Paulson defends bailout, lawmakers seek foreclosure aid

WASHINGTON -- Lawmakers on Tuesday blasted Treasury Secretary Henry Paulson's management of the sweeping $700 billion financial rescue law, accusing him of ignoring provisions designed to help homeowners at risk of foreclosure.

House Financial Service Committee Chairman Barney Frank, D-Mass., pushed Paulson and Federal Reserve Chairman Ben Bernanke at a hearing to support a $24 billion mortgage relief plan developed by Federal Deposit Insurance Corp. Chairman Sheila Bair.

"The fundamental policy issue is our disappointment that funds are not being used out of the $700 billion to supplement mortgage foreclosure reduction," Frank said. "There, I believe, is an overwhelmingly ... powerful set of reasons why some of the ... money must be used for mortgage foreclosure."

Paulson said he had "reservations" about using the $700 billion to directly aid homeowners but would keep searching for ways to address the housing crisis.

Rep. Maxine Waters, D-Calif., countered that Paulson's decision to "absolutely ignore the authority and the direction that this Congress had given you just amazes me."

"You seem to be flying a $700 billion plane by the seat of your pants," Rep. Gary Ackerman, D-N.Y., told Paulson.

FDIC Chairman Bair, at the same hearing, told lawmakers it was "essential" Treasury offer loan guarantees and credit help to slow foreclosures, and warned that 4 million to 5 million mortgages will enter foreclosure over the next two years if nothing is done.

The FDIC says its plan could avert about 1.5 million foreclosures by encouraging lenders to restructure loans by having the government share in the cost of defaults. It is estimated the plan could cost the federal government about $24 billion.

"We are clearly falling behind the curve," Bair said. "Much more aggressive intervention is needed if we are to curb the damage to our neighborhoods and broader economic health."

Federal Reserve Chairman Ben Bernanke endorsed the FDIC's approach to ease foreclosures, but with some reservations, noting it could expose the government to substantial costs.

"I want to say this is a very promising approach," he said. "A very strong point of the FDIC program is it's simple and it's run by the (loan) servicers rather than the government."

Frank said after the hearing he expects the White House will bend on the issue of foreclosure modification.

The hearing came a week after Paulson announced he was abandoning his original plan to buy troubled assets from financial firms, either directly or via auctions. Paulson said that would have required a "massive commitment" greater than the $350 billion initially available under the law. Instead, Treasury will concentrate on its program to buy stock in banks and financial firms, helping rebuild capital and boost lending.

Paulson said the bailout plan wasn't "a panacea for all our economic difficulties" and would be more effectively used by investing in financial companies to shore up the system. He said Treasury actions under the $700 billion law had helped avert the collapse of the international financial system, saying credit markets appeared to have "turned a corner."

Bernanke cautioned, however, that markets remain fragile and that "overall, credit conditions are still far from normal, with … banks reporting that they continued to tighten lending standards through October."

Treasury has allocated all but $60 billion of the first $350 billion available under the law, but Paulson has no current plans to ask Congress to release the rest of the money.

Lawmakers pressed Bernanke for details about a slew of special lending programs the Fed has developed to aid frozen credit markets. The Fed's balance sheet has ballooned to $2 trillion from $800 billion last year.

The financial bailout program approved last month was originally intended to buy bad loans from banks to free them up to make fresh loans, but Treasury has scrapped that plan and has focused on using it to buy equity in financial institutions.

Some lawmakers were clearly upset at the change of course.

Democratic Rep. Gary Ackerman of New York said Congress was caught by surprise by what "seems to be the second-largest bait-and-switch scheme that history has ever seen, second only to the reasons given us to vote for the invasion of Iraq."

Even the banking industry seemed puzzled. "It's been very confusing and very difficult," Edward Yingling, president of the American Bankers Association, told the committee. "It's confusing for bankers ... customers don't know how to react."

Little help for automakers

Paulson was also pressed about possibly tapping bailout funds to help distressed U.S. automakers but again ruled that out. He said any solution for automakers, who are pressing their case in Congress on Tuesday, should be one that helped them to re-tool to make more energy-efficient vehicles, and that wasn't what the bailout fund was set up to do.

He said Treasury was working with the U.S. central bank on a potential program, to be run by the Fed, that could be used to buy highly rated debt backed by auto loans, which could help automakers and make it easier for consumers to obtain loans.

Paulson said the bailout had "turned a corner in terms of stabilizing the system" but added that falling housing prices were the root cause of the current downturn and a correction in the housing sector may be prolonged by a weakening economy.

A real estate trade group on Tuesday reported that U.S. single-family home prices in metropolitan areas plunged 9.0% in the third quarter from a year earlier, pressured by the high number of foreclosed and other distressed properties on the market.

Bernanke said continuing to inject capital into banks "will be critical for restoring confidence and promoting the return of credit markets to more normal functioning."

He said there were some signs of a return to more normal conditions but said markets were still unsettled and many banks continued to restrict their lending through October.

Contributing: Reuters