US prepares toxic-debt plan

NEW YORK // The government is preparing a sweeping bailout to mop up hundreds of billions of dollars in toxic mortgage debt, after curbing short-selling and guaranteeing money-market mutual funds in an effort to bring stability to the financial markets. The moves capped a week in which financial markets faced their most serious confluence of crises since the Great Depression in the 1930s and threatened national economies and the worldwide banking system. "It's like having a heart attack, and you go and get your chest cracked open and get it fixed, but the next morning you're still hurting," said Warren Simpson, managing director at Stephens Capital Management in Little Rock, Arkansas. "This has been a beast of biblical proportions. Nobody has seen anything like it." Lawmakers promised fast action on the toxic-debt plan, which two banking industry sources put in the US$500 billion (Dh1,8 trillion) to $800bn range. A Treasury spokesman declined to comment. As the US government brought out the big guns to tackle the mounting financial crisis, investment bank Morgan Stanley bought itself some time to come up with a plan for its future and continued talking to Wachovia and other banks about a merger. On Saturday, a US bankruptcy judge approved British bank Barclays' deal to purchase the core US business of Lehman Brothers. But much of the markets' focus was on Washington, as officials from the US president's administration, Congress and the Federal Reserve worked to craft a number of plans to restore confidence in shaken stock markets. The US government has pledged more than $1tn to prop up the financial system and housing market. In the most recent example of a government entity stepping in to ease fears, the Treasury said on Friday it would use $50bn to back money-market mutual funds whose asset values fall below $1 in another step to contain raging financial turmoil. "The problems were critical, both in the credit markets and with banks," said Blake Howells, director of equity research at Becker Capital Management in Portland, Oregon. "The government is trying to stop a domino effect of more institutions failing, and taking others down." US stocks soared as the Dow Jones industrial average closed up 368.8 points, or 3.4 per cent, at 11,388.4, and the Nasdaq rose 74.8, or 3.4 per cent, to 2,273.9. Other global markets also reacted sharply. Government officials said they had more work to do. "We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system's stresses," Henry Paulson, the treasury secretary told a news conference. "The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy." Banks worldwide have suffered more than $500bn of write-downs and loan losses since the global credit crisis began more than a year ago. The crisis grew more acute this month with government takeovers of mortgage companies Fannie Mae and Freddie Mac; the bankruptcy of Lehman Brothers; Merrill Lynch's shotgun agreement to be bought by Bank of America; and a bailout of insurer AIG. This came just six months after a government-backed rescue of Bear Stearns. Government officials have indicated their willingness to do what they can to prevent a major financial institution from going under and roiling the overall markets. A government plan was expected to be sent to Congress this weekend. "They are absolutely petrified of just a run on financial assets and they came very close to that on Thursday," said Boris Schlossberg, director of currency research at GFT Forex in New York. "At this point they have just decided that fiscal responsibility goes out the door." The banking issues were not limited to the US. UK lender HSBC Holdings walked away from a $6.3bn deal for control of Korea Exchange Bank, fuelling speculation it may be turning its attentions to its embattled rivals in the West. And the Euro zone'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 (FSA) imposed a four-month ban on short-selling financial stocks on Thursday, the US Securities and Exchange Commission followed suit on Friday with an immediate 10-day ban. The world's central banks also redoubled their efforts to lubricate the seized-up money markets. Japan, Australia, India and Indonesia pumped in $42bn after the US Fed co-ordinated a $180bn package a day earlier. Washington's proposal to draw the poison from banks' mortgage assets and the first of the short-selling bans had an immediate and dramatic effect. President Bush said on Friday government intervention was necessary to solve the problems plaguing the financial markets, calling it a "pivotal moment for America's economy." "Given the precarious state of today's financial markets and their vital importance to the daily lives of the American people, government intervention is not only warranted, it is essential," he said. While many on Wall Street cheered the ban on short-selling, the sentiment was not unanimous. Options traders, who sell stock short to balance their trading positions, were caught off guard, and warned that the measure could paralyse derivatives markets. The main complaint was that the crackdown was a knee-jerk reaction that will not fix the banking sector's underlying weaknesses ? a pile of bad debts, hard-to-value mortgage securities and a breakdown of investor confidence. Former Fed chairman Alan Greenspan called the ban "a terrible idea." Mr Paulson and Ben Bernanke, the Fed chairman, planned 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. The MSCI index of regional shares excluding Japan rose eight per cent and Tokyo stocks ended up 3.8 per cent. The Shanghai index soared 9.5 per cent after China stepped in with a reform package to halt a 69 per cent slide from last October's record high. In Europe, all the continent's major markets jumped. The FTS Eurofirst index surged 8.2 per cent, its biggest one-day percentage gain. Sovereign wealth fund China Investment Corp (CIC), Morgan Stanley's largest shareholder, was said to be in talks to raise its stake to as much as 49 per cent from the 9.9 per cent position it bought for $5bn in December, 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 $24bn at Thursday's close. Yesterday morning, a senior CIC official, quoted by the official Xinhua news agency, said Wall Street's two remaining stand-alone investment banks, Morgan Stanley and Goldman Sachs, were capable of tackling their problems on their own. Morgan Stanley declined to say whether it was in talks. A US fund to deal with bad mortgage-related assets would be similar to the Resolution Trust, set up to clean up bad debts from the S&L crisis in the late 1980s. "We talked about a comprehensive approach that will require legislation to deal with illiquid assets on financial institutions' balance sheets," Mr Paulson said. According to two Congressional aides, the Treasury head has been shopping around his plan to create the fund. Barney Frank, 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," said Haag Sherman, co-founder and managing director of Salient Partners in Houston. The financial crisis spilt into the US presidential race as Republican Sen John McCain said the Federal Reserve should "get out of the business of bailouts," while Democratic Sen Barack Obama said he supported efforts to shore up the financial markets' confidence and would hold off from presenting his economic recovery plan. *Reuters