessimistic picture.

A simple reality seemed to set in: $700 billion really is a lot of money. Especially when you don't have it.

The sheer scale of the proposed bailout prompted two investment themes, both of them downers. Some investors worried that so much government spending would spark inflation, while others became more convinced than ever that America's economy was stalling. Either way, more deficit spending on that scale could only hurt.

Stocks, which had climbed sharply higher in the two previous sessions, lost ground around the world. Declines ranged from 1 or 2 percent in Europe to just over 4 percent on the Nasdaq index. The Dow Jones industrial average dropped 372.35 points to 11,016.09, or 3.3 percent.

The dollar had a very bad day, hurt by those inflation fears. It fell the most against the euro since the European currency's debut in 1999, dropping 2.3 percent, and slumped about 1.8 percent against the yen. Traders predict it will fall further.

Commodities climbed in value. Oil soared, posting its biggest one-day gain ever. It jumped more than $25 a barrel at one point yesterday and eventually gained $16.37 for the day to settle at $120.92, just days after trading below $100. But technical issues may have driven those October contract prices artificially higher. Prices of oil for November delivery climbed more moderately, gaining about 6 percent to $109.37 a barrel. Higher oil prices were a hedge against a falling dollar.

Gold prices rose to over $900 per ounce, extending gains from last week. Gold for December delivery climbed $44.38 to $909 an ounce. The flight to safety hasn't gone out of style this week.

One ray of good news out of financial markets: short-term US Treasury securities. Treasury bills that mature in three months or less continued to recover to more normal prices. Investors who stampeded into those securities in a near panic had driven yields to nearly zero percent last week.

Three-month Treasury bills yielded 0.83 percent yesterday. That's just half what the same securities yielded a month ago, but the recent climb still suggested a continued recovery in short-term credit markets.

All these markets were pushed up or down based mostly on investor reaction to the government's bailout plan, even though new information was limited.

Of course, there is no shortage of unknowns when it comes to the bailout plan. No one knows how much money the government will actually draw down in its efforts to reestablish securities markets connected to home loans, or how much it will ultimately recoup.

The real price tag is anyone's guess. But many fear it will be very large and the government will have to come up with a huge amount of money to invest in the short term.

Big deficit spending is usually a reliable way to jack up inflation and hurt the value of the dollar. But other investors are unconvinced prices will head higher in this case.

"In the short term, I'm hard pressed to see how this is inflationary," says Ken Taubes, head of US portfolio management at Pioneer Investments in Boston. "A credit crisis of this magnitude is quite disinflationary, if not deflationary. Asset value is being destroyed and lending isn't happening."

That isn't good for the economy or the stock market, at least in the short term. Stock prices acted that way across the board yesterday.

Declines suffered by big stock market indexes were as wide as they were deep. Just 33 stocks included in the Standard & Poor's 500 index advanced yesterday, while 466 lost ground. All 10 industry groups in the index lost at least 1 percent of their value.

Bank stocks were among the biggest losers of the day, in part reflecting uncertainty about how the government bailout plan will reshape the financial services landscape. The S&P 500 Banks index plunged 12 percent, the most since the measure was created 19 years ago. Merrill Lynch recommended selling most small and midsize banks because the government plan would probably hurt them more than help.

One bad day in the markets isn't the end of the world, especially after investors had reacted so bullishly immediately after the government bailout plan emerged. But anxiety over the plan's vast unknowns and the real danger involved are nothing to shrug off.

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