Talk of bond insurer rescue spurs late stock rally

NEW YORK (Reuters) - U.S. stocks rallied late on Friday on news that banks were near an agreement to bail out bond insurer Ambac Financial, a deal that could prevent further damage to the banking industry and credit markets.

After trading in negative territory for most of the session, stocks turned positive in the last half hour after CNBC television reported a bank rescue may come as soon as next week. A source later told Reuters that progress has been made in recent days, but that a deal may still fall through. For details, see

The triple-A credit ratings of Ambac and rival MBIA have come under threat because of their exposure to risky mortgage bonds. That has forced banks to write down the value of holdings insured by the two companies.

Earlier, financial shares had led the decline after Merrill Lynch & Co recommended investors sell Fannie Mae (FNM.N) and Freddie Mac (FRE.N), the biggest U.S. home financing companies in anticipation of further deterioration in financial markets.

News of the potential rescue plan caused the Dow to swing from a loss of about 80 points to a 96-point gain by the close, led by a reversal in financial shares.

"The Ambac news turned the entire stock and index futures markets around. The rally almost fed on itself as traders looked to get long wherever they could," said Joe Kinahan, chief derivatives strategist at online brokerage thinkorswim in Chicago.

The Dow Jones industrial average .DJI rose 96.72 points, or 0.79 percent, to end at 12,381.02. The Standard & Poor's 500 Index .SPX gained 10.58 points, or 0.79 percent, to 1,353.11. The Nasdaq Composite Index.IXIC added 3.57 points, or 0.16 percent, to close at 2,303.35.

For the week, the Dow ended up 0.3 percent and the S&P 500 gained 0.2 percent, but the Nasdaq fell 0.8 percent.

Volume was about 1.4 billion, down from last year's daily average of 1.9 billion on the New York Stock Exchange, which also reported at the close that short interest rose in the first part of February to a fresh record.

AMBAC ROARS BACK

Shares of Ambac, which had been lower for most of the day, surged 16 percent to end at $10.71, while MBIA shares gained 2.4 percent to $12.18, both on the New York Stock Exchange.

The S&P financial index .GSPF rose 1.6 percent, while an index of bank shares .BKX rose 1.7 percent.

Fannie Mae and Freddie Mac shares sharply pared losses but still ended lower for the day. Fannie Mae shares were down 0.9 percent at $28.72 at the close, while Freddie Mac shares were down 4.1 percent at $26.61.

The Merrill downgrade was the latest in a long series of bad news for the financial sector where investors are reacting to woes stemming from defaults in the subprime mortgage market that have led to much stricter lending conditions.

GENENTECH UP LATE ON DRUG OK

After the close, shares of Genentech Inc DNA.N rose more than 8 percent to $77.99 following news that U.S. regulators had approved the company's cancer drug, Avastin, for the treatment of breast cancer.

During the regular session, Express Scripts Inc (ESRX.O) rose 2.4 percent to $66.31 on Nasdaq after the pharmacy benefits manager raised its 2008 profit forecast due to favorable trends.

Nasdaq volume was fairly brisk, with about 2.3 billion shares traded, above last year's daily average of 2.17 billion.

Advancing stocks outnumbered declining ones on the NYSE by 3 to 2, while on the Nasdaq, the opposite trend held, with about 4 stocks falling for every 3 that rose.

(Additional reporting by Doris Frankel; Editing by Jan Paschal)