A radical U.S. plan to mop up toxic mortgage debt and a spreading ban on short-selling drove bank stocks up as much as 40 percent on Friday as urgent talks over rescue takeovers in the sector continued.
As the authorities brought out the big guns to tackle the financial crisis, U.S. investment bank Morgan Stanley continued talking to Wachovia Corp and other banks about a merger, while discussing a possible increased investment from China's sovereign wealth fund, sources familiar with the plans said.
UK lender HSBC Holdings walked away from a $6.3 billion deal for control of Korea Exchange Bank, fuelling speculation it may be turning its attentions to one of its embattled rivals in the West instead.
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 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 ban for an initial 10 days. French regulator AMF said it was also talking to other Eurozone regulators about market dealings, leading to expectations that the shorting ban would snowball.
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. Federal Reserve co-ordinated a $180 billion package a day earlier.
In Europe, there were signs that the stress was easing. The cost of borrowing dollars overnight fell back towards the Fed's 2 percent target, and three-month borrowing costs slid. The Bank of England offered $40 billion to banks, but only half of it was taken up.
TOXIC DEBT PLAN
Thursday's proposals by Washington to draw the poison from banks' mortgage assets and the first of the short-selling bans had an immediate and dramatic effect.
U.S. stocks clocked their biggest percentage gain in six years late on Thursday, powering a rally in the dollar and pushing oil prices higher, and on Friday Asian and European markets picked up where New York's left off.
The price of gold and government bonds, traditional safe havens in times of turmoil, both slipped back.
U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke plan 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 in Hong Kong.
"At present confidence is the most important factor, and this will only be maintained if the rescue plans are delivered on both sides of the Atlantic," said Andrew Turnbull, senior sales manager at ODL Securities.
Stock markets did not wait for details.
The MSCI index of regional shares excluding Japan was up 7 percent, and Tokyo stocks ended up 3.8 percent. The Shanghai index roared 9.5 percent higher after the Chinese government 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 in early trade. The pan-European FTSEurofirst 300 was up 6.3 percent, while some of Europe's biggest banks, UBS, HBOS, Lloyds TSB and Royal Bank of Scotland were up between 29 and 47 percent.
Sovereign wealth fund China Investment Corp, Morgan Stanley's largest shareholder, with a 9.9 percent stake it bought for $5 billion in December, was in talks that could see its stake climb to as much as 49 percent, 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. An unidentified CIC official told the Xinhua news agency that an increase in the stake would face U.S. political obstacles.
Sources familiar with the plans said Morgan Stanley's parallel discussions with Wachovia began Wednesday night with a proposal from Wachovia CEO Robert Steel to Morgan Stanley CEO John Mack and have since reached a more formal stage.
Morgan Stanley declined to say it was in talks, but a spokeswoman confirmed it was "focused on solutions" to address its falling stock price.
A U.S. fund to deal with bad mortgage-related assets would be similar to the Resolution Trust Corp, which was set up to clean up bad debts from the savings and loan crisis in the late 1980s at a $400 billion cost to taxpayers.
"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, he has been shopping around a plan to create the fund.
Rep. Barney Frank, who is 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. They won't have to rush into the arms of suitors to avoid collapsing," said Haag Sherman, co-founder and managing director of Salient Partners in Houston.
In addition, New York's Attorney General Andrew Cuomo began a wide-ranging probe into possible illegal short-selling in the stocks of Wall Street firms such as Morgan Stanley and rival Goldman Sachs Group Inc.
At one stage on Thursday, Morgan Stanley's stock dropped as much as 42 percent and Goldman as much as 25 percent, adding to several days of huge declines that have wiped out tens of billions of dollars of market value. However, after news of the moves by authorities in the U.S. and UK, they were both trading higher in after-hours trade.
Investors are questioning whether the investment banking model is doomed after the bankruptcy filing earlier this week of Lehman Brothers Holdings Inc and the proposed sale of Merrill Lynch.
There has even been speculation that Goldman, the most powerful investment bank and once seen as untouchable, may be in need of a partner, possibly a retail bank.
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