UPDATE 2-Bailout clears US Senate, heads back to House

(adds Senate passage, new material throughout)

By Donna Smith

WASHINGTON, Oct 1 (Reuters) - A $700 billion financial industry bailout was approved by the U.S. Senate on Wednesday and headed back to the House of Representatives where leaders, stung by a 'no vote' that rocked markets on Monday, were cautiously optimistic it would pass in coming days.

"We are working very hard to see if we can pass a plan that will stabilize our economy," House Majority Leader Steny Hoyer told reporters before the Senate overwhelmingly passed the bill.

The Maryland Democrat said he expected the House to take up the bill on Friday and that he thought some of the changes made in the Senate would help attract more Republicans.

"We need a 100 Republican votes to pass this. We didn't get them on Monday, hopefully the Republican leadership will be able to get their members to support it this time around," Hoyer said.

The Senate voted 74-25 for the legislation after adding a $150 billion package of tax breaks for businesses and alternative energy development. The package also includes alternative minimum tax relief for some 24 million mostly middle class taxpayers.

Following the vote, Senate Majority Leader Harry Reid, a Nevada Democrat, told reporters he expected the House to approve the bill.

Senate leaders hope that sweetening the bailout plan with tax breaks and a provision to increase bank deposit insurance to $250,000 from $100,000 would help win more Republican support in the House, which rejected the bailout in a stunning 228-205 defeat on Monday.

HOUSE OUTLOOK

But the Senate move ruffled some House Democrats who had voted for the bailout plan including Rep. Charles Rangel, who heads the tax writing House Ways and Means Committee. The House had passed its own version of the package that extends a number of expired and expiring tax breaks and unlike the Senate included more revenue raising measures to cover the cost to the Treasury.

"Senate leadership took an unprecedented gamble when they attached a package of tax extenders to the emergency financial rescue legislation," Rangel said in a statement. However he did not say he would switch his "yes" vote on the bailout bill because of it.

Rep. John Shadegg, an Arizona Republican said that he may change his "no" vote to "yes" because of changes in the bill including the deposit insurance increase.

"I'm strongly leaning that way," he said in an interview with CNN. "In this business, it's trust but verify. I want to read the bill."

House Republican Leader John Boehner of Ohio said he expected more votes for the bill.

"I'm optimistic that we'll have the votes to pass this ... but I'm not taking anything for granted," he said in an interview on Fox News' "Your World with Neil Cavuto."

The expanded insurance for bank depositors would come as three of the biggest U.S. banks have succumbed to the crisis in recent months, with more teetering before the Nov. 4 presidential and congressional elections.

President George W. Bush, while expressing confidence in the bill's fate this time around, pressed his case, warning lawmakers the measure was needed "so as to stabilize this (economic) situation, so that it doesn't get worse."

Both presidential candidates, Republican Sen. John McCain and Democratic Sen. Barack Obama, voted for the package.

Financial markets on Wednesday marked time in the run-up to the Senate vote. The Dow Jones industrial average closed down nearly 20 points, in contrast to the record 778-point drop on Monday in reaction to the failed vote in the House.

Beyond the tax cuts, congressional leaders worked broadly to convince voters the bailout is for "Main Street," not just Wall Street. The House defeat of the bill was triggered by an angry stream of voter complaints.

"This isn't for lower Manhattan," the home of the U.S. financial district, Reid, a Nevada Democrat, said.

Instead, unlocking the spreading credit freeze will help "people keep their jobs ... buy a car ... be able to get a loan for that car," Reid added.

Senate Republican Leader Mitch McConnell of Kentucky, who has seen some of his recent re-election poll numbers sink amid the growing economic crisis, explained to voters who are angered at thought of taxpayers bailing out Wall Street why the legislation is necessary. (Additional reporting by Richard Cowan, editing by Jackie Frank)