Paulson, Bernake Defend $700B Bailout

Paulson, Bernanke defend $700 billion bailout

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By JEANNINE AVERSA, AP Economics Writer
1 HOUR AGO

WASHINGTON - Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke waged a stout defense of their management of a $700 billion financial bailout on Capitol Hill Tuesday, just one week after the administration abandoned the original strategy behind the rescue.

Focusing the program on infusing billions into banks _ and possibly other types of companies _ to pump up their capital and bolster lending to customers was deemed a faster and more effective approach to stabilizing the financial system than buying rotten assets from financial institutions, the centerpiece of the original plan, Paulson said.

Buying those toxic debts would have required a "massive commitment" of the bailout money, Paulson said in testimony before the House Financial Services Committee. As economic and financial conditions quickly worsened, it became clear that the first installment of the money _ $350 billion _ for that purpose "simply isn't enough firepower," he said.

It's crucial that the administration be nimble in assessing changing conditions and adapt the bailout strategy accordingly, the Treasury chief said. "If we have learned anything throughout this year, we have learned that this financial crisis is unpredictable and difficult to counteract," Paulson said.

Last week, Paulson changed course and said the government would not use any of the $700 billion to buy bad assets from banks. That had been the focus of the plan Paulson and Bernanke originally pitched to lawmakers.

"There is no playbook for responding to turmoil we have never faced," Paulson said. "We adjusted our strategy to reflect the facts of a severe market crisis."

However, Rep. Barney Frank, the committee's chairman, worried the administration was sending confusing signals to taxpayers and Wall Street investors, and said he has "serious concerns about the improvised and ad hoc nature" of Treasury's implementation of the program.

"We all understand that when conditions on the ground change, policymakers must be agile enough to adjust to those changed circumstances," the Massachusetts Democrat said. "But changing too quickly, without adequately explaining why you've changed or what you're going to do next, risks sending mixed signals to a marketplace that is in dire need of certainty and a sense of direction."

Going forward, the ability of Treasury to use the bailout program for capital injections and to take other steps to stabilize the financial system _ including any actions needed to prevent the disorderly failure of a major financial institution _ "will be critical for restoring confidence and promoting the return of credit markets to more normal functioning," Bernanke told the panel.

Paulson said the department will focus on rolling out a capital injection program to pour $250 billion into banks in return for partial ownership stakes in them. Treasury on Monday confirmed that it supplied $33.56 billion to 21 banks in a second round of payments. That followed the initial $125 billion allocated to nine of the country's largest banks, and brought the total earmarked payments to $158.56 billion.

Treasury also will search for new ways to boost the availability of auto loans, student loans and credit cards, which have been become harder to get due to the credit crisis.

Specifically, the department along with the Federal Reserve, is exploring using some of the bailout money to bankroll a new loan facility designed to help companies that issue credit cards, make student loans and finance car purchases. Paulson said he expected putting up only a "relatively modest share" of the bailout money for this facility.

Paulson repeated his opposition to using some of the bailout money to provide guarantees for mortgages at risk of falling into foreclosure, another huge source of distress for the economy.

In a break with the administration, Federal Deposit Insurance Corp. Chairman Sheila Bair, also testifying before the panel, pressed anew for using $24 billion of the bailout money to help some American households avoid foreclosure. As foreclosures mount, the government is "clearly falling behind the curve," she said.

So far, the Treasury Department has pledged $250 billion for banks and has agreed to devote $40 billion to troubled insurer American International Group_ its first slice of funds going to a company other than a bank. That leaves just $60 billion available from Congress' first bailout installment of $350 billion.

Paulson said he is not planning to initiate another capital injection program beyond those already announced. Thus he's unlikely to tap the remaining $350 billion before the Bush administration leaves office on Jan. 20. That would mean the incoming administration of President-elect Barack Obama would decide whether and how the money should be spent.

The idea behind the capital injection program is for banks to use the money to rebuild reserves and lend more freely to customers. However, banks do have the leeway to use the money for other things, such as buying other banks, paying dividends to investors or bonuses to executives. That has touched a nerve with some lawmakers.

Locked-up lending is a prime reason why the U.S. is suffering through the worst financial crisis since the 1930s. All the fallout from the housing, credit and financial crises have badly hurt the economy, which is almost certainly in recession, analysts say.