UPDATE 3-US Treasury working on aid for GM, Chrysler merger

(Adds report on loans, Chrysler statement)

By Karey Wutkowski

WASHINGTON, Oct 27 (Reuters) - The U.S. government is considering direct financial assistance to facilitate a possible merger between General Motors Corp GM.N and Chrysler LLC, a private sector source familiar with Treasury discussions told Reuters on Monday.

The Treasury Department is weighing aid of at least $5 billion, which could include capital injections and government purchases of bad auto loans, according to the source, a financial policy executive who spoke anonymously because the discussions are private.

Emergency financing, at least initially, most likely would be focused on GM and Chrysler and not Ford Motor Co (F.N), which is struggling but still better off financially than its U.S. rivals, the source said.

A Treasury decision could come this week, the source said.

Separately, the Wall Street Journal reported the Energy Department is working to release $5 billion in loans to GM to help it finance the merger. The money, according to the report citing a person familiar with the matter, would come from $25 billion in financing approved by Congress last month to help domestic manufacturers make more fuel efficient cars.

An Energy Department spokeswoman said it would be "premature to estimate" a timetable for approving loans. Detroit and its allies in Congress have been pressuring the Bush administration to expedite the money, which regulators have said may not be available for six to 18 months.

White House spokeswoman Dana Perino said officials the Treasury, Energy, and Commerce departments have been in contact with automakers about help -- emphasizing the loan program for fuel efficient cars and the potential for Treasury to buy up bad car loans to spur new lending and jump-start sales.

Domestic manufacturers are burning through cash and their performance outlook has worsened. On Monday, Moody's Investors Service downgraded GM's credit rating on continuing liquidity concerns.

GM shares fell 8.4 percent on the New York Stock Exchange.

White House has long been cool to any straight bailout of the auto industry, although talk among insiders of immediate and substantial help has intensified in recent days with merger negotiations accelerating.

Industry supporters inside and outside of government have mounted a furious lobbying campaign to tie the health of automakers to the needs of the general U.S. economy, and have elevated the bailout discussion to the presidential campaign, which concludes Nov. 4.

Carly Fiorina, an economic adviser to Republican presidential candidate John McCain, said on Monday the government can assist automakers but not save the industry, meaning that taxpayers should not be on the hook for a long-term investment. On Sunday, former Treasury Secretary Robert Rubin, an Obama adviser, did not rule out robust help for automakers under certain conditions.

Federal aid is considered a requirement for completing the GM/Chrysler deal since larger GM has failed to find an outside investor to help fund its acquisition with sales plummeting and prospects uncertain, other sources have said.

GM Chief Executive Rick Wagoner was in Washington in recent days to lobby administration officials. Former Treasury Secretary John Snow is the chairman of Chrysler owner, Cerberus Capital Management [CBS.UL].