Treasury Secretary Henry Paulson on Wednesday backed away from the government's plan to use $700 billion in bailout funds to buy troubled mortgage assets and instead called for a fresh injection of cash to financial institutions.
Paulson, seeking to defend the unprecedented and controversial Troubled Asset Relief Program from critics, said the government's new goal would be to support financial markets, which supply consumer credit in such areas as credit card debt, auto loans and student loans.
To date, no toxic assets have been purchased with the bailout funds. At Wednesday's news conference in Washington, Paulson said, "Our assessment at this time is that this is not the most effective way to use TARP funds. But we will continue to examine whether targeted forms of asset purchase can play a useful role, relative to other potential uses of TARP resources."
He said the Treasury Department and Federal Reserve had "taken the necessary steps to avoid a broad, systemic failure" of troubled banks and financial institutions.
Credit markets became dangerously logjammed in September as interbank lending and loans to businesses ground to a halt, threatening to bring down the global economy.
The Bush administration responded with a rescue plan passed by Congress in October that had originally been aimed at buying up bad debt from banks so they could continue lending.
But Paulson said the financial industry's situation has worsened since the bill was passed, prompting him to spent nearly $250 billion to buy equity stakes in banks.
"Although the financial system has stabilized, both banks and nonbanks 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," Paulson said.
The Treasury secretary warned that the nation's financial system "remains fragile" and that "significant illiquid assets" continued to present difficulties.
But "overall, we are in a better position than we were" two months ago, he said.
Paulson's remarks came on the same day that the Federal Reserve and three other federal banking regulators issued new guidelines to institutions to work with mortgage borrowers to avoid defaults. In addition, the guidance encourages banks to set dividend payments for shareholders and compensation for executives with the current crisis in mind.
Referring to the move, Paulson said that "'ordering' is too strong, but 'encouraging'" best described the guidelines.
He said the Treasury Department was evaluating a second program that would provide government investments that would match private investments in efforts to raise capital.
"In developing a potential matching program, we will also consider capital needs of nonbank financial institutions not eligible for the current capital program," Paulson said.
Earlier, the White House appeared to rule out a rescue for the nation's ailing auto industry, and Paulson on Wednesday reiterated that the financial industry is "where the focus is right now."
He did not rule out expanding the program to car manufacturers, but he warned of the danger of bailing out industries without government oversight.
"I know the automakers are important to the U.S.," he said. "They are a key part of our manufacturing industry. I have said and the administration has said, very clearly, we need a solution, but we need a solution that leads to viability."
As Paulson spoke, U.S. stocks extended early-morning losses that followed on Asian and European markets.
From NPR and wire reports