Stocks Rally on Debt Plan, But Is It a Turning Point?

A proposal to help financial institutions shed their bad debts sparked a big rally on Wall Street, but it was unclear whether the move was a turning point in the credit crisis.

Treasury Secretary Henry Paulson is working on a plan that would set up a government facility to take on bad debts from financial institutions, Wall Street sources have told CNBC.

The facility would be similar to the Resolution Trust Corporation, which was set up in 1989 to take on all the failed thrift assets during the savings and loan crisis, these sources said.

A plan could be announced as early as Friday, sources said.

The news sparked a big rally in stocks after a day in which investors remained nervous about the spreading effects the global credit crisis. Europe and Asia closed lower.

The market also got a lift as regulators moved against short sellers, who bet on stocks declining and have been blamed for fueling a lot of the panic in markets in recent months.

Overnight, the Federal Reserve announced coordinated moves with five of the world's major central banks to add up to $180 billion in liquidity to global money markets, which had virtually frozen up this week after upheaval on Wall Street.

The move gave some reassurance to panicked investors and sparked rallies, though stocks later lost ground amid concern about more failures of big financial institutions.

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Morgan Stanley topped the list of major financial firms scrambling to find a buyer, with CNBC reporting that the No. 2 Wall Street investment bank was in advanced merger talks with Wachovia.

Morgan, whose shares are down 50 percent this month, has also approached Chinese sovereign wealth fund China Investment Corp about boosting its stake in Morgan Stanley,following a $5 billion investment late last year.

Goldman Sachs Group , the other surviving independent Wall Street investment bank, is also facing concern that the credit crunch could constrict the short-term funding that it traditionally relied on.

Washington Mutual , the struggling savings and loan, has also put itself up for auction.

And Lloyds TSB sealed a rescue takeover of HBOS to create a dominant British mortgage and savings bank in a $22 billion deal helped through by the government.

The concerted action by central banks follows Wednesday's rout in financial markets, roiled by fears of more Wall Steet failures after a week that saw Lehman Brothers file for bankruptcy, Merrill Lynch lose its independence and a $85 billion U.S. government bailout of insurance giant AIG .

AIG, a component of the Dow Jones Industrial Average, will be replaced by Kraft Foods , it was announced Thursday.

Meanwhile, U.S. asset manager Putnam Investments said it had closed its $15 billion Prime Money Market Fund due to redemption pressures. That followed Tuesday's news that another big money-market fund, Reserve Primary Fund, fell below $1 a share in net asset value.

Nervous investors are scrambling into U.S. Treasuries, sending yields on one-month paper to just 0.010 percent, while three-month rates traded as low as 0.020 percent, the lowest since at least 1954.

Meanwhile, the Volatility Index, Wall Street's main barometer of investor fear, closed at levels not seen since late 2002.

“We’re just advising clients to hold it out,” said Patrick DeMay, operations manager at Carver Financial Serivces. “The biggest insurance companies and broker-dealers looking weak doesn’t help. Some of the companies being brought down in stock values are actually very stable companies but the confidence has eroded for entire sectors, sometimes not rightfully so.”

—Reuters contributed to this report.

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