NEW YORK - Wall Street extended a huge rally Friday as investors stormed back into the market, relieved that the government plans to rescue banks from billions of dollars in bad debt. The Dow Jones industrials rose more than 375 points, giving them a massive gain of more than 785 points over two days, and Treasurys fell as money flowed into equities.
A new ban on short selling, or placing bets that a stock will fall, was likely adding to the market's gains. And Friday was a quarterly "quadruple witching" day, which marks the simultaneous expiration of options contracts, an event that often adds to volatility.
"A big chunk of this is scaring all the shorts to cover their bets," said Joe Battipaglia, market strategist at Stifel, Nicolaus & Co.
Treasury Secretary Henry Paulson, speaking about the rescue plan said a bold approach is needed to remove troubled assets from the books of financial firms. He offered few details, but said he would work on it through the weekend with congressional leaders.
A plan to help the banking industry could help alleviate the uncertainty that has been sending the markets into tumult over the past week. Lending has grinded to a virtual standstill in the wake of this week's bankruptcy of Lehman Brothers Holdings Inc. and the bailout of teetering insurer American International Group Inc.
The government took other steps Friday to restore stability to the financial system. The Federal Reserve said it will expand its emergency lending and let commercial banks finance purchases of asset-backed paper from money market funds. The Fed will also buy short-term debt obligations issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks.
And to help calm investors' anxieties, the Treasury Department has decided to use a Depression-era fund to provide guarantees for U.S. money market mutual funds. Money market mutual funds are typically considered safe, but many investors have been fleeing them due to worries about the funds' exposure to souring corporate debt.
To help limit the freefall in financial stocks, the Securities and Exchange Commission on Friday enacted a temporary ban on the short-selling of nearly 800 financial stocks. Short-selling is the common practice of betting against a stock by borrowing shares and then selling them in the open market. A short-seller's hope is the stock will fall; if it does, the stock can be bought back at the lower price. Those cheaper shares can be returned to the lender, allowing the investor to pocket the profits.
Wall Street observers have disagreed over the extent to which pressure from all those bets that a stock will fall shaped investor sentiment and strangled some financial stocks, like those of Lehman Brothers last week. Some say the fundamental problems with the financial stocks warranted the pessimism while others say the short selling was a death knell for some financial names.
"The federal government has been petitioned by Wall Street to take evasive action in the money markets, the stock and bond markets, to avoid a complete meltdown of the credit system," said Battipaglia. "Once the credit system melts down, the economy falls. We can hand-ring about if this is the proper thing for the government to do, or if Wall Street pulled the panic button too soon, but that's something for the historians to sort out."
In late morning trading, the Dow rose 375.35, or 3.41 percent, to 11,395.04.
Broader stock indicators also surged. The Standard & Poor's 500 index rose 42.22, or 3.50 percent, to 1,248.73, and the Nasdaq composite index rose 62.67, or 2.85 percent, to 2,261.77.
Treasury prices dropped as investors poured money back into stocks. The yield on the 3-month Treasury bill — a safe investment to which investors have rushed this week — rose to 0.80 percent from 0.07 percent late Thursday. Yields move opposite from price. The yield on the benchmark 10-year Treasury note shot up to 3.77 percent from 3.53 percent late Thursday.
"Everything they had done had been a Band-Aid approach, at the margins," said Jay Mueller, economist at Strong Capital Management. "Now we're dealing with the root problem."
On Thursday, the Fed and other major central banks around the world joined forces to inject as much as $180 billion into global money markets in an attempt to keep the credit crisis from worsening. But with worries swirling about the financial health of such major companies as thrift bank Washington Mutual Inc. and investment bank Morgan Stanley, the cash infusion was not enough to alleviate the tension on Wall Street.
An afternoon report, however, that the government was in the midst of crafting a plan to assume banks' bad debt led to a late-day surge in stocks. The Dow rose 410.03, or 3.86 percent, its biggest percentage point gain since October 2002.
"If a solid plan is put in place, it's definitely going to be a positive in easing the pain," said Stephen Carl, principal and head of equity trading at The Williams Capital Group. He added, though, that "it depends on how it's structured."
Wall Street's whipsaw week saw a massive loss Monday, a rebound on Tuesday, another drop Wednesday, and the rally on Thursday.
The dollar rose against most other major currencies in Friday trading. Gold prices fell. Light, sweet crude for October delivery rose $1.44 to $99.32 a barrel on the New York Mercantile Exchange.
Advancing issues outnumbered decliners by about 8 to 1 on the New York Stock Exchange, where volume came to an enormous 1.38 billion shares.
The Russell 2000 index of smaller companies rose 23.51, or 3.25 percent, to 747.32.
Overseas stock markets soared. Japan's Nikkei stock average jumped 3.8 percent, and Hong Kong's Hang Seng index surged 9.61 percent. In Europe, Britain's FTSE 100 surged 7.88 percent, Germany's DAX index jumped 4.90 percent, and France's CAC-40 rose 7.95 percent.