Small caps dragged down by bailout jitters, WaMu

After a green day on Thursday, small caps opened lower on Friday, after it became evident that lawmakers could not come to an agreement on the $700 billion bailout plan and after Washington Mutual (NYSE:WM), one of the nation’s largest thrifts, failed.

At 10:07 a.m. ET the Russell 2000 (NYSE:IWM) was down 10.20, or 1.45%, to 695.54.

Federal regulators seized Washington Mutual on Thursday after it became evident to the Federal Deposit Insurance Corp. that there had been such a large run on deposits that the bank no longer had sufficient liquidity to continue operating. WaMu’s failure marks the biggest bank failure in U.S. history. After taking over the bank, regulators struck a deal with J.P Morgan (NYSE:JPM) to sell the majority of WaMu’s operations to the bank for $1.9 billion. As a result of the deal, JP Morgan supersedes Bank of America as the largest bank in the nation as measured by deposits. The fact that no banks were willing to purchase WaMu until it failed is a sign of the market’s low confidence in the system and is all the more reason for a bailout plan to pass to restore confidence.

Negotiations over the $700 billion bailout plan continue on Capitol Hill after what appeared to be a strong compromise unraveled after a meeting at the White House with Congressional leaders and Presidential candidate hopefuls. The compromise was put on hold after the House Republicans presented an alternative plan that would allow banks to purchase insurance for toxic mortgages instead of relying on taxpayer money. President Bush made a statement this morning to try to reunite Congress behind the plan. The President said, “We are going to get a package passed.”

Fears that the bailout plan is stalling, saw angst continue to overtake the credit markets. The spreads between three-month Libor to three-month Overnight Index Swap are higher and continue to point to a complete collapse of lending between banks. Short-term money markets continue to be enveloped in disarray. Yields on the one-month to six-month treasures are surprisingly higher this morning and remain in positive territory, while yields on the two-year and ten-year treasuries . . .

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