Banking Crisis: World Markets Soar on Us Rescue Hopes

Share prices have soared across the world, with Wall Street rising more than 400 points within minutes of the start of trading in New York, on hopes that the American government will ride to the rescue of the country's distressed banks.

The mood was also lifted by a ban this side of the Atlantic on the practice of short-selling and hopes for a rescue of Wall Street's second largest investment bank Morgan Stanley.

The dramatic rise in the Dow Jones industrial average (DJIA), one of its strongest ever openings, helped push the FTSE 100 index up 431.3 points to 5311.3 by the close.

The FTSE 100's dramatic rally represents an 8.84% rise on the day, which has added ?103bn to the value of the index's constituents. This was the index's biggest rise since it was created by the Financial Times and London Stock Exchange in 1984.

But the sense of relief, after one of the most turbulent four days in stockmarket history, has not just been felt in London and New York.

In France, the CAC-40 index of leading French companies rose 9.27%, while in Germany the flagship DAX index closed up 5.56%.

Europe's rally came after Asian stockmarkets rose overnight following yesterday's rally on Wall Street of over 400 points as news of the government's proposed bailout leaked. Japan's Nikkei 225 index rose 3.75% while Hong Kong's Hang Seng index was up almost 10%.

New York's rally came after news that the US treasury and the country's central bank are putting together a government-sponsored firm - dubbed "bad bank" - which would take control of toxic financial assets and clean up the banking system.

Traders hope the move will stop the contagion which started with the collapse of Bear Stearns last year and reached a dramatic crescendo this week with the collapse of Lehman Brothers, Merrill Lynch's shotgun wedding with Bank of America and the bailout of America's largest insurer AIG.

Hopes are growing that another troubled bank, Morgan Stanley, could be rescued by a Chinese government-backed investment fund or clinch a deal with rival Wachovia. The China Investment Corp already has a 9.9% stake in Morgan Stanley, which it bought last December, and is in talks to raise that stake to 49%.

Morgan Stanley is also locked in talks about a potential merger with America's fourth largest retail bank, Wachovia, which is based in Charlotte, North Carolina. Such a deal would leave Goldman Sachs as the only remaining major independent American investment bank.

Rob Carnell at ING Financial Markets said the American government's plan for "bad bank" "is giving equity markets a rare chance to be far more optimistic". "What is being talked about is a vehicle for lancing the boil of bad property related assets that is causing banks to stop lending to one another ? and leading to the aggressive shorting that has already claimed some high profile names."

"It could draw a line under what has been described by some as the worst financial crisis since the Great Depression."

The market was also pushed higher by last night's unprecedented move against short-sellers - people who sell shares they do not own on the hopes of pushing the price lower and buying them back at a profit.

New rules brought in by the Financial Services Authority which banned new so-called "short positions" being taken - or existing positions being increased - in financial services stocks, from midnight last night.

Anyone with an existing short position - essentially betting that a stock price will go down - has until next Tuesday to close down that position by buying shares, or they must disclose their positions to the regulator.

This rule opens the way to naming and shaming of short-sellers, who as a rule prefer to retain some degree of anonymity, and as a result many have been closing their positions by buying shares in the market this morning, which has helped boost stocks.

The Irish financial regulator also banned short positions being taken in Bank of Ireland, Allied Irish Banks, Irish Life and Permanent or Anglo Irish Bank.

Triple witching

Share prices in London are also being boosted by the scheduled quarterly expiry of a number of futures and options contracts later today - a process known as "triple witching".

Triple witching takes its name from the residents of the heath in Shakespeare's Macbeth, because it involves three characters that can bring discord.

The characters are actually different classes of financial derivative which all come to the end of their trading period at the same time - stock index futures, index options and stock options. Their expiry can greatly increase volatility in the market. In fact it should be called quadruple witching, as the process now includes the expiration of single stock futures as well.