Markets rebound as US government readies bailout

The sight of governments around the world marshalling unprecedented resources to prop up some of the most famous names in banking has helped to restore optimism to battered stock markets.

In the US, Treasury secretary Hank Paulson summoned the chief executives of major banks to inform them the government would be taking stakes in at least nine institutions, the first step in a comprehensive bailout likely to be announced this morning.

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Some $250bn (£144bn) is expected to be set aside for capital infusions, and the Treasury is also considering guaranteeing some types of bank debt, making it more likely institutions will also be able to raise private capital.

Meanwhile, Germany, France and other eurozone countries joined the UK in promising money for banks and government guarantees on lending. In all, European countries put almost €2trn (£1.6trn) behind the continent's financial system yesterday.

Equities staged a powerful rebound from last week's slow-motion crash, with the UK's FTSE 100 heading back up 324.8 points (8.3 per cent) to 4,256.9, and other global markets following suit. The French stock market enjoyed its best day ever, up 11.2 per cent; Germany's Dax rose 11.4 per cent, and in New York the Dow Jones surged 936 points, or 11.1 per cent, to 9,388 – its biggest percentage rise since 1933.

Investors had last week routinely raised the spectre of a new Great Depression; traders yesterday said concerted government action made that disastrous outcome less likely, and long-term investors were tempted by the idea of picking up shares in solid companies at bargain prices.

European government leaders made good on promises at their weekend summit meeting, when they pledged a "coordinated and ambitious" response to the financial crisis, including a raft of common measures to guarantee, refloat and partially nationalise the banks. The plans, modelled on the UK bailout, were described as a possible "super bazooka" by Michael Saunders, an economist at Citigroup. The aim is to restore a semblance of confidence to the financial markets so credit can once again be extended to the businesses and consumers that need it.

"No one can expect that any of this will avert recession," said Mike Lenhoff, chief strategist at Brewin Dolphin in London. "The forces of economic contraction were set in motion long ago by the credit crisis. But the intention behind introducing a coordinated and, to a large extent, uniform response is to restore confidence and prevent a recession from turning into something far worse."

Germany approved a package worth up to €500bn, which includes €400bn to guarantee inter-bank lending and €80bn that will be injected directly into ailing banks. The French President, Nicolas Sarkozy, said his government would set up a €40bn fund to invest in banks that need new capital, and would provide €320bn to guarantee bank financing. Austria is to spend up to €85bn, and the Italian government pledged to inject as much money as needed without giving any specific figures. Most of the national plans are subject to parliamentary approval and few governments have yet calculated the impact on the public finances of these extraordinary moves.

The German Chancellor, Angela Merkel, said only the government could restore "the necessary trust" to the public and financial markets. "Today we have established a first building block for new financial market conditions," she said. "We have one goal – to help create new confidence, between banks, in the economy and among citizens."

The world's most powerful central banks also issued their own coordinated plan to flood the gummed-up credit markets with dollars.

The Federal Reserve said it was removing a cap on the amount of US currency it sends to the Bank of England, the European Central Bank and the Swiss central bank, which would now be able to borrow any amount they wish in return for appropriate capital. The three are among nine central banks to whom the Fed had previously offered $630bn in dollar loans, which the banks are then meant to lend on into their local financial systems. Credit markets around the world, which often trade debt instruments denominated in dollars, have been frozen due to a crisis of confidence in the solvency of their participating banks.

All the government activity appeared to have the desired effect in the credit markets, helping to ease some of the signs of strain. There were substantial falls in Libor, the London inter-bank offered rate, which measures the interest rate at which banks lend to each other and which has been at elevated levels while banks have been reluctant to part with their money. The Libor rate on three-month dollar loans fell 7 basis points to 4.75 per cent, equalling its biggest fall in more than six months, according to the British Bankers' Association. The one-month dollar rate declined to 4.56 per cent, while the one-week euro rate fell to 4.34 per cent.

US credit markets, however, were largely closed due to the Columbus day holiday, and much rests on the resumption of trading there this morning.

Mr Paulson is putting the finishing touches on a bailout plan for the US banking system, under pressure to match the moves in Europe. A failure to offer the same guarantees could trigger a flight of capital to Europe. The heads of Morgan Stanley, Bank of America, JPMorgan Chase, Goldman Sachs and other major institutions were called to a meeting at the Treasury yesterday.

Neel Kashkari, the ex-Goldman Sachs executive who is in charge of the bailout plan, said the government was moving quickly. "We are designing a standardised programme to purchase equity in a broad array of financial institutions. As with the other programmes, the equity purchase programme will be voluntary and designed with attractive terms to encourage participation from healthy institutions. It will also encourage firms to raise new private capital to complement public capital."