U.S. shift on financial bailout raises new concerns

By Mark Felsenthal - Analysis

WASHINGTON (Reuters) - The Bush administration's decision to drop what it once billed as its main weapon to fight the financial crisis has raised concerns that many more firms may now seek public funds to survive the downturn.

"The TARP (Troubled Asset Relief Program) has morphed with breathtaking speed into something altogether different from how it was sold," RBS Greenwich Capital chief economist Stephen Stanley said in a note to clients.

The government originally planned to restore credit flows by buying mortgage assets compromised by defaults, but Treasury Secretary Henry Paulson said on Wednesday the plan would focus instead on recapitalizing financial institutions and supporting consumer credit.

Treasury's decision to take a stake in struggling insurer American International Group (AIG.N) this week sets a precedent other firms are likely to want to follow, Stanley said.

The government could be swamped with requests for help from companies beyond the financial sector, including struggling U.S. auto giants such as General Motors Corp GM.N.

"Once you start to move in that direction ... you'll have a stampede of requests coming in," said Brian Bethune, an economist for Global Insight in Lexington, Massachusetts. "The purpose of the whole thing was to deal with systemic risks to the financial system, not to become a general bailout for economy wide problems," he added.

SCRAMBLE

U.S. officials have scrambled since the summer of 2007 to halt a sharp pullback in lending that began with mortgage delinquencies but escalated into a full-blown credit crisis that has sharply slowed economic activity around the planet.

After a series of moves to prop up financial institutions, and an alphabet soup of special facilities to provide funding to banks and other firms, the Treasury and the Federal Reserve abandoned a piecemeal approach in October when they persuaded Congress to approve a $700 billion rescue package.

The main focus of the plan was to put in place a program to buy impaired mortgage-related assets to clear up uncertainties about credit and restore lending, but Treasury quickly shifted to taking equity stakes in banks.

Paulson confirmed on Wednesday that Treasury had concluded that buying assets was not the best use of government funds.

Instead, the government would expand the purchases of stakes in financial institutions, he said.

Paulson also said the Treasury and the Federal Reserve are considering a program to help restore credit flows to U.S. households by using financial rescue funds to lure investors back to markets for securitized debt, such as car loans, student loans, and credit cards.

STRAINS EASING

In a sign some of the government efforts may be having an impact, some indications of credit strains have eased. Three-month interbank borrowing rates, a measure of perceived risks of borrowing, declined for several weeks before rising on Thursday on nervousness about changes to the bailout plan.