"The markets are obviously in a wait-and-see mode -- if there's a loss of confidence in anything, it's not lending institutions, it's the political system," said Hugh Johnson, chairman of Johnson Illington Advisors.
After dropping more than 125 points at the start, the Dow Jones Industrial Average pulled off its lows to rally late in the day, gaining 118.20 points to 11,140.26 on hopes that Congress will come to agreement on the rescue plan this weekend. The blue-chip index fell 2% for the week.
Of the Dow's 30 components, 19 ended higher, with financials leading the blue-chip turnaround, with J.P. Morgan Chase gaining 11%; Bank of America Corp. climbing 6.8%, and American Express Co. up 4.4%.
The S&P 500 climbed 3.82 points to 1,213.00, giving it a weekly decline of 3.2%.
Consumer staples -- viewed as an area to turn when the market is on the defense -- proved the best performing sector, followed by consumer staples and health care. Energy, materials and utilities fronted losses among the index's 10 industry groups.
Noteworthy laggards in the energy sector included Massey Energy Co. , off 8.6%, and Tesoro Corp. , down 5%.
Hard-hit financials included Washington Mutual Inc. , off 90.5%, Wachovia Corp. , down 27%, and National City Corp. , which was off 25.7%.
Consumer staples -- viewed as an area to turn when the market is on the defense -- proved the only sector moving higher late in the session.
The Nasdaq Composite Index dropped 3.23 points to finish at 2,183.34, a weekly loss of 4%.
"People are hoping that some kind of deal gets done, and maybe believing what the president said, that this is a difficult process," said Robert Pavlik, chief investment officer at Oaktree Asset management. "There is optimism on Wall Street but not on Main Street."
Volume on the New York Stock Exchange was roughly half of where it stands on a more typical trading day, with nearly 1.2 billion shares exchanged, and declining stocks routing gainers roughly 2 to 1. On the Nasdaq, nearly 809 million shares exchanged hands, and decliners topped advancers 4 to 3.
"What it is showing you is traders are increasing their risk exposure, but long-term investors are staying on the sidelines," Pavlik said of the light trading volume.
On Thursday, word that a tentative bailout deal had been reached unleashed a full-scale stock rally, with the Dow closing nearly 200 points higher and breaking a three-day losing streak.
The bank package, however, encountered resistance when a White House meeting blew up in acrimony, with House Republicans reportedly rejecting a demand by Democrats that they return to the table. Democratic leaders now say they won't bring the package to a vote unless Republicans support it. .
Adding urgency to the financial sector's dire straits was the move on Washington Mutual , with regulators seizing and then selling the bank to J.P. Morgan Chase & Co. for $1.9 billion. .
"WaMu's failure looks to be the first victim of the failed bailout plan," said Marc Pado, equity strategist at Cantor Fitzgerald.
WaMu had seen as exodus of $16.7 billion in deposits since Sept. 15.
J.P. Morgan is selling at least $8 billion in stock to boost its capital position.
Amid that grim backdrop, the Federal Reserve and other central bankers again took steps to attempt to get banks lending to each other, adding $13 billion to the existing $277 billion in swap lines.
The Fed, the Bank of England, the European Central Bank and the Swiss National Bank will use the swap lines to provide dollar-liquidity through one-week loans in an ffort to ease funding pressures through the end of the quarter.
In economic news Friday, the Commerce Department reported that the U.S. economy was not as strong in the second quarter as previously believed, held back by weaker consumer and business spending.
The economy grew at a 2.8% annualized pace in the quarter, revised down from the previous estimate of 3.3%, the government said in its third and final estimate of quarterly gross domestic product. Economists had expected GDP to be revised up to 3.4%.
Uncertainty surrounding the U.S. financial bailout plan was a key factor for oil, with crude-futures closed at $106.89 a barrel on the New York Mercantile Exchange, down $1.13, or 1.1% for the session, but a weekly gain of 4%.
By Kate Gibson