The facility would be similar to the Resolution Trust Corporation, which was set up in the late 1980s to take on all the failed thrift assets during the savings and loan crisis, these sources said.

Paulson is said to be shopping the proposal to lawmakers in Congress, a congressional aide told Reuters.

Such a move, according to its advocates, would allow banks to shovel bad debt off their balance sheets and send them back to business as usual.

In turn, that could allow the housing market to recover because it would restore banks willingness to lend.

"This will bring real trust back into the market." Donald Marron, chairman of Lightyear Capital, said on CNBC. "It would free up real, spendable capital in these organizations. They can use that to make loans, to make transactions and to build confidence in the system. This is a confidence crisis."

The news sparked a big rally in stocks after a day in which investors remained nervous about the spreading effects the global credit crisis. Europe and Asiaclosed lower.

Stocks also got a lift after Britain announced Thursday that it would bar short-selling until January.

Meanwhile, Calpers, the nation's biggest pension fund, said it would no longer lend out Morgan Stanley or Goldman Sachs shares to short-sellers, who profit from stock declines, the Wall Street Journal said. Both stocks have been pummeled recently by heavy short-selling.

Both decisions came after U.S. securities regulators reimposed tightener rules on short-sellers.

Meanwhile, U.S. asset manager Putnam Investments said it had closed its $15 billion Prime Money Market Funddue to redemption pressures. That followed Tuesday's news that another big money-market fund, Reserve Primary Fund, fell below $1 a share in net asset value.

For Investors

Overnight, the Federal Reserve announced coordinated moves with five of the world's major central banks to add up to $180 billion in liquidity to global money markets, which had virtually frozen up this week after upheaval on Wall Street.

The move gave some reassurance to panicked investors and sparked rallies, though stocks later lost ground amid concern about more failures of big financial institutions.

Morgan Stanley topped the list of major financial firms scrambling to find a buyer, with CNBC reporting that the No. 2 Wall Street investment bank was in advanced merger talks with Wachovia.

Morgan, whose shares are down 50 percent this month, has also approached Chinese sovereign wealth fund China Investment Corp about boosting its stake in Morgan Stanley,following a $5 billion investment late last year.