Sept. 26 (Bloomberg) -- The yen rose, headed for a second weekly gain against the dollar, as U.S. lawmakers disagreed over a rescue plan for the financial industry and Washington Mutual Inc. became the nation's biggest bank to collapse.

The Japanese currency also strengthened against the euro and the Australian dollar after a group of Republicans opposed to the Treasury's $700 billion asset-purchase plan submitted an alternative proposal, prompting investors to pare so-called carry trades. The dollar rose against the euro as investors sought the relative safety of U.S. Treasuries.

``The continuing uncertainty about the rescue package and risk aversion favors the yen,'' said Audrey Childe-Freeman, senior currency analyst with Brown Brothers Harriman & Co. in London. ``Something needs to come out sooner than later.''

The yen rose to 105.36 per dollar as of 10:29 a.m. in London, from 106.56 yesterday in New York, taking this week's gain to 2 percent. The euro bought 153.56 yen, from 155.68, down 1.2 percent for the week. The dollar rose to $1.4573 per euro, from $1.4609 yesterday and $1.4466 on Sept. 19.

The new proposal to ease the credit crisis came after President George W. Bush met with Republican presidential candidate John McCain and Democratic rival Barack Obama to discuss the financial-markets rescue, according to Senate Banking Committee Chairman Christopher Dodd.

Dodd, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke favored a plan that would use taxpayer money to buy troubled assets from financial companies. The rival proposal calls for a mortgage-backed security insurance fund financed by premiums from the holders of those securities.

`No Favors'

``The delay of the package isn't doing the markets any favors,'' said David Powell, a currency strategist with Bank of America Corp. in London. ``But we still see the package being passed next week. Nobody wants to be seen as the person who caused the breakdown on these negotiations.''

The Australian dollar bought 87.11 yen, down 2.1 percent from a week ago, while the New Zealand dollar fell 1 percent to 71.98 yen. In carry trades, investors get funds in countries with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target lending rate compares with 7 percent in Australia and 7.5 percent in New Zealand. The risk is that currency moves erase profits.

The U.S. government closed Seattle-based Washington Mutual, which faced $19 billion of mortgage-related losses, after customers withdrew $16.7 billion since Sept. 15, the Office of Thrift Supervision said in a statement. JPMorgan Chase & Co., the third-biggest U.S. bank by assets, agreed to acquire WaMu's deposits and branches for $1.9 billion.

Central Bank Action

The Fed, the European Central Bank and their counterparts in the U.K. and Switzerland said today they will provide dollars to money markets for the next week to ensure ample liquidity at the end of the quarter. The three-month London interbank offered rate, or Libor, that banks charge each other for dollar loans jumped yesterday by the most since 1999 amid concern that Paulson's bailout plan will be diluted as it makes its way through Congress, causing banks to hard cash.

``This is a negative story for the dollar,'' said Motonari Ogawa, director of currency trading in Tokyo at Barclays Capital Inc., a unit of the U.K.'s third-biggest bank. ``News about Washington Mutual will make the market nervous and people will doubt whether a U.S. rescue plan will work.''

The dollar rose against the euro as Treasury notes extended their longest winning streak since February. The yield on the two-year note fell 17 basis points to 2 percent, according to BGCantor Market Data. It dropped about 40 basis points in the past five weeks. Europe's Dow Jones Stoxx 600 Index decreased 1.4 percent, extending its drop this week to 3.9 percent.

Volatility Index

The yen may extend gains as the VIX volatility index closed above 30 for nine straight days, showing markets are facing a shock similar to the 1997 Asian currency crisis and 2001 terrorist attacks, according to JPMorgan Chase.

The VIX index, a Chicago Board Options Exchange gauge reflecting expectations of stock market price changes and a barometer of risk aversion, was at 32.82 late in New York yesterday headed for its fifth weekly gain. It rose to 42.16 on Sept. 18, the highest since October 2002.

``The U.S. needs to act quickly, because the financial system and the dollar are at risk,'' said Akio Shimizu, chief manager of currency trading in Tokyo at Mitsubishi UFJ Trust & Banking Corp., a unit of Japan's largest publicly listed lender.

Libor Rises

The collapse of Lehman Brothers Holdings Inc. and the U.S. government takeover of insurer American International Group Inc. have helped cause credit markets to seize up. The three-month London interbank offered rate, or Libor, for dollars rose to 3.77 percent yesterday, the highest level relative to the Fed's target rate on record.

``The credit channel is blocked up,'' said Stephen Malyon, co-head of currency strategy in Toronto at Scotia Capital Inc., a unit of Canada's third-largest bank by assets. ``Odds favor the next move by the Fed will be a cut. It surely will hurt the dollar.''

The dollar has fallen 4 percent against the euro since touching a one-year high of $1.3882 on Sept. 11. The dollar reached $1.6038 on July 15, the weakest level since the European currency made its debut in 1999.

To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Stanley White in Tokyo at swhite28@bloomberg.net

Last Updated: September 26, 2008 05:38 EDT