Dow plunges on bailout plan fears

A new sell-off in financial stocks sent the US stock market plunging last night, as traders fretted about the progress of the government's $700bn (£377bn) bailout plan, and badly damaged credit markets showed only a modest improvement.

With numerous questions remaining over the details of the federal plan to buy troubled assets, and with continued chaotic trading among hedge funds affecting markets of all kinds, the Dow Jones plunged 3.3 per cent, erasing the gains from Friday's rally. Many financial stocks fell by double-digit percentages.

The FTSE 100 had earlier closed down 1.4 per cent at 5,236.26, as the one-off benefit of banning the short-selling of financial stocks wore off. The US Securities and Exchange Commission widened its short-selling ban to cover 31 more American companies not in the financial sector but which have large finance arms, including GE and General Motors, but most ended lower.

"We need to have confidence built," said Rob Lutts, chief investment officer at Cabot Money Management. "This government opening of the chequebook – it's a stopgap measure that will calm people and help us buy a little bit more time, but ultimately what we need to see is more confidence."

A surge in the oil price – its biggest one-day gain ever – was also weighing on stocks, although traders pointed to technical factors surrounding the expiry of futures contracts and said the underlying rise was more modest.

There were tentative improvements to liquidity in the credit markets, but trading remained volatile. The unwillingness of banks to lend to each other eased a little and central banks scaled back the massive liquidity injections they used last week to keep money moving and forestall a market collapse that would quickly hurt businesses in the real economy.

The London inter-bank interest rate for borrowing in dollars (Libor) slid by 28 basis points to 2.97 per cent, a significant improvement but still at distressed levels. It is 97 basis points higher than the Federal Reserve's target rate, compared with an average 10 basis points during the past seven years.

And in the US, the interest rate on three-month Treasury bills continued to be depressed, suggesting nervous investors are still buying super-safe investments. The rate was 0.92 per cent last night. On Thursday, at the height of the panic, investors were accepting the bonds with no interest yield at all, just to be certain they would not lose money.

The spread on corporate bonds, which measures the extra interest buyers get over that paid on Treasury bills, tightened slightly from elevated levels, suggesting reduced risk aversion.

New York's state governor, David Paterson, said his administration would begin to regulate parts of the credit derivatives market, since many of these obscure instruments – where losses caused the collapse of insurance giant AIG last week – were effectively used as insurance, an industry which is regulated by the states.

Meanwhile, reports from Washington suggested plans to spend $700bn of US taxpayers' money buying the toxic assets currently clogging up bank balance sheets might be widened to include not just mortgage-related investments but also vehicle loans and credit card debts parcelled into derivatives. Democrats continued to insist on additional measures to help the economy and to punish Wall Street, but hope remained for a political consensus.

The US plan had a supportive response from the other major economies – but no nation has yet said it will adapt and adopt it. In Britain, the Chancellor Alistair Darling studiously avoided the topic in his speech to the Labour Party conference yesterday, saying that while the financial crisis was "a global problem and will require global solutions" it also needed "not a knee-jerk reaction, but a measured response".