Treasury Secretary Henry Paulson is considering setting up a government facility to take on bad debts from financial institutions and prevent the global credit crisis from worsening, CNBC has learned.

The facility would be similar to the Resolution Trust Corporation, which was set up in 1989 to take on all the failed thrift assets during the savings and loan crisis, sources said.

Paulson plans to meet privately and discuss the plan with leadership from the House of Representatives, including members of both parties, at 7 p.m. New York time tonight.

Paulson will brief House Speaker Nancy Pelosi and other congressional leaders on the proposal this afternoon, CNBC has learned. Federal Reserve Chairman Ben Bernanke is expected to accompany Paulson.

The Bush administration wants to make sure Congress is behind the idea before it moves ahead on the plan, a source told CNBC.

Such a move, according to its advocates, would allow banks to shovel bad debt off their balance sheets and allow the firms to go back to business as usual. It would also eliminate the need for individual company bailouts.

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."

Charlie Gasparino breaks the story on Paulson's plan. Watch video at left.

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

The Treasury Department and Federal Reserve, which engineered an $85 billion rescue plan for insurer American International Group earlier this week, declined to comment.

The aide also pointed to an opinion piece in Wednesday's Wall Street Journal by former Federal Reserve Chairman Paul Volcker, former Comptroller of the Currency Eugene Ludwig and former Treasury Secretary Nicholas Brady in which they said such a body could buy up troubled real estate debt to get credit markets working again.

The rapid-fire rescues of financial firms may end up tarnishing America's free-market reputation as the moves expose defects in the U.S. economy, undermining its standing with foreign buyers of the dollar and U.S. Treasury securities.

The government's actions might add hundreds of billions to a budget deficit already expected to hit a record next year. The salvage operations, which include Tuesday's takeover of American International Group Inc., also raise questions about the U.S. commitment to a free-market economy that, until recently, was the envy of the world.

America's credit ``profile is now weaker because contingent risks have become actual risks to the U.S. government,'' said John Chambers, managing director of sovereign ratings at Standard & Poor's in New York.

The result: Foreign investors may demand higher compensation for providing the money the U.S. government and economy depend on. That, in turn, could translate into lower living standards for Americans as borrowing costs are pushed higher and the dollar is pulled lower.....

You know you're in a heap of trouble when the lender of last resort suddenly runs out of money.

Having pumped $100 billion into the banking system and lent $115 billion more to rescue Bear Stearns and AIG, the Federal Reserve was forced to ask the Treasury yesterday to borrow some extra money to replenish its coffers. If there was any good news in that, it was that investors here and abroad were eager to help out, having decided that the only safe place to put their money is in U.S. government securities. Indeed, demand was so brisk at one point yesterday that, for an investor, the effective yield on a three-month Treasury bill was driven below zero, once the broker's fee was figured in.

This is what a Category 4 financial crisis looks like. Giant blue-chip financial institutions swept away in a matter of days. Banks refusing to lend to other banks. Russia closing its stock market to stop the panicked selling. Gold soaring $70 in a single trading session. Developing countries' currencies in a free fall. Money-market funds warning they might not be able to return every dollar invested. Daily swings of three, four, five hundred points in the Dow Jones industrial average.....

One of life's rules is that there's bad in good and good in bad. The total collapse of the U.S. financial system is no exception. Even in the midst of the current financial despair we can look around and identify many collateral benefits.....

1) We finally get to see what's inside these big Wall Street firms.

2) We are creating the financial leaders of tomorrow.

3) Ordinary Americans get a lesson in low finance.

4) We have lots of new houses.

5) Huge numbers of Wall Street executives will have the time to raise their children.

The response to the gravest financial crisis in generations has been engineered to a remarkable degree by a committee of three.

From the rescue of Bear Stearns to the takeovers of Fannie Mae , Freddie Mac and American International Group , all the key decisions have been made by Treasury Secretary Henry M. Paulson Jr., Federal Reserve Chairman Ben S. Bernanke and Timothy F. Geithner , the president of the Federal Reserve Bank of New York .

It is this unusual collaboration among a consummate dealmaker, a professor and a seasoned public servant that could determine how the nation weathers the most profound threat to its economy in modern times. Despite their disparate backgrounds, the three men have formed a close, informal partnership built on rapid-fire phone calls and open debate that breaks the mold of Washington policymaking.....

For the last year, as the nation’s economy lurched from crisis to crisis, the chairman of the Federal Reserve, Ben S. Bernanke, had been warning Henry M. Paulson Jr., the Treasury secretary, that the worsening situation might ultimately force a sweeping federal intervention.

A longtime student of the Great Depression, Mr. Bernanke was acutely aware of what could happen without a decisive move. Finally, the moment that called for action arrived late Wednesday. Less than 24 hours after the Fed bailed out American International Group, the giant insurer, it was clear the turmoil gripping Wall Street was only growing worse and that ad hoc solutions were not working.

Talking into a speaker phone from his ornate office, Mr. Bernanke told Mr. Paulson that it was time to adopt a comprehensive strategy that Congress would have to approve. Mr. Paulson understood. Reluctant in recent days to send Congress a plan that lawmakers had warned had little chance of quick passage, he had worried that a rejection would only further shock the markets. But during two conference calls Wednesday night and Thursday morning, he agreed that they had no choice.....

It was the end of an era on Wall Street as the Federal Reserve granted permission for the last two major investment banks — Goldman Sachs and Morgan Stanley — to become bank holding companies in order to stay in business.

The Fed announced late Sunday evening that it had approved the request, which will allow Goldman and Morgan Stanley to create commercial banks that can take deposits, bolstering the resources of both institutions.

The change of status means both companies will come under the direct regulation of the Fed, which oversees the nation's bank holding companies. The banking subsidiaries of the two institutions will face the stricter regulations that commercial banks are required to meet. Previously, the primary regulator for Goldman and Morgan Stanley was the Securities and Exchange Commission.

The Bush administration on Saturday formally proposed a vast bailout of financial institutions in the United States, requesting unfettered authority for the Treasury Department to buy up to $700 billion in distressed mortgage-related assets from the private firms.

The proposal, not quite three pages long, was stunning for its stark simplicity. It would raise the national debt ceiling to $11.3 trillion. And it would place no restrictions on the administration other than requiring semiannual reports to Congress, granting the Treasury secretary unprecedented power to buy and resell mortgage debt.

"This is a big package, because it was a big problem," President George W. Bush said Saturday at a White House news conference, after meeting with President Álvaro Uribe of Colombia. "I will tell our citizens and continue to remind them that the risk of doing nothing far outweighs the risk of the package, and that, over time, we're going to get a lot of the money back."

After a week of stomach-flipping turmoil in the financial system, and with officials still on edge about how global markets will respond, the delivery of the administration's plan set the stage for a four-day brawl in Congress. Democratic leaders have pledged to approve a bill but say it must also include tangible help for ordinary Americans in the form of an economic stimulus package.

Staff members from Treasury and the House Financial Services and Senate banking committees immediately began meeting on Capitol Hill and were expected to work through the weekend. Congressional leaders are hoping to recess at the end of the week for the fall elections, after approving the bailout and a budget measure to keep the government running.

Administration and congressional negotiators worked through the weekend to craft legislation that would provide the largest bank rescue plan and give sweeping powers to the U.S. Treasury to buy mortgage-related debt from financial firms.