NEW YORK (Reuters) - The U.S. government curbed short-selling and guaranteed money-market mutual funds on Friday as it worked on a sweeping bailout to mop up hundreds of billions of dollars in toxic mortgage debt, sending global stock markets soaring.
The moves capped a week in which financial markets faced their most serious confluence of crises since the Great Depression in the 1930s and threatened national economies and the worldwide banking system.
"It's like having a heart attack, and you go and get your chest cracked open and get it fixed, but the next morning you're still hurting," said Warren Simpson, managing director at Stephens Capital Management in Little Rock, Arkansas. "This has been a beast of biblical proportions. Nobody has seen anything like it."
As the U.S. government brought out the big guns to tackle the mounting financial crisis, investment bank Morgan Stanley bought itself some time to come up with a plan for its future and continued talking to Wachovia Corp and other banks about a merger.
But much of the markets' focus on Friday was on Washington, as officials from President George W Bush's administration, Congress and the Federal Reserve worked to craft a number of plans to restore confidence in shaken stock markets.
The U.S. government has pledged more than $1 trillion (520 billion pound) to prop up the financial system and housing market.
In the most recent example of a government entity stepping in to ease fears, the U.S. Treasury said on Friday it will use $50 billion to back money-market mutual funds whose asset values fall below $1 in another step to contain raging financial turmoil.
"The problems were critical, both in the credit markets and with banks," said Blake Howells, director of equity research at Becker Capital Management in Portland, Oregon. "The government is trying to stop a domino effect of more institutions failing, and taking others down."
U.S. stocks soared on the plans as the Dow Jones industrial average closed up 368.75 points, or 3.4 percent, at 11,388.44, and the Nasdaq rose 74.80, or 3.4 percent, to 2,273.90. Other global markets also reacted sharply.
WORKING FOR THE WEEKEND
Government officials said they had more work to do. The toxic-debt plan, still being crafted, is expected to cost hundreds of billions of dollars.
"We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system's stresses," Treasury Secretary Henry Paulson said at a press conference. "The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy."
Banks worldwide have suffered more than $500 billion of write-downs and loan losses since the global credit crisis began more than a year ago.
The crisis grew more acute this month with government takeovers of mortgage companies Fannie Mae and Freddie Mac; the bankruptcy of Lehman Brothers; Merrill Lynch shotgun agreement to be bought by Bank of America; and a bailout of insurer AIG. This came just six months after a government-backed rescue of Bear Stearns.
Government officials have indicated their willingness to do what they can to prevent a major financial institution from going under and roiling the overall markets. A government plan was expected to be sent to Congress this weekend.
"They are absolutely petrified of just a run on financial assets and they came very close to that on Thursday," said Boris Schlossberg, director of currency research at GFT Forex in New York. "At this point they have just decided that fiscal responsibility goes out the door."
The banking issues were not limited to the United States. UK lender HSBC walked away from a $6.3 billion deal for control of Korea Exchange Bank, fueling speculation it may be 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 of Ireland, which has been pummeled by a property market slump at home.
After Britain's Financial Services Authority (FSA) imposed a four-month ban on short-selling financial stocks on Thursday, the U.S. Securities and Exchange Commission followed suit on Friday with an immediate 10-day ban.
Meanwhile, the world's central banks redoubled their efforts to lubricate the seized-up money markets. Japan, Australia, India and Indonesia pumped in $42 billion after the U.S. Fed coordinated a $180 billion package a day earlier.
Washington's proposal to draw the poison from banks' mortgage assets and the first of the short-selling bans had an immediate and dramatic effect.
President Bush said on Friday government intervention was necessary 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 markets and their vital importance to the daily lives of the American people, government intervention is not only warranted, it is essential," he said.
Paulson and Federal Reserve Chairman Ben Bernanke planned to work through the weekend with Congress on a plan to deal with the toxic bank assets that have been choking the financial system for a year.
"This is a more substantial and systemic solution than the ad-hoc interventions we have seen in recent days," said Dariusz Kowalczyk, chief investment strategist at CFC Seymour.
The MSCI index of regional shares excluding Japan rose 8 percent and Tokyo stocks ended up 3.8 percent. The Shanghai index roared 9.5 percent higher after China stepped in with a reform package to halt a 69 percent slide from last October's record high. In Europe, all the continent's major markets jumped.
Sovereign wealth fund China Investment Corp (CIC), Morgan Stanley's largest shareholder, was said to be in talks to raise its stake to as much as 49 percent from the 9.9 percent position it bought for $5 billion in December, sources familiar with 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 the official Xinhua news agency, said Wall Street's two remaining stand-alone investment banks, Morgan Stanley and Goldman Sachs, were capable of tackling their problems on their own. Morgan Stanley declined to say whether it was in talks.
A U.S. fund to deal with bad mortgage-related assets would be similar to the Resolution Trust Corp, set up to clean up bad debts from the S&L crisis in the late 1980s.
"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, the Treasury head has been shopping around his plan to create the fund.
Rep. Barney Frank, chairman of the House Financial Services Committee, said there was concern that establishing a formal entity to buy the assets would take too long.
"I think it will start to provide a floor to asset values and allow institutions to work through this in a systematic manner," said Haag Sherman, co-founder and managing director of Salient Partners in Houston.
The financial crisis spilled into the U.S. presidential race as Republican Sen. John McCain said the Federal Reserve should "get out of the business of bailouts," while Democratic Sen. Barack Obama said he supported efforts to shore up the financial markets' confidence and would hold off from presenting his economic recovery plan.