July 14 (Bloomberg) -- Treasuries gained, pushing two-year note yields down the most in more than two weeks, as stocks fell on concern that U.S. banking-system losses may be worsening.

Predictions of wider losses overshadowed the Treasury Department's support of Freddie Mac and Fannie Mae. Washington Mutual Inc. posted its biggest drop ever and National City Corp. tumbled to a 24-year low after last week's collapse of IndyMac Bancorp Inc. spurred speculation that more regional banks may be short of capital.

``There's a significant amount of grave concern about the banking sector,'' said T.J. Marta, a fixed-income strategist at RBC Capital Markets in New York, the investment-banking arm of Canada's biggest lender. ``Now what we're having is solvency concerns.''

The yield on two-year note fell 15 basis points, or 0.15 percentage point, the most since June 26, to 2.46 percent at 4:07 p.m. in New York, according to BGCantor Market Data. The price of the 2.875 percent security due in June 2010 rose 9/32, or $2.81 per $1,000 face amount, to 100 25/32.

The benchmark 10-year note's yield declined 10 basis points, the most since June 6, to 3.86 percent. It earlier touched 4.02 percent, the highest since July 2.

Treasuries initially declined after Treasury Secretary Henry Paulson put a plan before Congress to provide support to Fannie and Freddie, the government-sponsored enterprises that purchase or finance almost half of the $12 trillion of U.S. mortgages.

Housing Recession

The Standard & Poor's 500 Index lost 0.9 percent. Washington Mutual, the biggest U.S. savings and loan, and National City, Ohio's largest bank, led the steepest decline in bank stocks in almost two decades.

``We all know they can't allow Fannie Mae and Freddie Mac to go under, but that doesn't mean they can't allow other institutions to go under,'' said Jeff Given, part of a group that manages $10 billion of bonds at MFC Global Investment LLC in Boston.

Paulson's announcement yesterday followed talks between the two mortgage-finance firms, government officials, lawmakers and regulators after Fannie and Freddie lost about half their value last week, stoking demand for the relative safety of government assets. The Federal Reserve separately authorized the firms to borrow from the central bank.

The Treasury secretary and Fed Chairman Ben S. Bernanke are trying to prevent a collapse of the companies that would exacerbate the worst housing recession in 25 years and deepen the U.S. economic slowdown.

Freddie's Auction

Freddie Mac drew higher-than-average demand for $3 billion of short-term notes today as the U.S. Treasury's rescue plan buoyed confidence the government will back the company's debt. The bid-to-cover ratio at Freddie Mac's bill auction, gauging demand by comparing total bids with the amount of securities offered, was more than 50 percent above the average of the past three months, according to Stone & McCarthy Research Associates.

Treasuries may reverse course before Bernanke delivers his semiannual testimony on the economy and monetary policy to Congress tomorrow, said Christoph Rieger, a fixed-income strategist at Dresdner Kleinwort in Frankfurt.

``The main event of this week is Bernanke's testimony,'' Rieger said. ``We see the risk of more selling, especially of two-year notes, as it's going to be difficult for Bernanke to be dovish in any way. We're expecting yields to move higher.''

Lending confidence at banks dropped to the lowest level since May 1 on revived concern credit losses will deepen. The so-called TED spread, the difference between what the U.S. government and banks pay to borrow in dollars for three months, was 1.34 percentage points.

Inflation Signs

Futures contracts on the Chicago Board of Trade show 39 percent odds the Fed will raise rates by at least a quarter- percentage point from 2 percent at its Sept. 16 meeting, down from an 87 percent probability a month ago.

Economists forecast that reports this week will show inflation in the U.S. accelerated. Prices paid to producers may have gained an annualized 8.7 percent in June, compared with a 7.2 percent rise in May, according to a Bloomberg survey.

Consumer prices may have advanced 0.7 percent in June from the previous month, according to a separate survey. The Labor Department is scheduled to release the reports on producer prices tomorrow and consumer prices on July 16.

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Sandra Hernandez in New York at shernandez4@bloomberg.net

Last Updated: July 14, 2008 16:12 EDT