It's never pretty on Wall Street when the action in Washington rules the markets.

That's certainly been the case this week, while Congress wrestles with the merit and shape of the $700 billion financial markets rescue package, proposed by Treasury Secretary Hank Paulson. The bailout debate promises to be the dominant theme for markets again on Thursday though the hearings with regulators have ended.

But President Bush has called a meeting at the White House for Thursday that will include the leadership of both parties and presidential candidates Democratic Sen. Barack Obama and Republican Sen. John McCain. The two candidates in fact may have soothed some of the markets' fears with a joint statement Wednesday evening supporting the idea of a rescue plan. (Watch Bush's address to the nation on the bailout plan)

The discussions on Capital Hill have unleashed volatility in the stock market, but the real action has been in the world of credit. The Dow Wednesday moved in a more than 170 point range, finishing down just 29 points at 10,825. The S&P 500 was off 2.35 at 1185.87.

In credit markets, the fear factor was high and you could virtually hear the flight to quality at the low end of the yield curve. The one-month London Interbank Offered Rate (Libor) jumped 22 basis points to 3.43 per cent from Tuesday's level. Just look at the two-year swaps spread, at 160 basis points Wednesday, above the level in last week's panic and a record level. Spreads widened dramatically across the credit markets as demand for short-term Treasury bills intensified.

• Bush Says US Is in Midst of Serious Financial Crisis

"You just don't get moves like this and get good reasons why. This is a multiple standard deviation move, relative to where you thought it could go a few months ago. This is really operating in unchartered territory," said Deutsche Bank Chief U.S. economist Joseph LaVorgna.

"I think it represents a confluence of factors. One is the profound spillover of Lehman, which certainly has added stress not just in the CDS market but in the money market. Importantly and maybe more so is what is shaping up as a very difficult quarter end," said LaVorgna. "Quarter end is typically when people horde liquid assets and that generally is the case. I think this quarter end is shaping up to be the mother of all quarter ends."

Credit strategists and traders say perhaps the biggest concern is that the Treasury plan will not work. There seems to be a building consensus though that it will get approved but with lots of strings attached. The possibility that it will be rendered ineffective by modifications in the approval process is the big worry.

"People are afraid this (rescue) might not happen," said one trader Wednesday afternoon. "You're seeing two-year swap spreads gapping out. Liquidity markets are completely shut, and when that happens it's a problem. Banks don't trust each other, and there's no such thing as an unsecured loan."

LaVorgna said there's no road map for the markets. "All of this is happening so fast. You can't say what the spillover will be -- high yield, high grade, libor to Fed funds, agency to governments. Everything other than a Treasury security looks on paper to be very cheap," he said. "... It's not about the price of credit. It's about the availability of credit. That is the key."

Econorama

There are a few data points to watch Thursday though it is unlikely the markets will pay much attention. Weekly jobless claims are released at 8:30 a.m. as are durable goods for August. New Home sales are reported at 10 a.m.

For Investors

• Watch What Buffett Is Doing: Pros
• How to Trade the Proposed Bank Bailout
• Cramer: Sell, Sell, Sell This Market
• Money Market Freeze Needs to Be Fixed
• S&P to Fall Another 40%: Analyst
• Banks After Lehman: Winners & Losers

It will not be long before Wall Street's focus swings back to the economy, and economists I've been speaking to expect it to look worse before it gets better.

"As crazy as it sounds, the fact that gasoline prices have been moving down has probably been an offset," to the credit issues, said LaVorgna. "The credit markets didn't really start to deteriorate wasn't until after Fannie and Freddie two weeks ago."

In New York Wednesday, Coca-Cola's Chairman Neville Isdell warned that Congress needs to act quickly on a rescue. "Unless those actions are taken quickly," the U.S. could fall into a deep recession. "Our whole system is under threat. It is always the cash flow that causes recessions. It is always that that drives companies out of business. We've got to solve it now." 

Markets Mayhem

Otherwise in Thursday's market, oil finished at $105.73 per barrel, down $0.88. Gasoline futures fell $0.03 cents per gallon to $2.5947 per gallon.

The 10-year Treasury gained 19/32, lowering its yield to 3.771 percent. The two-year gained 11/32, lowering its yield to 1.936 percent. The dollar gained 0.6 percent against the euro.

Questions?  Comments?