NEW YORK (AP) – 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.

“A big chunk of this is scaring all the shorts to cover their bets,” said Joe Battipaglia, market strategist at Stifel, Nicolaus & Co.

Restoring stability

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 ground 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 injected another $20 billion in temporary reserves into the U.S. financial system. The central bank also will 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. Traders can lose, however, if the stock rises.

Analyzing the fall

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-wring 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.”

It’s difficult to quantify how much of the market’s gains reflect short sellers who are forced to step in and cover their bets by buying now rising stocks that had predicted would fall. While that played some role in the advances Thursday and Friday, the Nasdaq composite index – dominated by big technology stocks, not financials – showed big gains along with the Dow and the Standard & Poor’s 500 index.

In early afternoon trading, the Dow rose 372.17, or 3.38 percent, to 11,391.86 after having been up as much as 463.36. Even with Friday’s big gains, stocks are essentially flat for the week after whipsaw sessions. Wall Street saw a massive loss Monday, a rebound on Tuesday, another drop Wednesday, and the rally on Thursday. The Dow has logged moves of more than 400 points every day except Tuesday.

Investors still jittery

“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.”

The stock market’s enormous moves for the week reveal how jittery investors have been about the tightness in the credit markets the possibility that other financial companies might succumb to the difficulties in the markets. Moves Thursday by the Fed and other major central banks to inject billion into global money markets perhaps helped forestall steeper selloffs but didn’t diffuse the Sturm und Drang and overall loss of confidence hammering the markets.

The only lasting move in a week of intense volatility came late in Thursday’s session when reports emerged that the government was considering a massive bailout. Wobbly stocks rocketed higher, giving the Dow a 402-point gain Thursday that continued into Friday.

“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.”

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