Bank worries soothed by debt, short-selling plans

By Christian Plumb

NEW YORK (Reuters) - U.S. and British officials intervened to restore confidence in battered global financial markets on Thursday, helping Wall Street bounce back to its best day in six years.

U.S. Treasury Secretary Henry Paulson shopped a plan to create a fund that would mop up toxic debt, and Paulson and Federal Reserve Chairman Ben Bernanke were to meet with congressional leaders Thursday night, sources said.

Meanwhile, British officials moved to crack down on short selling of banks.

"It's very good news, generally speaking," said Haag Sherman, co-founder and managing director of Salient Partners in Houston. "I think it will start to provide a floor to asset values and allow institutions to work through this in a systematic manner. They won't have to rush into the arms of suitors to avoid collapsing."

Morgan Stanley and rival Goldman Sachs Group Inc, the largest surviving independent Wall Street investment banks, have been facing concerns that the credit crunch could constrict the short-term funding they need to do business.

BOUNCE BACK

Paulson's plan would be similar to the creation of the Resolution Trust Corp (RTC), which was used to clean up bad debts from the savings and loan crisis in the late 1980s at a $400 billion cost to taxpayers.

The U.S. housing bust of the past two years has created hundreds of billions in toxic debt that has plagued bank balance sheets and led to the credit crisis.

In recent weeks, the government has stepped in to rescue three massive financial institutions: American International Group Inc, Fannie Mae and Freddie Mac, while opting to allow another, Lehman Brothers Holdings Inc, to fail.

On Thursday, battered U.S. financial stocks bounced back. After plummeting 42 percent, investment bank Morgan Stanley ended up nearly 4 percent. Beaten down banking shares like Wachovia Corp and Washington Mutual Inc flipped from massive losses to gains of 59 percent and 49 percent, respectively.

Volatility was the name of the game. The Dow Jones industrial average fell as much as 150 points at one point, finally closing up 410 points.

U.S. Treasury debt prices tumbled, with the benchmark 10-year debt slid 31/32, its yield rising to 3.54 percent.

Despite the revived markets, there were still signs of major stress at U.S. financial institutions. Washington Mutual Inc, the largest U.S. savings and loan, has failed to attract formal offers despite being shopped around to larger banks like JPMorgan Chase & Co and Wells Fargo according to sources familiar with the situation.

Morgan Stanley is in talks to sell a larger equity stake to China Investment Corp, sources said. Also, Wachovia Corp, the fourth-largest U.S. bank, has also emerged as a leading candidate to pair up with the investment bank. A source familiar with Morgan's plan said negotiations between the two had advanced to a more formal stage.

There was concern the companies might be acting too hastily to strike merger deals in the wake of the bankruptcy filing of Lehman Brothers Holdings Inc and Merrill Lynch & Co Inc's shock decision to sell itself to Bank of America Corp.