Paulson backs off asset plan; crisis cures at risk

By Steven C. Johnson

NEW YORK (Reuters) - The U.S. Treasury backed away from using a $700 billion bailout fund to cleanse bank balance sheets of bad mortgage debt, while Europe reported more gloomy economic news, fanning fears of a worldwide recession.

Global stock markets fell, with Wall Street down for a third straight day and the tech-heavy Nasdaq closing at a five-year low. The price of oil, which depends on global growth, tumbled 5 percent to just above $56 a barrel.

Secretary Henry Paulson, in the most explicit sign yet that Treasury was abandoning its initial plan for the rescue funds, said he preferred to focus instead on buying stakes in banks to encourage them to increase lending.

Treasury initially promoted the bailout as a way to help banks unload toxic mortgages, but Wednesday, Paulson defended the change in a news conference, saying, "I will never apologize for changing an approach or strategy when the facts change.

Paulson's announcement added to worries stoked by dismal employment data from Britain and a World Bank warning Tuesday that global trade may contract in 2009.

The combination of tight credit conditions and a global downturn has set off what economists say has become the worst financial and economic crisis in 80 years and left investors bracing for more interest rate cuts.

"We are certainly prepared to cut ... again, if that proves to be necessary," Bank of England Governor Mervyn King said after predicting slower UK growth and inflation next year.

The crisis also continued to take a toll on companies, with top U.S. electronics retailer Best Buy reporting it had cut its full-year growth outlook, boosting fear about the impact of slower consumer spending on the U.S. economy.

"Whether it's economic indicators or company news, it's just too awful," said Takashi Ushio, head of the investment strategy division at Marusan Securities in Tokyo.

RESCUE EFFORTS AT RISK

Elsewhere, efforts to cure national economies and companies ailing from the credit crisis looked like they were in danger Wednesday.

The International Monetary Fund withheld official backing for a $6 billion bailout plan for Iceland, the Financial Times reported, putting loans to the North Atlantic country at risk.

Some of British bank Barclays' biggest shareholders have threatened to vote against a plan to raise 7 billion pounds ($10.8 billion) in fresh capital unless the bank improves terms of the deal, British newspapers reported.

Paulson's about-face unsettled investors who had backed the Treasury's rescue effort precisely because it was promoted as a vehicle to buy toxic mortgage debt from banks to cushion potential losses and kick-start lending.

"If it's not going to do what it says on the tin, then it's also not going to provide a systemic solution to the financial crisis," said Divyang Shah, chief market strategist at Commonwealth Bank in London.