Congress to tweak bailout or risk deep recession

By David Lawder and Patrick Rucker - Analysis

WASHINGTON (Reuters) - U.S. efforts to revive a $700 billion bank bailout bill with some new provisions offered hope for battered markets on Tuesday, and economists warned of a long and deep recession if efforts to resuscitate it fail.

The defeat of the bill on Monday in the U.S. House of Representatives left two likely scenarios -- the plan gets tweaked enough to win passage, or Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke return to a limited tool box and piecemeal approach to dealing with the financial crisis.

A complete rewriting of the bill appears unlikely.

"For the near-term, we're going to get some modification on the Paulson plan and pass it or we're not going to get anything," said Michael Mussa, former chief economist at the International Monetary Fund.

"The worry is that if we don't pass the Paulson plan, we could have a steep recession that is among the worst we've seen in the post-War era," said Mussa, now a senior fellow at the Peterson Institute for International Economics in Washington.

The $700 billion financial rescue plan aimed to unfreeze credit markets by having the Treasury buy up problem assets that are plaguing bank balance sheets, stalling lending, and adding to fears that more institutions will fail.

The bill's spectacular rejection in a razor-thin vote on Monday spurred policy-makers and congressional leaders to try to persuade about a dozen Republican lawmakers who voted "no" to change their minds.

"It's going to take us a little bit of time to figure out where the possible votes are -- figure out what, we hope, small policy changes are necessary to attract those votes," White House economic adviser Keith Hennessey told Fox News Channel. "We're starting to do that."

One possible change that gained traction on Tuesday would lift the federal guarantee on bank deposits up to $250,000 from the $100,000. The Federal Deposit Insurance Corp formally asked for a temporary increase and presidential nominees John McCain and Barack Obama threw their support behind the proposal.

POWER VACUUM

The defeat of the bill was driven by a collection of Republicans and Democrats, many of whom face tight re-election races on November 4 and are getting angry calls and emails from constituents upset at the idea of bailing out Wall Street.

Many Americans see the bailout as an excessive burden to taxpayers and believe the money would reward Wall Street executives who should have been more careful with their money. They also are irked by the idea of helping people who took out larger home mortgage loans than they could afford. Rising mortgage defaults are at the root of the current crisis.

The bill's defeat underscored the absence of a strong hand in Washington, as neither lame-duck President George W. Bush, Democratic House Speaker Nancy Pelosi, or House Republican leader John Boehner were able to deliver the needed votes.

Paulson and Bernanke also were guarded in their pitch for the program, reluctant to say publicly that a severe recession could ensue if no action was taken. The result was a disconnect with "Main Street" America.

GETTING THE SWAY-ABLES