Stocks in Europe and Asia, along with S&P futures, climbed overnight and sent the dollar lower against the higher yielders and higher against the yen on speculation the U.S. government would increase its control over Citigroup. Treasuries fell.


Citigroup surged 24% in Germany after the Wall Street Journal said the bank is in talks with federal officials that may result in the government converting a portion of its non-voting preferred stake into as much as 40% of common stock, thereby taking a larger controlling interest without a full nationalization. Barclays and Hang Seng Bank, Hong Kong’s second-largest by assets, added more than 4% and the Royal Bank of Scotland Group climbed 15% after a person familiar with the situation said RBS plans to cut costs by more than 1 billion pounds ($1.44 billion) and split into two units.


Apparently, Citigroup officials approached officials at the Federal Reserve and the Office of the Comptroller of the Currency with a plan that would allow them to convert a substantial amount of the $45 billion of preferred shares held by the government into common stock, giving the government a much bigger ownership stake in the bank.


For Citigroup, the move would allow them to retire a portion of its existing debt, and through an accounting maneuver, immediately bolster the amount of common stock. That would appease investors and regulators, who are expected to make a bigger cushion of common stock a requirement when details of the new stress test are announced this week. But any such exchange would severely dilute existing Citigroup stockholders since it would require the bank to issue more shares.


But it looks as if the plan will not be happening, at least the way that Citigroup officials envisioned it. On Monday, the U.S. Department of the Treasury, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Reserve Board today issued a joint statement which said that the government will implement its Capital Assurance Program on Feb. 25 and describes how a temporary nationalization could occur.


Institutions which fail the government's new stress-tests would first need to find new capital in the private sector. Failing that, the government will make new capital injections in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position, a provision which explicitly allows for nationalization.


Concerns over Japan's economy have upended the yen's status as a safe-haven currency and led to a break in the yen's longstanding inverse correlation with stock markets, along with the liquidation of speculative positions after the U.S. federal-funds rate was cut to meet Japan's low interest rates.


Japanese stock holdings with a foreign-exchange hedge by foreigners have been reduced to less than half from 23 trillion yen to 11 trillion yen, said Tohru Sasaki, an analyst at J.P. Morgan. This suggests foreign-exchange transactions by foreign investors in Japanese stocks are now less than half of what they were before, he said.


If stocks continue to fall, bets in the foreign-exchange market will decline as well, diminishing the correlation between these markets.


Mr. Sasaki said that, as the economic slowdown continues, overseas investment from Japan should shrink, leaving the yen exchange rate to be dominated by foreign investors. Foreigners sell yen when the Nikkei declines, foreigners buy yen to acquire Japanese stocks when the Nikkei starts rebounding, he said. That means, in the long term, the dollar could gain against the yen when stocks turn negative.