U.S. stocks rallied the most in six years yesterday (Thursday) – with traders actually cheering the ticker action from the floor of the New York Stock Exchange – on the news that the federal government is taking steps to shore up the unraveling U.S. financial system and end the global credit crisis.

After two straight days of sharp selling, U.S. stocks whipsawed their way to major gains yesterday on investor hopes that federal government moves will halt a global credit crisis so severe that some leading market experts are talking about a depression-like downturn. The blue-chip Dow Jones Industrial Average jumped 617 points from its low of the day after U.S. Sen. Charles Schumer, D-NY, proposed plans for a new agency that would function during the current financial crisis much like the Resolution Trust Corp. did during the Savings and Loan Crisis of the late 1980s and early 1990s.

Institutional investors and regulators both here and overseas are taking steps to curtail speculative short selling.

For the day, the Dow rocketed 410.03 points, or 3.86%, to close at 11,019.69. The Standard & Poor’s 500 Index – which tumbled 4.7% twice this week – rebounded from its lowest level since May 2005 to zoom 50.12 points, or 4.33%. With its close at 1,206.51, the broad U.S. stock index recovered most of Wednesday’s 4.7% drop.

Both the Dow and the S&P 500 posted their biggest percentage gains since October 2002, Bloomberg News reported.

The tech-laden Nasdaq Composite Index roared ahead by 4.8%, rising 100.25 points, and closing at 2,199.10.

Seven stocks climbed for each that fell on the New York Stock Exchange, the Big Board’s broadest rally since April.

Wachovia Corp. (WB) soared 59%, Citigroup Inc. (C) added 19% and Bank of America Corp. (BAC) advanced 12%, which caused the KBW Bank Index to post its biggest gain since July. Morgan Stanley (MS) rose 3.68% for the day – erasing an earlier 46% loss – while Goldman Sachs Group Inc. (GS) closed down 5.68%, almost fully reversing a 25% decline after three of the top U.S. pension funds stopped loaning shares of U.S. brokerages to speculators who wanted to sell the institutions “short.”

“Any actions regulators or other entities or players take to try to slow down the bear raids will be received positively,” David Katz, the chief investment officer of Matrix Asset Advisors in New York, told Bloomberg. “There’s no reason a Goldman Sachs or a Morgan Stanley should be forced to sell themselves in a shotgun wedding if they’ve got economic models that work, and they do.”

Gold futures surged for a second straight day yesterday, with the benchmark contract eclipsing the $900-an-ounce mark for the first time in six weeks, as investor anxiousness over the fate of the global financial system sent them scurrying into hard assets.

Gold jumped $70 an ounce on Wednesday – its largest one-day gain ever – to reach $846.60 an ounce. The yellow metal yesterday tacked on an additional $46.50 an ounce, a jump of 5.5%, to end the day at $897 an ounce on the Comex division of the New York Mercantile Exchange (CME). At one point, the contract traded as high as $926.

In electronic trading, however, gold last fell back $40 to $857 and U.S. stocks staged a massive late-afternoon rally, amid signs that investors are starting to gain confidence in measures to provide capital to troubled financial firms.

The recent jump in gold prices “can be attributed to large amounts of money fleeing to the yellow metal as a safe haven in these troubled times,” Sam Kirtley, editor of Gold-Prices.biz, told MarketWatch.com.

Kirtley noted that the financial crisis “will probably worsen over the coming months,” meaning the money that the central banks are pumping into the system is adding to inflationary pressures – a reality that is “certainly showing in gold [prices].” [For a related story on the actions of the global central banks elsewhere in today’s issue of Money Morning, please click here].

Another expert agrees that the financial crisis “will probably worsen,” but was far less sanguine about any benefits.

Jeffrey E. Gundlach, chief investment officer at The TCW Group Inc., a Los Angeles-based mutual-fund firm, told clients on a conference call late Wednesday that the crisis in credit and housing is actually getting worse – and could last for years, if not decades. In the deteriorating climate he sees unfolding, Gundlach said, the S&P 500 could fall another 30%, Citigroup could become an “AIG-sized debacle,” default rates could soar even on prime mortgages and a banking crisis will emerge in Europe.

According to Gundlach, financial institutions may suffer write-offs that could surpass $1 trillion before conditions improve. That means there’s still a long way to go. As of late August, credit losses and write-downs at the world’s 100-largest banks and brokerages topped $506 billion, Gundlach said.

“This is no market for old men,” Gundlach, who also manages TCW’s flagship Total Return Bond Fund (TGLMX), told MarketWatch. “This is no market for old-school thinking.”

Gundlach said housing prices would decline for several more years, the kind of slump not seen since the Great Depression. Indeed, it’s possible that home prices will be sluggish until 2022.

“If it’s like the Depression experience – and it sure is shaping up that way – it could take several years,” he said. “Maybe we won’t see a bottom in home prices until 2014.”

By Jennifer Yousfi, William Patalon III and Jason Simpkins
Money Morning Editors

Source: The Government’s Financial Crisis Fix-it Plan Sends Stocks Soaring, Though Some Argue There’s no Quick Fix for this Disaster

(Part 1)