WASHINGTON 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.
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.
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.
The U.S. commercial paper market has grown for the third week in a row, although it remains heavily dependent on Fed backing. The Fed launched a program to buy this type of short-term corporate debt in late October.
The U.S. TED spread, the spread between 3-month Treasury bills and interbank lending rates, narrowed on Wednesday and was sharply lower than peaks reached in October. However, it remains at a historically high level.
But the administration remains confronted with glaring signs of far deeper economic damage that are likely to put the broader financial system at risk.
"The extraordinary measures taken thus far, while somewhat helpful in reducing market stress, have not reversed a severe tightening in credit that is now dragging down the economy," Goldman Sachs economist Ed McKelvey told clients.
The U.S. economy shed 240,000 jobs in October and shrank by an annualized 0.3 percent in the third quarter. Most analysts predict sharper contraction in the last three months of 2008.
"More and more the focus is on the terrible economy which is hurting the financial sector itself," said economist Harm Bandholz with UniCredit Markets and Investment Banking in New York.
Paulson was unapologetic about his shift in strategy, saying he needed to adapt to changing conditions.
But some analysts said the government's efforts to be nimble may have come at the some cost of credibility.
"If you do it too quick, too often, it leads to the impression that you're running around without any overall direction," Global Insight's Bethune said.
"He has to keep saying the purpose of these resources is to mitigate risks in the financial system," Bethune added.
(with additional reporting by Jennifer Ablan)