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US works on bank debt plan

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Governments on both sides of the Atlantic took radical steps to restore confidence in battered financial markets on Thursday, as the United States proposed a taxpayer-funded mopping up of toxic mortgage-related debt and Britain cracked down on short selling of bank stocks.

The impact was immediate and dramatic, driving the US stock market up by its biggest percentage gain in six years, powering a rally in the dollar, and pushing oil prices higher, while the gold price slipped. Asian stocks also rallied. US Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke plan to work through the weekend with Congress on a plan to deal with toxic bank assets choking the financial system.

They met with Congressional leaders on Thursday night but did not talk directly about a fund afterwards. “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 is concern that establishing a formal entity to buy the assets would take too long. A fund 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.

“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.

Britain’s Financial Services Authority imposed a four-month ban on short selling of financial stocks, and a source briefed on the matter said the US Securities and Exchange Commission is considering a temporary ban on short sales of some, or all, stocks. “We are likely to take additional steps in the days ahead that are more particularly addressed to this urgent situation,” SEC Chairman Christopher Cox told reporters.

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. At one stage on Thursday, Morgan Stanley’s stock dropped as much as 42% and Goldman as much as 25%, 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 United States and the UK, they recovered, and were both trading higher in after-hours trade.

Investors have been questioning whether the investment banking model is doomed after the failure earlier this week of one rival, Lehman Brothers, and the proposed sale of another, Merrill Lynch.

There has even been speculation that Goldman, the most powerful investment bank and once seen as untouchable, may have to seek a partner, possibly by buying a retail bank. (Reuters)

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