Credit Crisis Update: U.S. Stocks Notch Record Gains On Investor Hopes For A New Bailout Plan

U.S. stocks soared yesterday (Tuesday) - with the Dow Jones Industrial Average (^DJI) gaining 485 points in posting its third-biggest point gain ever - as investors surged back into stocks just one day after the surprise rejection of a $700 billion bailout plan touched off a record sell-off.
On Monday, after the House of Representatives refused to approve the compromise bailout accord, the Dow Jones plunged nearly 778 points - for its biggest point drop ever - as $1.2 trillion in shareholder wealth was eradicated from U.S. shares. The Standard & Poor’s 500 Index dove 8.79%, incurring its biggest loss since the 1987 stock market crash, while the tech-laden Nasdaq Composite Index (^IXIC) plummeted 9.14%. Overseas markets had been pounded earlier in the day. All told, The MSCI World Index of 23 developed markets skidded 6.9%, its worst showing in 21 years.

But U.S. shares came screaming back yesterday (Tuesday), with all three major indices posing huge gains early - and kept adding to those gains throughout the day, despite eroding credit conditions - as central banks and governments around the world stepped in to prop up flagging credit markets.

The Dow gained back more than half its record Monday loss, climbing 485.21 points, or 4.68%, to close at 10,850.66. The broad Standard & Poor’s 500 Index gained 58.35 points (5.27%), to hit 1,164.74. And the tech-heavy Nasdaq Composite Index zoomed 98.60 points (4.97%), to close at 2,082.33.

“There are at least some hints of optimism that something will still happen soon with regards to the [bailout] bill,” Jim Dunigan, managing executive of investments at PNC Wealth Management in Philadelphia, told Reuters. “It’s not surprising with the washout [Monday] that you’d get some bounce-back [yesterday], both due to bargain hunters and some prospects of a resolution. All eyes are still on Washington.”

In related developments yesterday:

• U.S. Senate leaders announced late Tuesday that their chamber plans to vote on a Wall Street bailout package tonight (Wednesday).  Any plan will include souped-up deposit coverage, which is already being sought by the Federal Deposit Insurance Corp. (FDIC).
• Earlier in the day, President George W. Bush and Senate leaders of both parties publicly vowed to push for a quick approval of a new financial bailout plan, despite the surprise Monday move by the House of Representatives to reject the pact that the Bush administration had negotiated with both parties in Congress. In a speech broadcast from the White House, President Bush urged lawmakers to avoid a potential economic crash, stating that “we are at a critical moment for our economy. Congress must act,” the International Herald Tribune reported.
• Indeed, the Federal Deposit Insurance Corp. (FDIC) said it will ask Congress for permission to at least temporarily insure greater amounts of deposits for each depositor at member banks. The FDIC right now insurances individuals’ deposits of up to $100,000 and retirement accounts up to $250,000.
• The U.S. Securities and Exchange Commission probably will resist calls to suspend the fair-value accounting rules that some members of Congress blame for exacerbating the global financial crisis, sources familiar with the issue reported. Although the SEC and the Financial Accounting Standards Board (FASB) yesterday issued “clarifications” on how banks should interpret existing rules requiring them to review assets each quarter and report losses if values decline, an actual moratorium isn’t being considered.
• Presidential candidates John McCain and Barack Obama called upon Congress to keep working on a financial-markets rescue plan and also pushed for an increase in FDIC deposit insurance as a short-term step to restore consumer confidence in the U.S. financial markets.

Foreign Market Reaction

Although the House rejection of the bailout legislation led to the crash-like 777-point drop in the blue-chip Dow index on Monday, reactions in the global markets were mixed yesterday.

In Asia, Japan’s Nikkei 225 Index plunged more than 4% to a new three-year closing low after shedding 483.75 points to close at 11,259.90. But Hong Kong’s blue-chip Hang Seng Index inched up 0.8% as it gained 135.53 points, to close at 18,016.20. Even with the slight gain, yesterday marked the end of the worst quarter for Hong Kong shares since 2001.

“It looks like Congress is going to be up in arms about this for a while but there are hopes that there may be other moves from authorities such as a rate cut from the Fed,” Yutaka Miura, deputy manager at Shinko Securities, told Reuters.

In Europe, bourses gained on the revived U.S. markets and government interventions into failing banks. The FTSEurofirst 300 index gained 1.6%, fueled by the strong early-morning gains in the United States. The Paris-based CAC40, London’s FTSE 100, Madrid’s IBEX 35 and the Frankfurt-based DAX all posted gains on hopes of a new bailout plan.

The London Interbank Offered Rate, or LIBOR, surged to a record high of 6.88% yesterday, the British Bankers’ Association said. LIBOR is the rate banks charge each other for overnight lending. Such a high rate - well above the Federal Funds rate of 2.0% - demonstrates the high level of risk-aversion currently in the market.

Central banks flooded the markets with short-term liquidity yesterday, but could do little to restore financial firms’ faith in lending.

“Come Thursday, when the package is presented again to the U.S. House, many of the same people who voted against it earlier today will change their minds because of the pressure coming from the markets,” Stephen Roach, chairman of Morgan Stanley Asia Ltd. (MS) said at a seminar in Hong Kong Monday, Bloomberg News reported.

Continued Bailout Hopes

Both the U.S. House and Senate were adjourned yesterday for the Jewish New Year holiday. The Senate will reconvene today - with members intending to actually vote on a new package tonight - while the House will gather again tomorrow (Thursday).

Despite the legislative holiday break, the executive branch continued its full-court press to get the bailout legislation passed.

“I realize this is a difficult vote for members of Congress,” President Bush said the White House address yesterday. “But the reality is that we’re in an urgent situation and the consequences will grow worse each day if we do not act.”

U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. also tried to underscore the benefit to the average American, and not just Wall Street bankers, as he lobbied politicians to move forward with the proposed bailout, Bloomberg reported.

“Markets around the world are under stress, and that reduces the availability of credit that businesses across America use to meet payroll and to purchase inventories,” Paulson said to reporters gathered outside the White House. “Families, too, feel the credit crunch as it becomes more difficult to get car loans or student loans.”

More Bank Bailouts

European governments stepped in again to aid more ailing financial institutions yesterday. In a united effort, Belgium, France and Luxemburg earmarked $9.2 billion (6.4 billion euros) in emergency cash for Dexia SA.

“Due to the significant deterioration in the business and market environment and the financial distress of a number of financial services companies, Dexia made a careful assessment of its situation and decided to take decisive action,” the bank said in a statement, MarketWatch reported.

In Ireland yesterday, in a bid to stabilize sinking bank shares, the Irish Finance Ministry pledged to back deposits for two years with taxpayer funds if necessary. The move pushed Irish financial stocks higher.

Iceland nationalized its third-largest bank, Glitnir, on Monday, which sent the Icelandic crown diving to a new low against the euro. Also on Monday, banks in Belgium, Germany and Britain received government aid.

In the United States, Citigroup Inc. (C) purchased the retail banking assets of Wachovia Corp. (WB). The shares of both domestic banks enjoyed major gains yesterday, with Citi’s stock climbing 15.6% to close at $20.51, and Wachovia’s shares advancing 90.22% to close at $3.50.

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