Stocks Surge as Bulls Roar in Late-Day Rally

The major indices surge into the final hour of trading on rumors of a government to launch a facility to take on bad debt.
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Updated from 2:33 p.m. EDT

Into the final hour of trading Thursday, stocks in New York rallied strongly following reports that the government may jump in to take on many of the securities at the core of the credit crisis.

The

Dow Jones Industrial Average

shot up 358 points to 10,967, and the

S&P 500

was better by 40 points at 1197. The

Nasdaq

was up 79 points to 2178.

The sharp move to the upside accompanied a report from

CNBC

that Treasury Secretary Henry Paulson was in discussions to initiate a Resolution Trust-like solution to the credit crisis. Following the Savings and Loan crisis in the late 1980s, the government created the trust to manage mortgage-related assets owned by defunct banks.

On Wednesday, stocks took a severe beating following the government bailout of insurance firm

AIG

(AIG) - Get Report

, which reminded investors of the severity and scope of the credit crisis. Pessimism on Wall Street was ramping in the wake of the AIG bailout, a bankruptcy for

Lehman Brothers

(LEH)

and a last-minute merger between

Merrill Lynch

(MER)

and

Bank of America

(BAC) - Get Report

.

Ahead of the latest session, more news emerged from the struggling financials space.

Washington Mutual

(WM) - Get Report

hired

Goldman Sachs

(GS) - Get Report

to help it prepare for a sale, while private equity firm TPG had helped clear the way for a merger by waiving an anti-dilution clause that would make WaMu pay for any dilution related to a capital raise or buyout.

Meanwhile,

The New York Times

and other news outlets reported that

Morgan Stanley

(MS) - Get Report

was in discussions to merge with

Wachovia

(WB) - Get Report

. The Government of Singapore Investment Corp. said it would take a stake in Morgan if approached, and

CNBC

reported that

HSBC

(HBC)

and China's CITIC Group were also interested. On Wednesday, Morgan Stanley and Goldman Sachs shares both faced pressure as investors wondered if any firm was safe on its own.

The market staged an early relief rally, said Mark Fightmaster, market analyst at Schaeffer's Investment Research. Historically, mergers in the financial sector have drawn a positive reaction from the markets, he said, but "It's just tough to read the market right now."

Dow Jones replaced AIG with

Kraft

(KFT)

on its 30-stock Industrial Average index, and Lehman Brothers ceased trading on the

New York Stock Exchange

and instead took residence on the pink sheets under the ticker LEHMQ.PK.

Several money-market funds, generally considered very safe investments, have lately been under pressure following the collapse of Lehman Brothers and other financial institutions.

Bank of New York Mellon's

(BK) - Get Report

Institutional Cash Reserves fund fell below $1 a share on Tuesday,

Bloomberg

reported. The fund's losses were tied to investments in debt from Lehman Brothers. Money-market funds generally target their share prices above $1. Below that value, the funds' investors face losses.

Separately,

Putnam Investments

, a segment of insurer

Great-West Lifeco

, shuttered Putnam Prime Money Market Fund, a $12.3 billion institutional fund. The company said it wasn't exposed to Lehman, WaMu or AIG securities.

The

Federal Reserve

and other central banks, including the Bank of England and European Central Bank, announced Thursday they would coordinate efforts to quell soaring international demand for dollar liquidity. The Fed said it would provide an additional $180 billion for its temporary reciprocal currency arrangements. This added support would provide dollar funding for both term and overnight liquidity operations by other central banks.

Although it's hard to gauge the long-term impact of the Fed's overnight operations, the short-term impact has been relief, followed by a return to credit stresses, said Mike Feroli, economist at JPMorgan. "So far, we're at least getting the first half of that proposition," he said. He said that the Bank of England's involvement may provide additional support, because London money markets show high demand for dollar funding.

Because Europe has no lender of last resort, the best way to provide dollars following a global spike in demand is to have the ECB buy short-term euro-denominated securities in exchange for dollars, said Brian Bethune, director of financial economics for Global Insight. "These are just short-term liquidity operations. The hope is the crisis will die down, and you'll be able to pull the liquidity back in," he said.

Reflecting credit turmoil overseas, British bank

Lloyds TSB

said it would buy British mortgage lender

HBOS

for $21.85 billion. The HBOS takeover was encouraged by the British government in an effort to prevent the company from failing.

Elsewhere, MidAmerican Energy, a subsidiary of

Berkshire Hathaway

(BRKA)

said it would buy

Constellation Energy

(CEG)

for $4.7 billion, or $26.50 a share in a cash deal.

As for earnings, shipping firm

FedEx

(FDX) - Get Report

reported first-quarter

earnings

of $384 million, or $1.23 a share, vs. $494 million, or $1.58 a share, a year ago. Despite the drop in EPS, the results met Thomson Reuters analyst estimates.

In the commodities space, crude oil rose 72 cents to settle at $97.88. Gold was gained $46.50 to settle at $897 an ounce, after finishing up $70 an ounce on Wednesday, the biggest one-day price jump ever.

Shifting to economic data, the Department of Labor's reported a surprise rise in initial jobless claims to a seasonally adjusted 455,000 for the week ended Sept. 13, up 10,000 from the prior week. Analysts had expected the figure to dip to 440,000, but the report reflects job losses associated with Hurricane Gustav.

Traders got an added boost in confidence from the Philadelphia Federal Reserve's September manufacturing report. The survey showed a reading of 3.8, beating expectations and improving dramatically from -12.7 in August.

On the other hand, the Conference Board's index of leading indicators for August fell 0.5%, suggesting the economy had been headed for a downturn even before the escalation of trouble in the credit markets.

Longer-dated Treasury securities were mixed. The 10-year note was up 2/32, yielding 3.41%. The 30-year was 15/32 lower to yield 4.1%. The dollar was rising vs. the euro and pound but falling against the yen.

Overseas, European indices were mixed. The FTSE in London was down, and the Dax in Frankfurt was marking slight gains. Asian markets, such as the Nikkei in Tokyo and Hong Kong's Hang Seng, finished in the red.