Toxic-debt plan and short-selling curbs lift markets

NEW YORK (Reuters) - The U.S. government was crafting asweeping bailout to mop up toxic mortgage debt that will likelycost hundreds of billions of dollars, curbed short-selling andguaranteed money-market mutual funds, sending global stockmarkets soaring on Friday.

The moves capped a week in which financial markets facedtheir most serious confluence of crises since the GreatDepression of the 1930s and threatened the stability ofnational economies and the worldwide banking system.

"It's like having a heart attack, and you go and get yourchest cracked open and get it fixed, but the next morningyou're still hurting," said Warren Simpson, managing directorat Stephens Capital Management in Little Rock, Arkansas. "Thishas been a beast of biblical proportions. Nobody has seenanything like it."

As the U.S. government brought out the big guns to tacklethe mounting financial crisis, investment bank Morgan Stanleybought itself some time to come up with a plan for its futureand continued talking to Wachovia and other banks about amerger.

But much of the markets' focus on Friday was on Washington,as officials from President George Bush's administration,Congress and the Federal Reserve worked to craft a number ofplans to restore confidence in shaken stock markets.

The U.S. government has to date pledged more than $1trillion to prop up the financial system and housing market.

In the most recent example of a government entity steppingin to ease fears, the U.S. Treasury said on Friday it will use$50 billion (27.3 billion pounds) to back money-market mutualfunds whose asset values fall below $1 in another step tocontain raging financial turmoil.

"The problems were critical, both in the credit markets andwith banks," said Blake Howells, director of equity research atBecker Capital Management in Portland, Oregon. "The governmentis trying stop a domino effect of more institutions failing,and taking others down."

WORKING FOR THE WEEKEND

Government officials said they had more work to do. Thetoxic-debt plan, still being crafted, is expected to costhundreds of billions of dollars.

"We must now take further, decisive action to fundamentallyand comprehensively address the root cause of our financialsystem's stresses," Treasury Secretary Henry Paulson said at apress conference. "The federal government must implement aprogram to remove these illiquid assets that are weighing downour financial institutions and threatening our economy."

U.S. stocks soared on the plans as the Dow Jones industrialaverage jumped 430 points to 11,450, and the Nasdaq rose 78points at 2,277.

"They are absolutely petrified of just a run on financialassets and they came very close to that on Thursday," saidBoris Schlossberg, director of currency research at GFT Forexin New York. "At this point they have just decided that fiscalresponsibility goes out the door."

The banking issues were not limited to the United States.UK lender HSBC Holdings walked away from a $6.3 billion dealfor control of Korea Exchange Bank, fuelling speculation it maybe turning its attentions to its embattled rivals in the West.

And the Eurozone's largest bank, Spain's Santander,declined to comment on a media report it was eyeing Bank ofIreland, which has been pummelled by a property market slump athome.

After Britain's Financial Services Authority imposed afour-month ban on short selling financial stocks on Thursday,the U.S. Securities and Exchange Commission followed suit onFriday with an immediate 10-day ban.

Meanwhile the world's central banks redoubled their effortsto lubricate the seized-up money markets. Japan, Australia,India and Indonesia pumped in $42 billion after the U.S. Fedcoordinated a $180 billion package a day earlier.

In Europe, there were signs that the stress was easing. Thecost of borrowing dollars overnight fell back toward the Fed's2 percent target, and three-month borrowing costs slid. TheBank of England offered $40 billion to banks, but only half ofit was taken up.

TOXIC-DEBT PLAN

Washington's proposal to draw the poison from banks'mortgage assets and the first of the short-selling bans had animmediate and dramatic effect.

Leading European shares surged more than 7 percent,Britain's top share index soared more than 8 percent, andMSCI's leading emerging market index jumped almost 10 percent.Gold and government bond prices, traditional safe havens, bothfell.

Battered U.S. financial shares also showed some life onFriday as Wachovia rose 35 percent, Washington Mutual rose 28percent and Merrill Lynch rose 24 percent.

President Bush said on Friday government intervention wasnecessary to solve the problems plaguing the financial markets,calling it a "pivotal moment for America's economy."

"Given the precarious state of today's financial marketsand their vital importance to the daily lives of the Americanpeople, government intervention is not only warranted, it isessential," he said.

Paulson and Federal Reserve Chairman Ben Bernanke plan towork through the weekend with Congress on a plan to deal withthe toxic bank assets that have been choking the financialsystem for a year.

"This is a more substantial and systemic solution than thead-hoc interventions we have seen in recent days," said DariuszKowalczyk, chief investment strategist at CFC Seymour.

The MSCI index of regional shares excluding Japan rose 8percent and Tokyo stocks ended up 3.8 percent. The Shanghaiindex roared 9.5 percent higher after China stepped in with areform package to halt a 69 percent slide from last October'srecord high. In Europe, all the continent's major marketsjumped.

MORGAN STANLEY

Sovereign wealth fund China Investment Corp (CIC), MorganStanley's largest shareholder, was said to be in talks to raiseits stake to as much as 49 percent from the 9.9 percentposition it bought for $5 billion in December, sources familiarwith the matter said.

Beijing is wary of adding to its Morgan Stanley holding,given that its existing holding is carried at a steep loss --the whole bank was only worth $24 billion at Thursday's close.

On Friday morning a senior CIC official, quoted by theofficial Xinhua news agency, said Wall Street's two remainingstand-alone investment banks, Morgan Stanley and Goldman Sachs,were capable of tackling their problems on their own.

Morgan Stanley declined to say it was in talks, but aspokeswoman confirmed it was "focused on solutions."

GOVERNMENT ACTION

A U.S. fund to deal with bad mortgage-related assets wouldbe similar to the Resolution Trust Corp, set up to clean up baddebts from the savings and loan crisis in the late 1980s.

"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, chairman of the House Financial ServicesCommittee, said there was concern that establishing a formalentity to buy the assets would take too long.

"I think it will start to provide a floor to asset valuesand allow institutions to work through this in a systematicmanner," said Haag Sherman, co-founder and managing director ofSalient Partners in Houston.

The financial crisis spilled into the U.S. presidentialrace as Republican Sen. John McCain said the Federal Reserveshould "get out of the business of bailouts," while Democraticcandidate Barack Obama said he supported efforts to shore upthe financial markets' confidence and would hold off frompresenting his economic recovery plan.

(Additional reporting by Kevin Plumberg, Dan Wilchins,Kristina Cooke, Jeff Mason and Lucia Mutikani; Additionalwriting by Tony Munroe and Will Waterman; Editing by DaveZimmerman and Jeffrey Benkoe)