Paulson shifts course, won't buy troubled assets

WASHINGTON - In a stunning turnabout, the Bush administration Wednesday abandoned the original centerpiece of its $700 billion effort to rescue the financial system and said it will not use the money to purchase troubled bank assets.

“Our assessment at this time is that this (the purchase of toxic assets) is not the most effective way to use funds,” Treasury Secretary Henry Paulson told a news conference.

Paulson said the administration will continue to use $250 billion of the program to purchase stock in banks as a way to bolster their balance sheets and encourage them to resume more normal lending.

But he was noncommittal about direct support for the auto industry, saying it was a "critical industry" but that the bailout plan was not designed for them.

Asked about a Democratic congressional leadership plan to rush financial aid to the industry, Paulson cautioned that “any solution has got to be leading to long-term viability” for the automakers.

Stocks, already reeling, ended trading sharply lower, partly because Paulson's comments at a news briefing underscored the extent of the problems in the financial system. The Dow lost more than 400 points.

Investors also were concerned that the Treasury will be investing more taxpayer dollars into the banking sector, which will dilute the value of existing shareholders, said Rudy Narvas, senior analyst at 4Cast Ltd. in New York.

Aides to President-elect Barack Obama have been playing down reports of tension with the Bush administration over help for the stricken auto industry.

Struggling General Motors, Ford and Chrysler are seeking $25 billion in additional assistance on top of $25 billion in federal loans approved in September to help them develop more fuel-efficient cars. GM reported last week that it lost $2.5 billion in the latest quarter and does not have enough cash to make it through 2009, raising the prospect of a potential bankruptcy filing. Company executives say they are determined to avoid bankruptcy.

Democratic Rep. Barney Frank, chairman of the House Financial Services Committee, announced Wednesday he would introduce legislation that would appropriate $25 billion of the $700 billion bailout as loans to automakers in exchange for a government stake.

Paulson on Wednesday said that non-financial firms as well as banks may need additional cash infusions but that he saw “implementation difficulties” aiding companies that were not federally regulated.

Paulson said the administration was looking at a major expansion of the program into the markets that provide support for credit card debt, auto loans and student loans. He said 40 percent of U.S. consumer credit is provided through selling securities that are backed by pools of these loans.

“This market, which is vital for lending and growth, has for all practical purposes ground to a halt,” Paulson said.

Paulson said the massive bailout effort, the largest in U.S. history, was showing results but that more efforts were needed given the most severe downturn being faced in housing.

“Our financial system remains fragile in the face of an economic downturn here and abroad,” Paulson said. “Market turmoil will not abate until the biggest part of the housing correction is behind us. Our primary focus must be recovery and repair.”

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