CORRECTED - TREASURIES-Prices fall on supply fears, waning safety bid

(Corrects description of source in paragraph 12 to "industry source" from "a source familiar with the discussions")

* Prices fall as modest stock losses let safety bid wane

* Supply fears weigh; Treasury need to fund bailouts eyed

* September consumer sentiment jump hurt Treasury prices

* Weak retail sales gave Treasuries early, brief lift (Updates analysts' quotes, prices)

By Ellen Freilich

NEW YORK, Sept 12 (Reuters) - U.S. Treasury debt prices fell on Friday as fear that the Treasury's recent interventions in the financial sector would lead to more debt issuance weighed on prices.

A modicum of stability in the stock market also sapped the safe-haven bid for lower risk government debt.

Bonds rose early in the session when the government reported unexpectedly weak consumer spending in July and August, adding to the recessionary cast of the economy.

When stocks struggled back from steep early losses, however, bonds reversed themselves and turned lower.

Benchmark 10-year Treasury notes US10YT=RR fell 21/32 in price, their yields rising to 3.72 percent from 3.65 percent late on Thursday.

Two-year notes US2YT=RR, which typically benefit from any safe-haven bid, ended unchanged, yielding 2.22 percent.

Investors spent the day focusing on the state of U.S. financial companies and trying to divine the future of investment bank Lehman Brothers Holdings Inc LEH.N.

Lehman LEH.N executives, potential buyers and government officials struggled on Friday to craft a buyout plan, ahead of what is expected to be a series of intense discussions this weekend between Lehman and potential bidders.

Bank of America Corp (BAC.N) is widely seen as a leading contender, with British bank Barclays Plc (BARC.L) also considered a possibility.

"There was a fair amount of position squaring because we've been getting bank failures on Friday and workouts happening on Saturday and Sunday," said Kevin Giddis, managing director and head of fixed-income trading at Morgan Keegan in Memphis Tennessee.

"We're setting up this weekend for a big one. WaMu, Lehman, Merrill Lynch... these are companies that could really turn the financial markets on its heels," he said.

JPMorgan Chase & Co (JPM.N) is in advanced discussions to acquire Washington Mutual Inc (WM.N), an industry source said on Friday.

"Everyone feels that we'll hear something over the weekend about at at least one of these companies," said Jill King, vice president and senior portfolio manager at Horizon Cash Management in Chicago. "If we don't, stocks will fall out of bed on Monday and Treasuries will rally."

Other financial companies whose shares plunged on Friday, included leading brokerage Merrill Lynch & Co Inc MER.N and American International Group Inc (AIG.N), once the world's largest insurer by market capitalization. AIG lost as much as a third of its value, while Merrill slid 11 percent.

Meanwhile the yield curve steepened, with the difference between short- and longer-term yields widening.

"Among shorter-dated Treasuries, yields are steady or going down a bit as they factor in the outside possibility that if unemployment worsens further, the Federal Reserve's next interest-rate move could be an ease," said Doug Roberts, chief investment strategist at Channel Communications in Shrewsbury New Jersey. "But yields are rising on longer-dated maturities because financial sector bailouts could lead to a fair amount of new Treasury issuance hitting the market; there's a concern that long-term Treasuries will start to flood the market."

Economic data released on Friday morning painted a mixed picture for the economy. The government said total sales at U.S. retailers in August fell 0.3 percent after a sharply revised 0.5 percent drop in July that previously was reported as only a 0.1 percent decline.

The data was seen by analysts as further evidence the U.S. may be falling into recession, and gave bonds an early boost.

The government also said U.S. August wholesale prices dropped by a bigger-than-expected 0.9 percent, the sharpest retreat in almost two years. Core prices, which strip out food and energy costs, rose 0.2 percent as expected after a 0.7 percent surge in July that had fanned inflation fears.

Things turned more bearish for bonds after The Reuters/University of Michigan Surveys of Consumers said U.S. consumer confidence soared unexpectedly to an eight-month high in September, with lower fuel prices soothing inflation fears and making Americans more hopeful about the economy.

Five-year Treasury notes US5YT=RR were trading 3/32 lower in price for a yield of 2.96 percent from 2.93 percent late on Thursday, while 30-year bonds US30YT=RR were 1-17/32 lower for a yield of 4.32 percent from 4.23 percent on Thursday.