Banks bounce back in huge rally
Shares of battered financials skyrocket after reports of a possible long-term plan to solve the credit crisis emerge.
NEW YORK (CNNMoney.com) -- In yet another wild day on Wall Street, shares of several big bank stocks staged a significant late-afternoon rally Thursday along with the broader market after reports surfaced about a potential long-term government solution to the credit crunch.
After getting pummeled earlier in the day on fears about the fate of the financial sector, shares of the nation's leading investment banks - Goldman Sachs and Morgan Stanley - both rallied in the last hour of trading.
Morgan Stanley (MS, Fortune 500) stock, which had plunged by as much as 46% at one point, finished nearly 4% higher.
After hitting a new four year-low of below $90 a share earlier, shares of Goldman Sachs (GS, Fortune 500) ended just 6% lower. The stock was down as much as much as 25% at one point Thursday.
Speculation, first reported on CNBC, that the federal government could create some sort of rescue entity to acquire troubled assets that have plagued financial institutions - similar to the Resolution Trust Corporation formed during the savings and loan crisis of the late 1980s and early 1990s - helped fuel the rally.
"The idea that the Treasury [Department] was considering an RTC-type entity was what really put this [rally] into hyperspace," said Richard Cripps, chief investment officer at Stifel Nicolaus.
For the day, the Dow Jones industrial average had gained close to 410 points, or 3.9%. The broader S&P 500 index and tech-fueled Nasdaq also participated in the advance, gaining 4.3% and 4.8% respectively.
Meanwhile, a key group of bank stocks, the S&P Banking Index, skyrocketed 16%. The index was down nearly 4% at its low point for the day Thursday.
The rally sent shares of Wachovia (WB, Fortune 500), which Morgan Stanley is reportedly considering a merger with, 59% higher Thursday.
Other banks often in the headlines lately also posted solid gains toward the end of the day, including Washington Mutual (WM, Fortune 500), whose shares climbed nearly 50%.
Just a day earlier, speculation emerged that the Seattle-based firm has put itself up for sale. JPMorgan Chase (JPM, Fortune 500), HSBC (HBC), Citigroup (C, Fortune 500) and Wells Fargo (WFC, Fortune 500) are said to be potential suitors, according to published reports, although a person close to the situation has told CNNMoney.com that JPMorgan is not interested in buying WaMu.
Shares of both Merrill Lynch (MER, Fortune 500) and Bank of America (BAC, Fortune 500), which announced a tie-up Monday worth roughly $50 billion, each gained more than 12%.
One economist blamed the earlier sell-off on fears about the future of Goldman and Morgan Stanley.
"The markets have become emboldened into thinking that independent investment banks won't be able to survive," said Robert Brusca, chief economist at Fact and Opinion Economics, who does not own shares of either firm.
"These are two very fine firms and I don't see any reason why they can't survive these attacks, which are essentially baseless," he said.
Some market observers, including top bank executives, had also blamed short sellers for the punishing declines in bank stock prices over the past few days. Short sellers typically borrow stock with the aim of selling it and buying it back at a lower price so they can pocket the difference.
Critics of short sellers have argued that some had been spreading rumors about a company while "shorting" the stock in order to drive the price lower.
Hoping to curb that behavior, the Securities and Exchange Commission unveiled new rules Wednesday aimed at curbing that practice.
Large institutional investors also joined efforts to try and curb short-selling abuses. CalPERS, California's pension fund for workers in the public sector, said Thursday it would restrict the loans of shares of Goldman Sachs, Morgan Stanley, State Street and Wachovia in its securities lending program.
At the same time, the Federal Reserve, along with five other global central banks, announced that they would inject $180 billion into money markets in order to help prop up the struggling financial sector.
Thursday's bank stock rally followed what was a particularly painful session on Wednesday driven by investor uncertainty about just how much worse the financial crisis will get. On Monday, Lehman Brothers filed for bankruptcy and just a day later the Fed decided to loan $85 billion to struggling insurer AIG.
While Thursday's recovery proved comforting for rattled investors, there's no guarantee that there won't be another big selloff Friday, warned Michael James, managing director of equity trading at the Los Angeles-based investment bank Wedbush Morgan.
"Volatility is not going to dissipate," he said. "Nervousness creates an overdone situation on both the downside and the upside." 
