November 12, 2008 / 12:24 AM / 11 years ago

Paulson backs off asset plan; crisis cures at risk

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.

Treasury Secretary Henry Paulson speaks during a news conference at the Treasury Building in Washington November 12, 2008. REUTERS/Mitch Dumke

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.

“The hope and optimism that lay with (the bailout program) was that we had moved away from fighting fires and toward a systemic solution, but now we have taken a lot more than a few steps back.”

Unlike the United States, Canada’s government said Wednesday it would buy up to C$50 billion ($41 billion) in insured mortgages from banks in order to boost lending.

Aides to U.S. President-elect Barack Obama, meanwhile, were playing down reports of tension with the Bush administration over help for the stricken car industry.

Democratic congressional leaders said they would push for emergency legislation to bail out struggling U.S. automakers, possibly by amending the $700 billion rescue program, which now only applies to banks and other financial firms.

Paulson said that nonfinancial firms as well as banks may need more cash infusions but that he saw “implementation difficulties” aiding companies not federally regulated.

General Motors Corp, Ford Motor Co and Chrysler LLC are seeking $25 billion in urgent assistance, in addition to loans to develop fuel-efficient cars.

DECLINE AND FALL

The World Bank said more countries were seeking its help, and its president, Robert Zoellick, warned that global trade may decline next year for the first time in more than a quarter century as the credit crisis reduces trade financing.

Zoellick said the bank expected its lending to increase to $35 billion this year from $13.5 billion last year.

Questions were beginning to be asked, however, about just how much help governments can give.

“The U.S.’ financial resources are already stretched and a flood of new demands may overwhelm a government already staring down at a record budget deficit next year,” UBS economists said in a note.

In the United States, electronics chain Best Buy slashed its full-year outlook just days after rival Circuit City filed for bankruptcy protection. That suggested consumers were reducing spending sharply.

France’s Natixis SA announced falling investment banking revenue and Italy’s UniCredit posted a sharp drop in quarterly net profit.

Holland’s ING posted its first-ever quarterly loss, while Swiss Life said third-quarter premium volumes fell 11 percent and warned it would not meet its full-year net profit outlook.

This came against a background of continuing decline in world economies.

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Euro zone industrial production fell a larger-than-expected 1.6 percent in September, underlining fears the economy contracted in the third quarter and entered a technical recession.

British unemployment rose to its highest level in more than a decade in the three months to September, while the Bank of England said the British economy would shrink sharply next year and inflation could be less than 1 percent.

The comments sent sterling to a record low against the euro and a 6-1/2-year low against the dollar.

Additional reporting by Alex Richardson in Singapore, Jeremy Gaunt in London and Reuters bureaus worldwide; Editing by

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