Feds switch to bailout Plan B

Their focus turns to propping up loan market instead of buying troubled mortgage securities

WASHINGTON -- The Bush administration formally abandoned the centerpiece of its $700 billion financial rescue plan Wednesday, reflecting the remarkable extent to which the Bush administration has been flying by the seat of its pants in the deepening economic crisis.

Treasury Secretary Henry Paulson said the administration would continue spending the available bailout funds on efforts to thaw the nation's credit markets -- a shift it began a month ago -- and scrub plans to buy troubled mortgage-backed securities.

The turnabout pointed up the challenge facing President-elect Barack Obama in creating a comprehensive and consistent strategy in the face of a roiling crisis.

"You've had a tremendous amount of improvisation here," said Douglas Elmendorf, a former Federal Reserve economist and an informal adviser to Obama's transition team. "Even smart people get things wrong when they have no models to follow and are acting quickly, so it's natural that there'd be some reworking."

Paulson, who originally dismissed emergency government investments in financial institutions as a recipe for failure, said that most of the first half of the $700 billion had already gone to emergency investments in banks and other institutions aimed at reviving the borrowing and lending that's crucial to the economy.

Although Paulson said those actions helped thaw credit markets and avoid "a broad systemic event" in the global economy, he acknowledged that most financial firms still are deeply reluctant to lend.

"Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards," Paulson said in a speech in Washington. "This is creating a heavy burden on the American people and reducing the number of jobs in our economy."

"First and foremost, because the system remains fragile, we must continue to stand ready to prevent systemic failures," he said. "The stability of our system remains the highest priority."

But the effort to provide that stability is in flux.

Not only did Paulson publicly acknowledge that the administration is shifting gears, but he said that the government's financial rescue mission was entering a "timeout" period as Obama prepares to take office. During that period, Obama and Congress must decide the role federal officials should play in the housing market, Paulson said.

Paulson's views on that are at odds with those of Obama and many congressional Democrats.

The Treasury secretary said far-reaching proposals to dramatically reduce home foreclosures by modifying existing mortgages would "require substantial government subsidies" that still need to be justified. He also turned aside calls to use some of the $700 billion Troubled Asset Relief Program fund to aid General Motors and other tottering U.S. automakers.

"We care about our auto industry in the U.S. They're a key part of our manufacturing industry," Paulson said. "We need a solution, but the solution has got to be one that leads to viability. The intent of the TARP was to deal with the financial industry."

Calling an audible

On Capitol Hill, reactions ranged from nonplused to I-told-you-so.

"My mouth is open," Rep. Jane Harman, D-Calif., told a television interviewer, comparing Paulson to a football team's quarterback changing the play at the line of scrimmage. "It was a very hard vote for many of us who voted for that package, and now all of a sudden we have an audible and we're spending it on something else."

Sen. Charles Schumer, D-N.Y., chairman of the Joint Economic Committee, said he was pleased the Bush administration had changed its strategy on how to spend the $700 billion rescue fund. Schumer had been skeptical about the logistics of buying troubled mortgage-backed securities when the rescue legislation was being crafted in September.

He and other lawmakers pushed to give Paulson the flexibility to use the money for other uses.

"Congress gave the secretary the authority, without him asking for it," Schumer said. "Now I suppose he's happy we did."

The $700 billion rescue plan approved by Congress authorized the Treasury secretary to spend half that amount immediately, while setting added requirements for releasing later installments.

Wednesday, Paulson offered no specifics on how he planned to spend the second half of the rescue package money -- suggesting those decisions would fall to the incoming Obama administration. Senior Democrats on Capitol Hill were clear about where they thought the remaining money should go.

"Obama should tell Paulson, 'Thank you, but you should ask for the money and use a substantial portion for mortgage foreclosure reduction,'" said Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee.