By Daniel Trotta
NEW YORK (Reuters) - The world bet solidly on recapitalizing ailing banks as the fastest way out of the financial crisis in a clear new direction on Monday that reinvigorated stock markets after their worst week in history.
Led by the Britain, European governments agreed to multibillion-dollar guarantees for the banking system in moves that may become a crucial test of investor faith in government's ability to reverse the downward spiral.
Stocks were up 7 percent in midday trading after the Dow tumbled 18 percent last week amid a climate of panic and uncertainty as credit markets seized up and major economies headed toward recession. European stocks closed 10 percent higher.
"Sometime last week it seemed like we faced Armageddon, so to have a coordinated plan on stabilizing banks is huge progress," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago.
Wall Street also focused on investment bank Morgan Stanley, which reached a financing deal with Mitsubishi UFJ Financial Group Inc (MUFG), possibly with U.S. government support. Morgan shares soared 73 percent, after losing 58 percent lost last week.
In addition, the U.S. Federal Reserve, the European Central Bank, the Bank of England and the Swiss National Bank said they would lend commercial banks as much U.S. dollar liquidity they needed.
That had an instant impact on bank-to-bank lending rates, which eased, but there was still no clear evidence of funds cascading from banks to companies.
U.S. bond markets were closed for the Columbus Day holiday. The euro and sterling gained strength on the European plans, and oil rose more than $3 to $81 a barrel.
The Treasury and Federal Reserve were working to finalize details of their own plan to recapitalize banks and stabilize financial markets in the wake of the measures announced in Europe.
For weeks the United States concentrated on a $700 billion rescue plan that emphasized buying up distressed debt from financial institutions, with Treasury Secretary Henry Paulson at first resisting U.S. government ownership of banks.
British Prime Minister Gordon Brown has shifted the world's attention to the other side the balance sheet by proposing to inject new capital into banks to get them lending again.
The United States has since moved closer to the positions of European leaders, who were in Washington over weekend for meetings of the Group of Seven major economies, the International Monetary Fund and the World Bank.
BROWN PROFILE RISES
Brown has yet to win a mandate from British voters but his global profile has risen amid the crisis. He also called on world leaders to create a new "financial architecture" to update the current international economic system, which was set up at a conference in Bretton Woods, New Hampshire, in 1944.
"Sometimes it does take a crisis for people to agree that what is obvious and should have been done years ago can no longer be postponed.," Brown said in a speech at the London offices of Thomson Reuters.
Britain's bank plan called for 37 billion pounds ($64 billion) of taxpayers' cash to bail out three major banks in a move that would likely make the government their main shareholder.
Germany, France, Italy and other European governments also announced rescue packages totaling hundreds of billions of dollars that were designed to combat the banking crisis, the worst since the Great Depression.
The moves calmed markets as well as the new Nobel laureate for economics, Princeton University economist Paul Krugman.
"I'm slightly less terrified today than I was on Friday," Krugman said. "We're going to have a recession and perhaps a prolonged one but perhaps not a collapse."
Japan said on Monday it was considering whether to guarantee all bank deposits, while the central bank said it might join further global efforts to boost dollar funding to strained money markets.
The two men vying to succeed President George W. Bush after the November 4 election were formulating their own plans.
Democrat Barack Obama, leading in public opinion polls, was due to give a major speech outlining his economic rescue plan at 1:30 p.m. EDT (1730 GMT) on Monday, while Republican John McCain was considering rolling out a new, comprehensive economic package.
($1=.5786 Pound)
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(Reporting by Reuters bureaus around the world; editing by Steve Orlofsky)
