U.S. works on bank debt plan

NEW YORK/WASHINGTON (Reuters) - Governments on both sidesof the Atlantic took radical steps to restore confidence inbattered financial markets on Thursday, as the United Statesproposed a taxpayer-funded mopping up of toxic mortgage-relateddebt 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 ReserveChairman Ben Bernanke plan to work through the weekend withCongress on a plan to deal with toxic bank assets choking thefinancial system.

They met with Congressional leaders on Thursday night butdid not talk directly about a fund afterwards.

"We talked about a comprehensive approach that will requirelegislation to deal with illiquid assets on financialinstitutions' balance sheets," Paulson told reporters.

According to two Congressional aides, he has been shoppingaround a plan to create the fund.

Rep. Barney Frank, who is chairman of the House FinancialServices Committee, said there is concern that establishing aformal entity to buy the assets would take too long.

A fund would be similar to the Resolution Trust Corp, whichwas set up to clean up bad debts from the savings and loancrisis in the late 1980s at a $400 billion (222 billion pounds)cost to taxpayers.

"I think it will start to provide a floor to asset valuesand allow institutions to work through this in a systematicmanner. They won't have to rush into the arms of suitors toavoid collapsing," said Haag Sherman, co-founder and managingdirector of Salient Partners in Houston.

Britain's Financial Services Authority imposed a four-monthban on short selling of financial stocks, and a source briefedon the matter said the U.S. Securities and Exchange Commissionis considering a temporary ban on short sales of some, or all,stocks.

"We are likely to take additional steps in the days aheadthat are more particularly addressed to this urgent situation,"SEC Chairman Christopher Cox told reporters.

In addition, New York's Attorney General Andrew Cuomo begana wide-ranging probe into possible illegal short-selling in thestocks of Wall Street firms such as Morgan Stanley and rivalGoldman Sachs Group.

At one stage on Thursday, Morgan Stanley's stock dropped asmuch as 42 percent and Goldman as much as 25 percent, adding toseveral days of huge declines that have wiped out tens ofbillions of dollars of market value. However, after news of themoves by authorities in the United States and the UK, theyrecovered, and were both trading higher in after-hours trade.

Investors have been questioning whether the investmentbanking model is doomed after the failure earlier this week ofone rival, Lehman Brothers, and the proposed sale of another,Merrill Lynch.

Morgan Stanley is in merger talks with U.S. bank Wachoviaand at the same time discussing the possibility of Chinesesovereign wealth fund China Investment Corp raising its staketo as much as 49 percent from the 9.9 percent it acquired inDecember, sources familiar with the plans said on Thursday.

The discussions with Wachovia began Wednesday night with aproposal from Wachovia CEO Robert Steel to Morgan Stanley CEOJohn Mack and have since reached a more formal stage.

There has even been speculation that Goldman, the mostpowerful investment bank and once seen as untouchable, may haveto seek a partner, possibly by buying a retail bank.