NEW YORK Fear that Greece may default on its debt reached new heights on Thursday, so much so that anxious investors were willing to pay to lend their money to the safest borrower they could think of -- the U.S. government.
European banks, meanwhile, faced higher short-term borrowing costs as investors fretted about their exposure to Greece and other indebted euro zone countries.
Not everyone thinks a default in tiny Greece would provoke the sort of losses and panic that rippled across world markets when Lehman Brothers collapsed, but for now, it seems few investors were willing to bet their portfolios on that.
"I suspect that many in Europe, and in the U.S., for that matter, are experiencing many of the same types of anxieties we felt here during those dark days in late 2008," said Kevin Giddis, managing director of fixed income at Morgan Keegan.
Investors worry that default in Greece or Portugal would hurt not only the European banks who hold their debt but also the U.S. money market funds that have invested heavily in those banks' high-yielding, short-term paper.
Such losses conjure up painful memories of 2008, when money funds exposed to short-term Lehman paper suffered a bank run that froze credit and pushed markets to the brink of collapse.
"We've been inundated by inquiries on (our) exposure to French banks, to German banks, our direct exposure to Greece," said Peter Li, director in money markets at Northern Trust. "The profile of our portfolios has gotten very, very conservative."
Sources said Thursday that Greece had won consent for a new five-year austerity plan from the European Union and International Monetary Fund but details were not yet clear.
The Greek parliament still must approve a set of unpopular spending cuts and tax increases by July 3 to obtain a 12 billion euro slice of emergency aid. Without help, the Greek government has said it will be unable to pay its debts by mid-July.
U.S. TREASURY BILLS IN DEMAND
Fitch Ratings estimated this week that as of May 31, the 10 largest U.S. money funds had half of their $755 billion invested in places that may be exposed to European banks.
In the last few days, though, there are signs that funds are trying to cut exposure to euro zone countries.
That's whet investor appetites for short-term U.S. government paper, valued for its relative safety and the ease with which investors can buy and sell it.
Rates on one-month U.S. Treasury bills have traded in negative territory each day this week, according to Tradeweb, and on Thursday, the three-month rate briefly turned negative for the first time since December 2008.
That means investors were willing to pay the government for the privilege of lending them money -- a sign that, at least for the moment, return of capital is more important than return on capital.
U.S. three-month Treasury bills yields were last bid on Thursday at 0.0125 percent, according to Tradeweb, while one-month bills yields were bid at 0.0025 percent.
BANK BORROWING COSTS TICK HIGHER
Banks were starting to feel the pinch as well.
The rate that Deutsche Bank said it had to pay for short-term unsecured loans from other banks rose, according data it submitted on Thursday to the British Bankers' Association.
The BBA compiles the London interbank offered rate, a benchmark for short-term credit.
"There's concern about the European banking system out there," said John Brady, senior vice president, interest-rate products at MF Global, Chicago.
"This morning in the Libor submissions, Deutsche Bank, which has been a low submitter all year long, raised their offered rate in all tenors of Libor, and the market's a little spooked right now."
Market sources said rates on the commercial paper issued by French banks have drifted higher over the last month, though one trader stressed they are not yet trading as if they are "extremely stressed credits."
Even so, analysts said it showed that unease about Greece's future was having definite effects across money markets.
"As money market funds pull their money out of European bank commercial paper and European bank CDs, it's going to drive up the borrowing rates in the money markets for banks," said Roseanne Briggen, analyst at IFR Markets, a unit of Thomson Reuters.
Jeff Given, portfolio manager at ManuLife Asset Management, said the rise in borrowing costs for German, French and Dutch banks has been gradual and may prove temporary if Greece's problems don't spread to other countries.
"Greece is a relatively minor problem. It's not going to cause SoGen and BNP to go out of business," he said. "The 800-pound gorilla is Spain."