WASHINGTON -- Secretary Henry Paulson said the Treasury has put a plan to purchase illiquid mortgage-related assets on hold.
Meanwhile, the Treasury Department, signaling a new phase in its $700 billion financial-rescue plan, is considering requiring that firms seeking future government money raise private capital in order to qualify for public assistance, according to people familiar with the matter.
The move isn't expected to apply to the existing $250 billion capital-purchase program, which is already injecting money into banks. But Treasury is considering attaching such conditions to any of its future capital investments, these people said.
At the same time, Treasury is unlikely to conduct any auctions to purchase bad loans and other troubled assets -- the original intention of the $700 billion rescue plan. Instead, Treasury is expected to continue focusing its firepower on injecting capital directly into the financial sector, these people 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, in helping to strengthen our financial system and support lending," he said, according to his prepared remarks.
House Financial Services Chairman Barney Frank (D., Mass.) said that Treasury disagreed with the plan to put asset purchases on hold. "We have a need to use that funding" for that purpose, Mr. Frank said at a hearing on Capitol Hill. Mr. Frank noted that Congress gave Treasury explicit authority to buy up mortgage-backed securities and whole mortgage loans as part of TARP.
Treasury has just $60 billion left in its rescue fund, and either the current or next administration will have to turn to Congress to request the second half of the promised $700 billion. Treasury has so far committed $250 billion to banks and is spending an additional $40 billion to buy preferred shares in American International Group Inc., the big insurer.
Treasury is expected to widen its program to inject capital into smaller, closely held banks, and is considering expanding its rescue to other nonbank financial institutions, such as insurers and specialty-finance companies. It may also do another round of financing for publicly traded banks. In addition, Treasury is under increasing pressure from Democrats in Congress to open the program to the ailing auto sector.
In another step, U.S. bank regulators could announce guidelines this week designed to encourage U.S. banks to remain active lenders as financial markets are squeezed. Many U.S. companies and individuals have become dependent on bank credit lines as financial markets have tightened up. The regulatory guidelines could also address sensitive issues of bank dividend payments and executive pay.
The fact that Treasury may now require firms to raise money marks a new phase for the government, which had resisted such a move previously. Before launching its $250 billion capital-purchase program last month, Treasury toyed with requiring banks to raise matching funds alongside any government investment, but it thought that might discourage some firms from participating. It also worried that firms would not be able to raise private money in the current market environment.
Instead, Treasury structured its investment in a way that it believed would encourage firms to eventually raise private funds. But Treasury officials now think market conditions may have improved enough that companies could raise private capital.
Some economists advocate requiring companies to raise matching funds, saying it lessens the government's ability to pick winners and losers.
"This idea has the great virtue of incorporating private-sector judgment on the viability and management of these financial firms," said Douglas Elmendorf, a senior fellow with the Brookings Institution and a member of President-elect Barack Obama's transition team.
The World Bank unveiled such an initiative on Tuesday for developing-country banks, in which it will put in $1 for every $2 the banks raise from others.
Initially, in late September, Mr. Paulson asked Congress for authority to purchase $700 billion worth of distressed assets, arguing that banks and other institutions were suffering from the rotten assets clogging their balance sheets.
Figuring out how to purchase assets has proved tricky, in large part because it's difficult to determine how to price such assets, many of which are backed by risky mortgages and carry depressed values. Buying them at market prices would further hurt banks, since the firms would have to write down the value of those assets. But paying above-market prices could potentially hurt taxpayers if the assets never recover in price.
Treasury has no current plans to purchase assets, people familiar with the matter said, and is instead focused on investing directly in firms that provide financing to the broader economy.
On Monday, Treasury and Federal Reserve officials held a phone briefing with Capitol Hill staffers about the government's revised rescue of AIG. While Treasury will buy $40 billion in preferred AIG stock, the Fed will use $50 billion to purchase distressed assets from the company. On the call, Hill staffers asked why the Fed was buying the assets instead of Treasury. Fed staffers said the structure will help insulate taxpayers, according to someone familiar with the call.
Still, some lawmakers are eager to see Treasury focus exclusively on capital injections, rather than asset purchases.
"The more you look at auctions or asset purchases, the more you have the same problem: How do you set the price?" said Sen. Charles Schumer (D., N.Y.).—Maya Jackson Randall, Michael R. Crittenden and Damian Paletta contributed to this article.
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