Stocks rally on report of federal entity for banks' debt; Dow up 410

Stocks had a stunning late-session turnaround Thursday, shooting higher and hurtling the Dow Jones industrials up more than 400 points after a report that the federal government may create an entity that will take over banks' bad debt.

The report on CNBC said Treasury Secretary Henry Paulson is considering the formation of an entity like the Resolution Trust Corp. that was set up after the failure of savings and loan banks in the 1980s.

The Treasury Department and Federal Reserve declined to comment Thursday on any discussions Paulson may have had with lawmakers about a Resolution Trust Corporation-style fix for a financial market crisis.

"We're not going to comment on rumors," Treasury spokeswoman Jennifer Zuccarelli said.

But investors were cheered by the notion of a huge federal intervention like the establishment of RTC to acquire the real estate debt that has hobbled financial institutions and led to the intense volatility in the markets this week.

If there's an RTC-like entity, "it's going to take a lot of the bad debt off the balance sheets of these companies," said Scott Fullman, director of derivatives investment strategy for WJB Capital Group in New York. That would alleviate many of the pressures causing the credit crisis, he said, and open up the credit markets again. But Fullman noted, "the devil's in the details."

"Bear markets are very sensitive to news. And on a scale of 1 to 10, this one is a 13," he said.

However, Fullman added, "the devil's in the details."

According to preliminary calculations, the Dow soared 410.03, or 3.86%, to 11,019.69.

Broader stock indicators also jumped. The Standard & Poor's 500 index rose 49.86, or 4.31%, to 1,206.25, and the Nasdaq composite index advanced 100.25, or 4.78%, to 2,199.10.

The report of a broader government bailout proved more reassuring to investors than moves before the opening bell Thursday by the Federal Reserve and other major central banks to inject as much as $180 billion into global money markets. The moves were an attempt to keep the credit crisis from worsening; the Fed added another $55 billion in overnight loans Thursday.

Grinding gears in the world's credit markets have driven up the cost of borrowing for businesses; banks have become hesitant to make loans even to other banks for fear of what institutions might be hobbled by soured debt. Investors are also contending with fears that more big-name financial companies could falter.

Worry in the markets had led to speculation about the future of such major players as thrift bank Washington Mutual and investment bank Morgan Stanley. Media reports have been saying that Wells Fargo and Citigroup are interested in a possible takeover of Washington Mutual; and a person familiar with the negotiations said Morgan Stanley and Wachovia are in talks about a possible combination. He spoke on condition of anonymity because the talks are ongoing.

"We're seeing a tremendous amount of nervousness. That nervousness is leading to volatility," said Anthony Conroy, head trader for BNY ConvergEx Group. He said the markets hadn't seen as much fractiousness since the 1920s.

Advancing issues outnumbered decliners by more than 2 to 1 on the New York Stock Exchange, where volume came to 1.85 billion shares. Trading remained heavy as it has all week amid investors' fears about the well-being of the financial system. But observers said traders were positioning themselves ahead of Friday's "quadruple witching," which marks the simultaneous expiration of four types of options contracts and can exacerbate volatility.

Investors shying from the risks of stocks turned to government-backed debt. On Wednesday, the 3-month Treasury bill — considered one of the safest short-duration assets — saw demand surge so high that its yield briefly dipped into negative territory for the first time since 1940. Investors are so focused on parking their money in safe assets that they're willing to take very little return on such investments.

The prices for short-duration Treasurys fell from Wednesday's levels. But the yield on the 3-month T-bill was still extremely low at 0.19% — up from 0.2% late Wednesday, but well below its yield of 1.60% just a week ago.

Longer-term bond prices fell. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3.51% from 3.42% late Wednesday.

Investors also continued a move into other safe havens. Gold rose again Thursday, up $50.20 to $900.70 an ounce on the New York Mercantile Exchange after posting its largest ever one-day price jump Wednesday.

Oil shot up early in the day, moving back above $100 as investors sought it as another haven. But crude fell back with the market's realization that the financial turmoil will likely exacerbate the drop in demand that has taken oil down sharply from its July record of $147.27 a barrel.

Light, sweet crude on the Nymex rose 72 cents to settle at $97.88 a barrel.

"We are in uncharted territory," said Linda Duessel, the equity market strategist at Federated Investors. "The seriousness and the size of this fallout has been underestimated from the beginning. It's most disconcerting what's going on in the credit market."

Investors remained jittery throughout Thursday's session. The Chicago Board Options Exchange's volatility index, known as the VIX, set a new high for the year in trading Thursday. Often referred to as the "fear index," the VIX at times rose to levels not seen since October 2002. But the VIX retreated after the report a government plan for bad bank debt.

Some market observers say a reading of more than 40 is necessary before the market can begin to excise its fears and carve out a rebound.

Mixed economic readings drew little attention as investors focused on the financials and the credit markets.

The Labor Department reported that initial claims for unemployment benefits rose by 10,000 last week to 455,000, due primarily to Louisiana's job losses from Hurricane Gustav. And the Philadelphia Fed said its regional manufacturing report improved to a 3.8 in September from a negative 12.7 in August. It marks the first positive reading since November.

Among financials, Morgan Stanley rose $2.15, or 10%, to $23.90 as the investment bank sought a buyer or cash infusion to shore up its flagging share price. The stock has fallen 38% in the past week following Monday's bankruptcy filing at rival Lehman Brothers Holdings Inc. and a forced sale of Merrill Lynch & Co. to Bank of America Corp.

The Russell 2000 index of smaller companies rose 40.38, or 5.97%, to 716.76.

Overseas, Japan's Nikkei stock average dropped 2.22% to its lowest closing level in over three years. Hong Kong's Hang Seng index lost 0.03%.

Britain's FTSE 100 fell 0.66%, Germany's DAX index rose 0.04%, and France's CAC-40 fell 1.06%.

Contributing: Reuters