Paulson, Bernanke defend $700 billion bailout

Defending the bailout
(L-R) U.S. Treasury Secretary Henry Paulson, Federal Reserve Bank Chairman Ben Bernanke and FDIC Chairman Sheila Bair testify before the House Financial Services Committee on Capitol Hill Tuesday, regarding the $700 billion bailout plan.
Chip Somodevilla/Getty Images

Treasury Secretary Henry Paulson told Congress Tuesday he opposes tapping a $700 billion taxpayer-funded pool to help struggling U.S. automakers as he and Federal Reserve Chairman Ben Bernanke defended their management of the bailout program, just one week after the administration abandoned the original strategy behind the rescue.

Although having a U.S. auto company fail during such a fragile time for the economy would not be a "good thing," Paulson told the House Financial Services Committee that he remains opposed to diverting $25 billion of the bailout money to aid Detroit as the panel's chairman Rep. Barney Frank, D-Mass., and other Democrats want.

"I don't see this as the purpose" of the bailout program, which is intended to stabilize jittery financial markets and get lending flowing more freely again, which eventually should help revive the ailing economy, Paulson said.

GM assembly line
A GM assembly line.

The U.S. has "turned a corner" in averting a financial collapse, but more work needs to be done to get things back to normal, he said.

Focusing the bailout 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 explained.

Buying those toxic debts would have required a "massive commitment" of the bailout money, Paulson told the panel. 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.

"There is no playbook for responding to turmoil we have never faced."

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."

But lawmakers worried the administration was sending confusing signals to taxpayers and Wall Street investors.

"We all understand that when conditions on the ground change, policymakers must be agile enough to adjust to those changed circumstances," said Rep. Spencer Bachus, R-Ala. "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."

Rep. Paul Kanjorski, D-Pa., complained about the administration's "180 degree change in policy," which he didn't necessarily fault, but suggested could hurt public confidence.

"Do we have a plan? Where are we going?" Kanjorski asked.

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 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 expressed reservations about using some of the bailout money to provide guarantees for mortgages at risk of falling into foreclosure. However, the administration will look for ways to provide foreclosure relief, he said.

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 warned.

Bernanke, meanwhile, called Bair's plan a "very promising approach."

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.

(Copyright 2008 by The Associated Press. All Rights Reserved.)