Paulson and Bernanke warn of costs of bailout delay

WASHINGTON (Reuters) - U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke on Tuesday urged Congress to act swiftly to put in place a $700 billion financial system bailout, warning delay would put the economy at risk.

Testifying before a sometimes-skeptical Senate Banking Committee, they said financial markets were in serious stress and needed to be stabilized quickly by cleansing them of illiquid assets.

Paulson wants lawmakers to approve a massive war chest, funded by taxpayers, to buy distressed debt from financial institutions to try to keep credit markets from choking up.

Lawmakers have vowed to move without delay, but also are insisting on changes. These include more protections for taxpayers and limits on compensation for executives of firms that would be offloading their bad assets onto the government.

"Action by Congress is urgently required to stabilize the situation and avert what could otherwise be very serious consequences for our financial markets and our economy," Bernanke said.

A rising tide of U.S. home foreclosures and loan defaults has spawned the greatest financial crisis since the Great Depression and, after a series of emergency actions to bolster individual financial firms, U.S. authorities say they must now try to save the system as a whole.

CONGRESSIONAL CRITICS

While congressional leaders have made clear they intend to move quickly, the Treasury's proposed plan drew some stiff criticism from lawmakers.

Sen. Richard Shelby of Alabama, the top Republican on the committee, said the plan "only codifies Treasury's ad hoc approach" to long-festering issues that have beset financial markets and said he feared it would waste taxpayers' money.

Committee Chairman Christopher Dodd of Connecticut called the Treasury proposal "stunning and unprecedented in its scope and lack of detail." Like many of his fellow Democrats, Dodd said it needed work, like more protections for taxpayers.

In a highly charged atmosphere at the hearing, there were occasional catcalls and clapping from spectators that led Dodd to warn the room would be cleared if it did not stop.

Paulson said the broader economy was under threat and said it was essential to move decisively beyond the case-by-case approach followed in the government takeover of mortgage finance companies Fannie Mae and Freddie Mac and the bailout of insurer AIG .

"We saw market turmoil reach a new level last week, and spill over into the rest of the economy," Paulson said. "We must now take further, decisive action to fundamentally and comprehensively address the root cause of this turmoil."

BUSH LENDS HAND TO BAILOUT PUSH

President George W. Bush tried to lend a hand to a hard-pressed Paulson and Bernanke, saying he understood lawmakers had questions but that speed was needed.

"There are good ideas that need to be listened to in order to get a good bill out that will address the situation," Bush said in a relatively rare nod to Democratic concerns.

White House spokesman Tony Fratto, asked what would happen if the bailout plan cannot be put in place this week, replied: "You should think of that as unthinkable."

Analysts said it appeared Paulson and Bernanke were trying to head off opposition to the bailout plan in Congress by stressing the dire consequences of failing to move quickly.

"The policy war on the financial crisis is as much about the psychological impact as about real intervention. It's no surprise, therefore, that the engineers behind the bank remedy plan are calling for fast implementation," said Lena Komileva, G7 market economist at Tullet Prebon in London.

U.S. stock markets opened just as the hearing began and prices were higher in early trading, reflecting hope that there would be some kind of bailout with minimum delay. On Monday, U.S. stocks had fallen sharply over concern a plan might stall as Democrats sought changes.

Paulson said there was "bipartisan consensus" for a quick legislative solution to the crisis and he urged Congress to "avoid slowing it down with other provisions that are unrelated or don't have broad support."

However, he and Bernanke provided few clues as to how they view separate add-on provisions suggested by lawmakers.

In addition to curbing executive pay and adding more safeguards for taxpayers, congressional Democrats also want to add assistance for homeowners facing foreclosure.

Senate Democrats, seeking to limit potential losses for taxpayers, have proposed that the government take equity stakes in firms selling bad debts to the U.S. Treasury, but the Treasury opposes that step.

Bernanke said financial market stress was worsening and said that heightened the urgency of a bailout plan.

"If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse," he said. "At this juncture, in light of the fast-moving developments, it is essential to deal with the crisis at hand."

(Additional reporting by Mark Felsenthal, Patrick Rucker and David Lawder, Editing by Chizu Nomiyama)