US Revamps How It Uses $700 Billion Bailout Fund

The Bush administration publicly backed away from using a $700 billion bailout fund to buy toxic mortgage assets as originally intended, and said it will focus instead on shoring up financial institutions with direct investments.

AP Henry Paulson

Treasury Secretary Henry Paulson told a news conference he was considering using remaining bailout funds on a second round of purchases of preferred shares in both banks and non-bank institutions that would match privately raised funds.

• How Will the Revised Plan Work?

He also said the Treasury was working with the Federal Reserve on a plan to shore up markets for securitized consumer debt such as car loans, student loans and credit cards, which could help restore credit flows to U.S. households.

The Treasury initially promoted the $700 billion Troubled Asset Relief Program to Congress as a vehicle that would buy illiquid mortgage assets from banks and other institutions to cushion potential losses, allowing them to resume lending.

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"This is not going to be the focus," Paulson said. He added, however, that the Treasury would continue to examine the usefulness of "targeted" purchases.

The administration's shifting focus disappointed Wall Street and stocks tumbled sharply, reflecting concerns about the scope of the U.S. economy's troubles and shareholder dilution in the financial sector.

"I think (Paulson) is catering to the political whim," said Robert Andres, chief investment strategist at Portfolio Management Consultants in Philadelphia. "Every time he opened his mouth this summer he said we need to fix the housing market and to buy mortgage-backed securities. This whole process got politicized."

The $700 billion financial sector bailout, approved by Congress in early October, is the United States' marquis effort to combat a credit crisis spawned by rising U.S. mortgage defaults that is now raging worldwide.

Paulson said the U.S. Treasury was duty-bound to help prevent mortgage foreclosures. But he warned that further aid would likely mean a significant government subsidy—signaling a lack of support for a Federal Deposit Insurance Corp proposal for more aggressive aid to borrowers.

Paulson made clear his priority for TARP funding was aiding the broad financial sector.

"The top priority has to be stability, making sure we have resources in reserve to deal with any systemic events," he said.

Paulson also sidestepped questions about whether the Treasury would use bailout funds to help struggling Detroit automakers, as the industry and some lawmakers have called for.

While he said the industry was a "critical" one for the United States, he said the purpose of the program was to provide financial stability. He said one option would be to amend legislation to allow $25 billion already approved for efficient vehicle production to be made available more quickly.

So far, the Treasury has focused on providing capital to federally regulated banks and thrifts, but Paulson said it was looking to broaden the effort to cover financial institutions that do not have a federal bank or thrift charter.

"Although the financial system has stabilized, both banks and non-banks may well need more capital given their troubled asset holdings, projections for continued high rates of foreclosures and stagnant U.S. and world economic conditions," he said.

The Treasury has allocated $250 billion of the bailout funds to direct capital injections into banks and thrifts via purchases of preferred stock.

It has earmarked another $40 billion to shore up insurer American International Group, leaving just $60 billion to dole out before Treasury would have to ask Congress to release a final $350 billion.

Paulson said he had no timeline for that request, which means the decision could be left to the incoming administration of President-elect Barack Obama, who takes office on Jan. 20.

He also signaled he would not seek to increase the overall size of the bailout fund.

"I still am comfortable that, with $700 billion, we have what we need," he said.

With an aim to restoring credit for households, Paulson said the Treasury and Fed were considering setting up a program to increase liquidity for top-rated asset-backed securities, but he provided few details.

"The initial shock of abandoning TARP is hitting stocks, but the support for consumer-level lending may be a silver lining as it goes to the root of what's ailing the economy, namely personal consumption," said Brian Dolan, chief currency strategist at FOREX.com in Bedminster, New Jersey.

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