Loan costs soar as access tightens

— -- If the credit markets are truly the lifeblood between Wall Street and the economy, that artery suffered a major shock Monday.

Unnerved by the House of Representatives' unexpected blockage of the proposed $700 billion financial bailout plan, credit markets constricted further as investors got even pickier about to whom they would lend money and gravitated to only the safest borrowers, including the U.S. government.

The bond market's tightness is presenting businesses and consumers with dramatically higher interest costs and less access to loans, the last thing the economy needs as the global financial system slows.

"Credit is a lifeline to our economy. This is extremely serious," says Robert Gahagan, director of taxable bond investment at American Century Investments. "This will cause good firms to not have the ability to get credit."

The flight to safety was clear in the:

•Rush for government securities. The race into Treasuries, especially the ones considered safest because they mature the soonest, showed just how nervous bond investors have become.

Investors scrambled to buy the safest security they could find: three-month Treasury bills. The three-month yield sank to 0.14% from 0.87%. That's a big decline considering that the Treasury increased the supply Monday by selling additional securities, says Tom di Galoma at Jefferies. Investors also piled into 10-year Treasuries, pushing the yield down to 3.58% from 3.86%, the biggest decline since Sept. 15 after Lehman's collapse and Merrill Lynch's forced sale to Bank of America, Bloomberg News says.

On Tuesday, the yield on the 3-month T-bill recovered to 0.62% as the Dow Jones industrial average rebounded somewhat.

The T-bill yield is still very low by historical measures, however — particularly when compared to lending rates between financial institutions.

"It's been, 'Buy the safest asset you can: Treasury bills.' That's where everyone is hiding," di Galoma says. "Money is flowing out of stocks and into bills."