Stocks surge on report of creation of government entity for bad debt

NEW YORK — Wall Street had a stunning late-session turnaround today, shooting higher and hurtling the Dow Jones industrial average up more than 400 points after a report that the federal government may create an entity that will take over banks' bad debt.

The Dow closed up 410.03 points, or 3.9 percent at 11,019.69, after having been down 150 points at midday. Today's gain reversed most of yesterday's 450-point decline. Microsoft, one of the 30 Dow stocks, gained 69 cents to $25.26 today. Boeing, also a Dow stock, advanced $1.11 to $58.11.

Broader stock indicators also jumped. The Standard & Poor's 500 index rose 50.12, or 4.3 percent, to 1,206.51, and the Nasdaq composite index advanced 100.25, or 4.8 percent, to 2,199.10.

Shares of Seattle-based Washington Mutual, the nation's largest thrift, closed up 98 cents, or 48.8 percent, at $2.99

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

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.

The report of a broader government bailout proved more reassuring to investors than moves before the opening bell today 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 today.

Worry in the markets had led to speculation about the future of such major players as 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.

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.

"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.

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 three-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.

Investors also continued a move into other safe havens. Gold rose again today, 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 today's session. The Chicago Board Options Exchange's volatility index, known as the VIX, set a new high for the year in trading today. 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 of 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.

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

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