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By Natsuko Waki, Reuters
LONDON - Investors will hand down their verdicts this week on worldwide rescue plans topping 1 trillion dollars designed to end the worst financial crisis since the Great Depression.
The Bush administration asked Congress on Saturday for $700 billion to bail out firms burdened with bad mortgage debt, seeking extraordinary authority as it seeks to prevent meltdown in the global financial system.
Senior Bush administration officials pressed counterparts in Japan, Germany, Britain and other nations to set up similar plans for their own troubled financial firms
After a rollercoaster week which saw the collapse of Lehman Brothers, the bailout of insurer AIG and the firesale of Merrill Lynch and UK bank HBOS, policymakers hit back, throwing a lifeline of billions of dollars to global markets and banning short selling.
The Federal Reserve led a central bank move on Thursday to flood $180 billion into jammed up money markets and on Friday the U.S. Treasury laid out $50 billion to guarantee money market mutual funds and crafted a plan to mop up toxic mortgage debt.
The market reaction on Friday was dramatic. World stocks, measured by MSCI, rallied 6.15 percent, posting their biggest one-day gain since at least 1988, while the dollar rallied more than 2 percent against the yen.
Russia, which was forced to suspend stock and bond trading for two days last week, is pledging $130 billion in emergency funds to help prop up local markets.
Under the latest U.S. plan to purge bombed-out assets from balance sheets, the U.S. government could acquire up to $700 billion in home and commercial mortgages and related assets from U.S.-headquartered banks and other institutions over the next two years.
U.S. Treasury Secretary Henry Paulson would have sweeping powers over the massive war chest and his decisions would not be reviewed by any court, according to a copy of the draft legislation obtained by Reuters.
Democratic lawmakers, who control both houses of Congress, said they hoped to approve the bailout quickly but wanted changes such as more oversight, limits on executive pay at participating firms, and assistance for homeowners.
"The drama of the past week achieved what was needed -- the political will to inject capital into the system that will support a bad assets, good assets' type of solution," said Paul Mortimer-Lee, global head of market economics at BNP Paribas.
"There had to be drama in the crisis. In other words, the financial crisis had to become so bad, so intense, so plainly and publicly frightening that it would change the political will. That appears to have happened."
In what will probably be another volatile week for asset markets, investors will also focus on testimonies by Federal Reserve chief Ben Bernanke and U.S. Treasury Secretary Henry Paulson and a speech by European Central Bank President Jean-Claude Trichet on Monday.
Their comments will clarify policymakers' resolve to fight the one-year-old credit crisis.
This week's data, including readings on the U.S. housing market, the euro zone services sector and German business morale, will give the latest on economic fundamentals -- nearly dismissed last week in the frantic selling of risky assets.
"Precedent from the early 1990s suggests that we may well have seen a significant turning point," said Paul Nivan, head of asset allocation at F&C Asset Management.
"A roadmap out of the crisis now appears much clearer, following a well-worn path of government intervention and capital injections but the deleveraging process which is underway has some way to run. The bear market has been halted, but many challenges and pitfalls lie ahead."
BEGINNING OF END?
Aside from reaction in equity and bond markets, investors will keep a close eye on money markets, where stress level eased following a concerted plan by the world's central banks to pump in extra dollar funds to free up bank-to-bank lending frozen by upheavals on Wall Street.
Earlier in the week, the panic exodus from risky positions triggered a rush into safe-haven U.S. Treasuries, pushing yields on short-term U.S. government paper to near zero at one point.
The so-called "quality spread" between 30-day AA-rated commercial paper and lower grade CP -- A2/P2 non-financial -- hit 280 basis points, twice the size of the spike in late 2000, according to Morgan Stanley.
Former Fed chairman Alan Greenspan cited the spike in 2000 as evidence of a complete breakdown in confidence in rational market operation and responded with a surprise half-point inter-meeting rate cut -- the first of 475 basis points of cuts.
The U.S. plan on domestic money markets funds will at least help stem the outflow from the $3.5 trillion sector, which was threatening to destabilize the broader financial market.
What is essential to long-term stability of the financial system is how sustainable Friday's risky asset rallies and the calming in money markets would be.
"Policymakers are responding in a piecemeal fashion so far but the cost of intervention is getting bigger and the reaction time faster -- we should expect much more financial shock and awe to come," said Neil Dwane, chief investment officer for Europe at asset management firm RCM.
"It seems obvious to conclude that the deleveraging must and will continue alongside both aggressive recapitalizations of banks and also the restructuring of the financial industry, post AIG and Lehman/Merrills."
Whipsawed by a massive wave of deleveraging, world stocks, measured by MSCI hit a 2-1/2 year low on Thursday, only to shoot back up to Monday's level.
Emerging markets also saw dramatic moves before recovering as foreign investors drained their capital out of economies which they see as more vulnerable in times of a global slowdown.
Given that, investors will eye further moves by emerging governments to help local banks and bolster stock markets.
China unveiled a set of bold steps to bolster its stock market, including scrapping its stamp tax on stock purchases and enlisting a state-owned agency to buy shares of listed firms.
"I don't think anybody should be under the illusion that the process of deleveraging will stop... It will continue in an orderly way," George Magnus, economic advisor to UBS, said.
(Editing by David Cowell)