The financial world has let out a huge sigh of relief as the US House of Representatives voted by 263-171 in favour of a $700 billion plan to rescue the US banking system.

The positive vote followed a rejection of President Bush’s first bail out package on Monday.

The new, greatly expanded version of the plan included Senate additions of around $100 billion in new tax breaks to win Republican votes.

The Dow Jones Industrial Average had rallied 250 points before the vote, factoring in a favourable result but fell back after profit taking.

Meanwhile, in a dramatic development in the banking arena, the sudden announcement today by Wachovia that it would be taken over by rival US bank Wells Fargo rather than US bank Citi triggered an angry legal objection by the latter bank. Citi is demanding that Wells Fargo and Wachovia immediately halt their $15.1 billion transaction.

Besides the bank takevover saga, investors had been focusing on the US bailout package vote. The vote comes at the end of a week of frenzied negotiations between the US government and lawmakers. George Bush and his Treasury Secretary, Henry Paulson, said the package is necessary to lift bad debts from balance sheets of banks and get the financial system working normally.

As an indication of the stress that the system has been under, short-term commercial borrowing rates in the inter-bank market have spiked, threatening to starve banks of vital funding. The British Bankers Association's fixing of three-month dollar London interbank offered rates was fixed at 4.33375 per cent, the highest since early January, according to Reuters.

The premium to borrow at Libor over anticipated policy rates, as measured by average Overnight Index Swap rates, blew out further to around 290 basis points, also a historic high.

Against this background, there has been heavy pressure on lawmakers to put aside their worries about the cost of a bailout package and vote it through. However, critics of a bailout have argued that it could reward banks and other institutions that have unwisely taken on risky debt and delay, but not remove, the need for a painful period of adjustment in the financial system that became bloated on cheap credit.
Earlier this week, the House of Representatives voted down an earlier version of the package. Global equity markets fell, sparking renewed calls for a deal to be put through. Later in the week, members of the Senate voted by 74-25 to approve a revised bailout deal. Both US Presidential candidates, John

McCain and Barack Obama, temporarily quit the campaign trail to vote for the measure.

Meanwhile, the takeover talks over Wachovia have turned into a bitter legal fight. Citi said Wachovia and Wells Fargo’s agreement to a deal was “in clear breach of an exclusivity agreement between Citi and Wachovia. In addition, Wells Fargo's conduct constitutes tortious interference with the exclusivity agreement”.

“The exclusivity agreement provides, among other things, that Wachovia will not enter into any transaction with any party other than Citi, and will not participate in any discussions or negotiations with any third party. The exclusivity agreement also provides that the parties would be irreparably harmed by any breach of the agreement and that the remedy of specific performance of the agreement is appropriate,” Citi said.

All three banks in the takeover saga oversee large wealth management operations, with Wells Fargo and Wachovia being predominantly domestic US players, while Citi has a significant presence overseas, such as in Europe and Asia.

Just prior to Citi’s stated objection to the Wachovia/Wells Fargo deal, analysts at Morgan Stanley, who take a bearish stance on Wells Fargo, said the deal would be accretive for earnings.

On Thursday, Wells Fargo agreed a wholly-stock based transaction with Wachovia, which unlike the Citi deal, did not involve government financial assistance. According to the terms of the deal, each share of Wachovia common stock will be exchanged for 0.1991 shares of Wells Fargo common stock, representing a value of $7 per share, based on Wells Fargo’s closing stock price on 2 October, the statement said.

Before the proposal was made, Wachovia had been negotiating with Citi to complete a deal supervised by US authorities that included assistance from the US government. Wachovia said it approved Wells Fargo’s offer.