Oct. 14 (Bloomberg) -- The cost of protecting corporate bonds from default fell in anticipation the Bush administration will announce plans to invest in nine U.S. banks including JPMorgan Chase & Co. and Goldman Sachs Group Inc.

The Treasury will spend about $125 billion in its latest attempt to shore up confidence in the financial system and will guarantee banks' newly issued senior unsecured debt for three years, people familiar with the proposal said.

``This should help ease some of the immense stress in credit markets,'' said Jim Reid, the London-based head of fundamental credit strategy at Deutsche Bank AG. Markets remain at an ``incredibly dysfunctional level,'' he said.

Credit-default swaps on the Markit iTraxx Europe index fell 6.5 basis points to 121.5, according to JPMorgan Chase & Co. prices at 10:29 a.m. in London. In Tokyo, Japan's benchmark credit-risk index dropped 42.5 to 182.5, Morgan Stanley prices show. That's the most since the gauge began trading in 2004, according to CMA Datavision.

The seven other U.S. banks in which the Treasury will take stakes are Citigroup Inc., Wells Fargo & Co., Bank of America Corp., Morgan Stanley, State Street Corp., and Bank of New York Mellon Corp., said the people. One of the people also said Merrill Lynch & Co. will receive an investment.

Credit-default swaps on Morgan Stanley dropped 182.5 basis points to 800, and Citigroup Inc. fell 22 to 200 in European trading, according to CMA.

iTraxx Financial

Contracts on the Markit iTraxx Financial index of 25 European banks and insurers fell 5 basis points to 90, JPMorgan prices show. Credit-default swaps linked to BNP Paribas SA fell 14.5 basis points to 39 and Royal Bank of Scotland Group Plc slid 9.5 to 84.5, CMA prices show.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality; a decline signals the opposite.

A basis point on a credit-default swap contract protecting 10 million euros ($13.7 million) of debt from default for five years is equivalent to 1,000 euros a year.

The three-month rate banks charge for euro loans dropped by the most since Dec. 28 yesterday after policy makers offered banks unlimited dollar funding and European governments pledged to take ``all necessary steps'' to shore up confidence among lenders.

Japan and Australia pumped $12.9 billion into the financial system today to help unlock money markets. Japan's overnight call loan rate fell to 0.58 percent after the operation at 9:11 a.m. in Tokyo, from 0.65 percent before the injection, according to Tokyo Tanshi Co.

To contact the reporters on this story: Oliver Biggadike in Tokyo at obiggadike@bloomberg.net;

Last Updated: October 14, 2008 05:36 EDT