Fed aids money markets; Wall Street falls

WASHINGTON (Reuters) - The U.S. Federal Reserve and governments around the world loosened strained financial markets on Tuesday by pumping in more money and launching bank rescues, but poor corporate profits and recession fears drove down commodities and U.S. stocks.

The Fed unveiled Washington's latest program to help the money market industry, saying it could lend up to $540 billion to five "special purpose vehicles" set up to buy certificates of deposit and commercial paper from money market mutual funds, which reeled after too many investors tried to take out their money.

Treasury Secretary Henry Paulson said he is not opposed to the idea of a second fiscal stimulus program, another piece of evidence that the Bush administration may accept another wave of government spending to help the economy, following Fed Chairman Ben Bernanke's endorsement of a new plan on Monday.

Japan and France earlier extended more help to banks and the IMF prepared to intervene in trouble spots such as Pakistan, Ukraine and Iceland.

Interbank lending costs came down again, offering tentative signs of renewed confidence in the financial system, as weeks of bailouts and rescue plans appear to have cooled the worst crisis since the 1930s Great Depression.

Paulson also said Treasury is looking at purchases of whole mortgage loans and the credit freeze is beginning to melt.

Nonetheless, he warned there may be "a number of difficult months" ahead before conditions improve. "We have a resilient economy but it will take time," Paulson said in an interview with the Charlie Rose show on PBS.

In the latest sign of the huge impact the financial crisis is wreaking in emerging markets, the government of Argentina said it was planning to take control of private pension funds. Labor leaders and many lawmakers applauded the nationalization as a way to guarantee pensions in a time of market turmoil, but the surprise move sent Argentine stock and bond prices into freefall.

'PRIVATE INVESTORS WILL COME BACK IN'

Governments around the world have promised $3.3 trillion to guarantee bank deposits and bank-to-bank lending, and in many cases have taken stakes in struggling banks.

"With honesty on bank balance sheets and enough government bucks, private investors will come back in," said Lawrence J. White, professor of economics at New York University's Stern School of Business, who helped oversee the liquidation of savings and loan assets in the late 1980s and early 1990s.

Government investment should be structured to ensure the government earns a profit if and when the banks' shares rise, White added.

U.S. stocks, hit by continuing investor concerns about slipping corporate earnings, slid hard after rising briefly into positive territory. The Dow Jones Industrial Average .DJI closed down 2.5 percent, the broader S&P .SPX lost more than 3 percent, and the NASDAQ Composite Index .IXIC dropped more than 4 percent.

The U.S. dollar raced to a year-and-a-half high against a basket of currencies as investors and companies continued to deleverage. The stronger dollar, in turn, sent gold and oil prices down nearly 4 percent.

Japanese stocks .N225 had closed 3.3 percent higher and European shares .FTEU3 closed down 0.8 percent.

The International Monetary Fund stood ready to help Pakistan, which said it needed up to $15 billion to avert a balance of payments crisis.

Ukraine also said it was close to agreeing to measures to allow it to receive IMF aid. Iceland as well appeared close to a deal with the IMF.

In the United States, the economy continued to dominate the presidential campaign two weeks before the November 4 vote. Democrat Barack Obama, who extended his lead over Republican John McCain in the polls, convened a panel of economic advisers and accused McCain of fumbling his response to the financial crisis.

Canadian banks cut their prime lending rates in response to lower funding costs and the Bank of Canada's 25 basis point interest rate cut earlier in the day, giving customers a shot at lower rates on various loans.

France's banks won some respite from the ravages of the financial crisis through a 10.5 billion-euro ($13.9 billion) state cash injection.

However, the Bank of England said Britain's economy is probably entering its first recession in 16 years, and the outlook has not worsened as rapidly as it has in the past month for a very long time, BoE governor Mervyn King said.

"We are far from the end of the road back to stability, but the plan to recapitalize our banking system, both here and abroad, will, I believe, come to be seen as the moment in the banking crisis of the past year when we turned the corner," King said.

Sterling fell 2 percent after King's comments.

In Japan, Economics Minister Kaoru Yosano said the country's big banks could get public funds if needed, as the government considered recasting a law to speed the flow of finance to credit-starved small firms.

(Reporting by Reuters bureaus around the world; Editing by Gary Hill)