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Treasury Redefines Its Rescue Program

Treasury Secretary Henry Paulson says that the $700 billion government rescue program will not be used to purchase troubled assets as originally planned. Video by AP

Paulson responded in the interview that such changes, including the use of bailout money to reduce foreclosures, were "not what the American people were expecting, and it's not what many in Congress are expecting."

But Paulson cannot ignore Congress. Once the first $350 billion has been drawn down, Paulson must go back to Congress to obtain access to the rest of the money.

When Paulson first presented the rescue plan to Congress, he pitched it as a program to buy up "toxic securities" -- complicated investments backed by failing mortgages and consumer loans -- that were sapping the confidence of investors.

"We moved away from it because we have a great responsibility to always evaluate the facts in front of us and say how do we take a finite amount of resources and how do we get the most powerful results?" he explained. He added that the program for making capital purchases in financial firms was "quicker, more efficient and more powerful."

Paulson added that he shied away from other measures to broaden the Treasury program because he wanted to ensure that there would enough money left to shore up the financial system, especially in the event of another shock, such as the implosion of a major bank.

"The longer we looked at it, the clearer it became that we should be saving more of the TARP," he said.

The details of the Treasury's program for loosening consumer credit are still to be worked out, officials said.

Among the options they are considering is investing in financial firms outside the traditional banking sector. But the Treasury would insist there be matching investments from private companies, officials said. That would give the department some confidence that the investment of public money would be safe.

The firms that would be eligible for this new round of capital purchases would include insurers, such as Prudential and MetLife, and specialty lenders for small businesses, such as GE Capital and CIT Group, officials said. But Paulson said the program would not begin until Treasury officials had evaluated whether the initial round of investments in banks was successful.

The Treasury Department is also considering giving tens of billions of dollars to the Federal Reserve to back the purchase of highly rated securities that are made up of large pools of student, auto and credit card loans. The market for these securities has shut down despite their high credit rating because investors no longer trust the ratings agencies after they failed to accurately evaluate securities based on mortgages. Treasury officials said they hoped this would jump-start trading and get the credit markets working again.

Despite mounting concerns over the health of consumer credit markets, banks have not reduced the volume of credit card lending. The balance of outstanding loans has risen slightly this year. But banks increasingly are reducing credit limits and declining to issue new cards, suggesting to regulators that a lending crunch is imminent.

"What's happened is that financial institutions have basically done what they always do under these circumstances -- they overreact when crises hit," said Joel L. Naroff of Naroff Economic Advisors, a consulting firm in Pennsylvania. "They went from giving anyone any amount of credit they wanted to giving very few people credit."

The market that provides private student loans is in particularly bad shape. Since late last year, no lender has been able to raise money for loans by selling them to investors. Instead, these lenders have relied on traditional sources of finance, such as banks. But in the past few months, those wells dried up, too.

Mark Kantrowitz, publisher of FinAid, which provides financial advice to students, said those attending for-profit colleges may see the most immediate impact because they generally have poorer credit ratings. But eventually, all students that rely on private student loans to supplement their federally guaranteed loans will feel the pain, he said.

With Obama pressing the need for a new economic stimulus package, Paulson said that bolstering the credit market would provide its own bump to the economy.

"I cannot imagine anything else will have a bigger stimulus impact than getting credit going again, getting lending going again," Paulson said.

To encourage more active lending, the four federal agencies that regulate banks issued a joint statement yesterday reminding the banks of their responsibility to make loans to creditworthy customers.

The statement said that banks should prioritize lending over dividend payments and other uses of money. It also warned banks against compensating executives in ways that encourage risk-taking -- for example, awarding bonuses for making a large number of loans without weighing whether they would be repaid.

One of the most politically fraught questions facing Paulson is how to help homeowners.

The legislation creating the $700 billion program states that one of its purposes is to preserve homeownership. But Treasury officials are struggling with how to get more companies to modify the terms of troubled mortgages.

"I just can't tell you how many proposals I've looked at to modify mortgages and keep people in their homes," Paulson said at the briefing. "This is a very complicated area. There are no easy answers."

While citing what he called the success of Hope Now, a private-sector effort put together by the Treasury, Paulson said officials were still exploring ideas. These include one proposed by Federal Deposit Insurance Corp. Chairman Sheila C. Bair, which would potentially lower monthly payments so that struggling homeowners could afford them.

But he drew a sharp distinction between those types of mortgage-modification programs and the other uses of the TARP money. He views the bank programs as investments in the financial system, not outright grants. The mortgage programs, he said, involve outright grants.

Staff writers Zachary A. Goldfarb and Lori Montgomery and staff researcher Eddy Palanzo contributed to this report.

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