Governments on both sides of the Atlantic took radical steps to restore confidence in battered financial markets on Thursday, as the United States proposed a taxpayer-funded mopping up of toxic mortgage-related debt and Britain cracked down on short selling of bank stocks.
The impact was immediate and dramatic, driving the U.S. stock market up by its biggest percentage gain in six years, powering a rally in the dollar, and pushing oil prices higher, while the gold price slipped. Asian stocks also rallied.
U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke plan to work through the weekend with Congress on a plan to deal with toxic bank assets choking the financial system.
They met with Congressional leaders on Thursday night but did not talk directly about a fund afterwards.
"We talked about a comprehensive approach that will require legislation to deal with illiquid assets on financial institutions' balance sheets," Paulson told reporters.
According to two Congressional aides, he has been shopping around a plan to create the fund.
Rep. Barney Frank, who is chairman of the House Financial Services Committee, said there is concern that establishing a formal entity to buy the assets would take too long.
A fund would be similar to the Resolution Trust Corp, which was set up to clean up bad debts from the savings and loan crisis in the late 1980s at a $400 billion cost to taxpayers.
"I think it will start to provide a floor to asset values and allow institutions to work through this in a systematic manner. They won't have to rush into the arms of suitors to avoid collapsing," said Haag Sherman, co-founder and managing director of Salient Partners in Houston.
Britain's Financial Services Authority imposed a four-month ban on short selling of financial stocks, and a source briefed on the matter said the U.S. Securities and Exchange Commission is considering a temporary ban on short sales of some, or all, stocks.
"We are likely to take additional steps in the days ahead that are more particularly addressed to this urgent situation," SEC Chairman Christopher Cox told reporters.
In addition, New York's Attorney General Andrew Cuomo began a wide-ranging probe into possible illegal short-selling in the stocks of Wall Street firms such as Morgan Stanley and rival Goldman Sachs Group Inc
At one stage on Thursday, Morgan Stanley's stock dropped as much as 42 percent and Goldman as much as 25 percent, adding to several days of huge declines that have wiped out tens of billions of dollars of market value. However, after news of the moves by authorities in the United States and the UK, they recovered, and were both trading higher in after-hours trade.
Investors have been questioning whether the investment banking model is doomed after the failure earlier this week of one rival, Lehman Brothers Holdings Inc, and the proposed sale of another, Merrill Lynch
Morgan Stanley is in merger talks with U.S. bank Wachovia Corp and at the same time discussing the possibility of Chinese sovereign wealth fund China Investment Corp raising its stake to as much as 49 percent from the 9.9 percent it acquired in December, sources familiar with the plans said on Thursday.
The discussions with Wachovia began Wednesday night with a proposal from Wachovia CEO Robert Steel to Morgan Stanley CEO John Mack and have since reached a more formal stage.
There has even been speculation that Goldman, the most powerful investment bank and once seen as untouchable, may have to seek a partner, possibly by buying a retail bank.
BOUNCE BACK
Some other talks that could lead to further massive consolidation of the banking sector continued on Thursday.
Washington Mutual Inc, the large U.S. savings and loan beleaguered by mortgage losses, continues to explore all options, such as talking to potential buyers or raising capital, sources familiar with the situation said on Thursday.
Still, news it has yet to secure a quick takeover bid led to the loss of some of its earlier gains in after-hours trading.
Potential suitors such as JP Morgan Chase & Co and Wells Fargo & Co have yet to submit formal offers, although negotiations are continuing with several parties that have expressed interest, sources said. In addition to JP Morgan and Wells Fargo, possible suitors include HSBC Holdings Plc and Citigroup Inc, a source familiar with the situation previously told Reuters.
The global banking sector has been plagued by hundreds of billions of dollars of mortgage-related debt that is worth much less than its original value because of the impact of the U.S. housing bust and the subsequent credit crisis.
In recent weeks, the government has stepped in to rescue three massive financial institutions: American International Group Inc, Fannie Mae and Freddie Mac
The response from authorities to the crisis had done little to restore confidence to global stock markets until news of the short selling crackdown and the possible bailout fund on Thursday. The Dow Jones industrial average, which fell as much as 150 points at one point, closed up 410 points.
Beaten down banking shares like Wachovia and Washington Mutual flipped from massive losses to gains of 59 percent and 49 percent, respectively.
However, shares of major trust banks slid on concern about the level of fund outflows, with State Street Corp closed down 9 percent, leading the decline, after tumbling 55 percent at one point.
The funds industry has been on edge since the asset value of one of the oldest and biggest U.S. money market funds on Tuesday slid below the amount investors had put into it — commonly known as "breaking the buck."
"We are seeing a ton of panic," said Conrad Gann, president of TrimTabs Investment Research, which tracks money flowing into and out of mutual funds. "It's not just the retail investors who are scared. It is the pros who are scared."
The Wall Street Journal reported that the U.S. government may create insurance for money-market mutual funds, similar to the insurance that now governs bank deposits.
'I AM WATCHING'
U.S. authorities have already pledged $900 billion to prop up the financial system and housing market
The UK ban on short selling came after the U.S. Securities and Exchange Commission introduced rules under which short sellers and broker-dealers must deliver stock by the end of business on settlement day, three days after the sale.
Morgan Stanley boss John Mack told employees at a town meeting he thought U.S. regulators were starting to understand the systemic risk posed by short sellers.
Cuomo put short sellers on notice. "I want the short-sellers to know today that I am watching," he said.
In a sign of the growing blame game arising from the crisis, Republican presidential hopeful Sen. John McCain called for the resignation of the SEC's Cox, a fellow Republican.
In his first remarks about the crisis since the government's $85 billion takeover of AIG earlier this week, President George W. Bush expressed concern about the turmoil, and said his administration was prepared to take further measures to strengthen and stabilize markets.
"The American people are concerned about the situation in our financial markets and our economy, and I share their concerns," he told reporters.
Earlier, the U.S. Federal Reserve announced coordinated moves with five of the world's major central banks to inject up to $180 billion in liquidity into global money markets.
That gave some reassurance to panicked investors, and slashed overnight money rates to 2 percent from 8.5 percent.
As an indication of the demand for liquidity, the Bank of England said it received bids of 202 billion pounds ($365 billion) for the 66 billion pounds on offer in its weekly open market operation.
British bank Lloyds TSB Group Plc took advantage of the market turmoil to achieve a long-held ambition by scooping up the country's biggest mortgage lender, HBOS Plc, in a $22 billion all-share deal.
HBOS shares, which had slumped due to fears about its funding, soared 40 percent, and the British government promised to rewrite competition laws to let the deal go through.
