Sept. 18 (Bloomberg) -- The cost to protect against defaults on corporate bonds fell amid speculation U.S. regulators are working on a plan to stem the financial crisis.

A benchmark gauge of credit risk in North America declined to the lowest in a week. Credit-default swaps on Morgan Stanley, Goldman Sachs Group Inc. and Wachovia Corp. also fell. All reached record highs yesterday amid a crisis of confidence in banks and securities firms.

U.S. Senator Charles Schumer, speaking with reporters in Washington, proposed a new agency to pump capital into troubled financial companies and said the Federal Reserve and Treasury ``are realizing that we need a more comprehensive solution.'' Schumer, a New York Democrat, heads the congressional Joint Economic Committee. The comments helped spur a 617-point rally in the Dow Jones Industrial Average from its lows of the day.

The Markit CDX North America Investment Grade Index, a benchmark gauge of credit risk tied to the bonds of 125 companies in the U.S. and Canada, dropped 24.7 basis points to 178.7 basis points, according to composite prices from CMA Datavision.

Contracts on New York-based Morgan Stanley fell 132 basis points to 866 basis points, according to CMA. The contracts began falling earlier today amid reports that it may sell a larger stake to China Investment Corp. and is also discussing a merger with Wachovia Corp.

Distressed Levels

Before today, Morgan Stanley shares had plunged 43 percent this week and some of the bonds traded at distressed levels yesterday as the deepening credit crisis fueled investor concern that the company may be limited in its ability to raise funds. China's state-controlled fund may buy as much as 49 percent of the company, and Chief Executive Officer John Mack was called by Wachovia indicating interest in a merger, said people familiar with the discussions.

``Morgan Stanley could get too-big-to-fail status instantly,'' said Andrea Cicione, a credit strategist at BNP Paribas SA in London. ``Strategically it makes a lot of sense.''

Credit-default swap sellers yesterday demanded as much as $2.1 million upfront and $500,000 a year to protect $10 million of Morgan Stanley bonds for five years, according to data from broker Phoenix Partners Group. That compares with about $866,000 today, CMA data show.

Contracts on Charlotte, North Carolina-based Wachovia dropped 101 basis points to 646 basis points. Credit-default swaps on New York-based Goldman fell 130 basis points to 490, according to CMA.

A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

Upfront Payment

The cost to protect Seattle-based Washington Mutual's bonds fell after the lender was put up for sale and attracted suitors including JPMorgan Chase & Co. The upfront price on the contracts fell 5 percentage points to 37 percentage points, CMA data show. That's in addition to 5 percentage points a year.

In Europe earlier today, credit-default swaps on the Markit iTraxx Financial index of 25 banks and insurers fell 10 basis points to 140, the biggest drop since March 25, according to JPMorgan prices. The Markit iTraxx Europe index of 125 companies with investment-grade ratings fell 13 basis points to 132.

Markets also were buoyed after central banks offered extra funds to calm money markets and Edinburgh-based HBOS Plc agreed to be bought by Lloyds TSB Group Plc after losing almost half its market value this week amid funding concerns.

The Fed almost quadrupled the amount of dollars central banks can auction around the world to $247 billion in a fresh coordinated bid to ease financial markets facing their worst crisis since the 1920s.

Credit-default swaps on HBOS dropped 152 basis points to 276, according to CMA prices. Contracts on HBOS traded as high as 725 basis points this week.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline signals the opposite.

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Abigail Moses in London Amoses5@bloomberg.net

Last Updated: September 18, 2008 18:07 EDT