WASHINGTON (Reuters) – Treasury Secretary Henry Paulson on Tuesday said the unpredictable nature of the current financial crisis meant it was necessary to ensure that financial bailout money was not diverted to other uses.

In testimony prepared for delivery to the U.S. House Financial Services Committee, Paulson said the $700-billion Troubled Asset Relief Program, or TARP, was intended to shore up the financial system and said there were other efforts under way to help homeowners avoid preventable foreclosures. 

“While I understand the interest in spending TARP resources on other approaches, the efforts already under way will do more to prevent foreclosures than might have been achieved through very large purchases of mortgage-related securities through the TARP,” he said. 

Paulson faces a grilling over a decision to use TARP funds for recapitalizing financial institutions instead of buying bad or so-called toxic assets as was originally proposed. 

He said that by the time Congress had approved the funds, the financial crisis had gone global and become so severe that “an asset purchase program would not be effective enough, quickly enough.” 

Paulson said the financial bailout was not intended as a stimulus package. “It was intended to shore up the foundation of our economy by stabilizing the financial system, and it is unrealistic to expect it to reverse the damage that had already been inflicted by the severity of the crisis.”

(Reporting by Glenn Somerville; Editing by James Dalgleish)


Below is the text of Treasury Secretary Henry Paulson’s testimony to the House Financial Services Committee on the financial bailout package.

“Good morning and thank you for the opportunity to testify this morning on implementation of the Emergency Economic Stabilization Act. I am grateful and everyone in this country should be grateful, for the efforts of Chairman Frank, ranking member Bachus, this committee and other members of Congress toward adoption of the financial rescue legislation, which created critically important authorities and financial capacity to stabilize our financial system. Before Congress provided these tools, we were facing a financial crisis without the authorities and resources necessary to meet the challenge. At the risk of oversimplification, the financial rescue package is about restoring confidence — restoring the confidence of depositors and investors in our financial institutions, and restoring the confidence that our financial institutions need so that they will get back to normal lending practices.

This law has already allowed us to take decisive action to prevent the collapse of our financial system. But more needs to be done, and it is my responsibility to use the authorities Congress provided to protect and strengthen the financial system, and in so doing, protect the taxpayer.

Let me summarize what the U.S. financial system has had to digest in just a few months’ time. We have not in our lifetime dealt with a financial crisis of this severity and unpredictability. We have seen the failures, or the equivalent of failures, of Bear Stearns, IndyMac Bank, Lehman Brothers, Washington Mutual, Wachovia, Fannie Mae, Freddie Mac, and AIG – institutions with a collective $4.7 trillion in assets when this year began. Each of these failures would be tremendously consequential in their own right under normal market conditions – but our economy and our financial system faced them in succession while at the same time the economy was weakening. Other large financial institutions were under significant pressure and market participants around the world were speculating about which institution would be next to fall.

And as you well recall, in September, after 13 months of market stress, the financial system essentially seized up and we had a system-wide crisis. Our markets were frozen, banks had pulled back very substantially from interbank lending. Confidence in our financial system and a number of our financial institutions had been seriously compromised. That was the background against which Chairman Bernanke and I met with the Congressional bipartisan leadership to explain the need for emergency legislation.

Our objectives in asking Congress for a financial rescue package were to first stabilize a financial system on the verge of collapse, and then to get lending going again to support the American people and businesses. We warned that the frozen credit markets were already severely damaging the U.S. economy and costing jobs. If the financial system were to collapse, it would significantly worsen and prolong the economic downturn that was already underway.

We needed the financial rescue package so we could intervene, stabilize our financial system, and minimize further damage to our economy. The rescue package was not intended to be an economic stimulus or an economic recovery package; it was intended to shore up the foundation of our economy by stabilizing the financial system, and it is unrealistic to expect it to reverse the damage that had already been inflicted by the severity of the crisis.

During the two weeks Congress worked on the legislation, market conditions worsened significantly. Many Americans look at the stock market as an indicator of the economy, and during this period they saw tremendous volatility. The Dow Jones Industrial Average fell more than 700 points on one single day, and over 9 percent during the two weeks the legislation was debated – stock market losses amounted to slightly more than $2 trillion.

But we were focused on the credit markets because they provide our basic economic fuel — borrowing and lending capital — that supports and creates jobs. The confidence in banks and of banks continued to diminish, as did the flow of funds between them. Interbank lending rates relative to policy rates were at the highest level this decade, indicating banks’ lack of confidence in one another and in the financial system.

And the problems extended well beyond the banks. Corporate bond spreads continued to increase, as did corporate credit default spreads and overall market volatility. Industrial company access to all aspects of the bond market was dramatically curtailed. For example, blue chip industrial companies were frequently unable to issue commercial paper with maturities greater than a few days as the commercial paper market became severely impaired. We received reports of small and medium-sized companies, with no direct connection to the financial sector, losing access to the normal credit needed to meet payrolls, pay suppliers and buy inventory.

Investor concerns became most evident in the “flight to quality” in the Treasury market, with short-term Treasury bill yields dropping to near zero.

During that same period, the government intervened to protect the financial system. The FDIC acted to mitigate the failure of Washington Mutual by facilitating its sale, and made clear that it would intervene to prevent Wachovia’s failure. And turmoil had developed in European markets. In a two-day period at the end of September the governments of Ireland, the UK, Germany, Belgium, France and Iceland intervened to prevent the failure of one or more financial institutions in their countries.

By the time legislation had passed on October 3, the global market crisis was so broad and so severe, we knew we needed to move quickly and take powerful steps to stabilize our financial system and to get credit flowing again. Our initial intent had been to strengthen the banking system by purchasing illiquid mortgages and mortgage-related securities. But by this time, given the severity and magnitude of the situation, an asset purchase program would not be effective enough, quickly enough. Therefore we exercised the authority granted by Congress in this legislation to develop and quickly deploy a $250 billion capital injection program, fully anticipating we would follow that with a program for troubled asset purchases.