Congress is pressed for bailout with dire warnings

NEW YORK (Reuters) - Congress must approve a $700 billion financial bailout or see the lifeblood squeezed from the world's richest economy, the U.S. central bank chief warned on Wednesday, as the crisis overran the U.S. presidential campaign.

Bush administration officials warned of a looming economic disaster akin to the Great Depression of the 1930s if an angry and rancorous Congress failed to act swiftly to fund a bailout that would be larger than the total cost of the Iraq war.

The president will seek to convince the American public to support the plan in a televised address Wednesday night.

Republican presidential candidate U.S. Sen. John McCain said he will break off from his campaign to return to Washington to help broker a deal, saying he feared legislation could not pass in its current form. Democratic candidate U.S. Sen. Barack Obama's campaign said the two senators had spoken Wednesday and would issue a joint statement calling on Congress to act.

While investors see an 80 percent chance that the U.S. Congress will approve the bailout by the end of the month, according to Intrade, an online betting market, many lawmakers are demanding changes to the bailout plan.

The changes include more protections for taxpayers and restrictions on the pay of executive at companies that unload their bad assets.

That uncertainty has roiled markets.

"There's a tremendous amount of anxiety whether this (bailout) bill will get passed," said Thomas di Galoma, head of U.S. government bonds at Jefferies & Co. in New York.

As Federal Reserve Chairman Ben Bernanke toiled to convince Congress to approve the hugely expensive plan allowing the government to buy up toxic mortgages that have dried up global credit, financial markets showed extreme strain.

Investors stampeded into cash, briefly pushing one-month interest rates to below zero on fears that lawmakers might delay or change the nature of the bailout. Scarce credit forced overnight lending rates for companies to 6.50 percent.

The U.S. dollar fell against the euro and global stocks seesawed as unease over the rescue plan -- which could cost every man, woman and child in America $2,300 -- kept investors on edge.

Treasury Secretary Henry Paulson, himself a former Goldman Sachs boss who built his $700 million fortune on Wall Street, tried to downplay the cost of the rescue.

"(This) is not a spending program," he told lawmakers. "It is an asset purchase program, and the assets which are bought and held will ultimately be resold with the proceeds coming back to the government."

A new report showed existing U.S. home prices fell a record 9.5 percent in August, and up to 40 percent of homes on the market were in foreclosure or being sold at a loss.

Wrangling over the bailout overshadowed news that Warren Buffett's Berkshire Hathaway Inc will invest $5 billion in embattled banking titan Goldman Sachs Group Inc, which is transforming itself from an investment bank into a traditional bank holding company to shield from the crisis. Goldman's shares rose 4 percent.

"I am to some effect betting on the fact that the government will do the rational thing and act properly," Buffett, one of the world's richest men and pre-eminent investors, told CNBC television.

But he added markets remained in a "dangerous situation."

Other nations braced for fallout from the crisis. Business confidence weakened in Germany, France and Italy in September, surveys showed, stoking fears that the euro zone is sinking into recession as the effects of U.S. financial market turmoil spread.

In the second day of congressional hearings, U.S. Rep. Baron Hill, a Democrat from Indiana, told Bernanke, "There is great angst in Congress over whether we should do this," and asked how to explain the need for an expense greater than the cost of the Iraq war since 2003 to regular Americans.

Bernanke bluntly warned, "Choking up of credit is like taking the lifeblood away from the economy."

"The economy will not function in a healthy way without the availability of credit," he said.

Asked if the crisis would match the Great Depression of the 1930s, Bernanke said, "I think this is the most significant financial crisis of the postwar period of the United States, and has in fact a global reach."

Sen. Charles Schumer, a New York Democrat, said top Democrats in Congress were committed to passing some sort of emergency measure before lawmakers adjourn in the next few days, but that Congress would need changes from Treasury's original proposal.

With many members of Congress up for re-election, lawmakers are reluctant to merely rubber-stamp the rescue plan.

"I suspect it's true of every one of my colleagues. (They) are not just against this bailout, they're very angry," Rep. Lloyd Doggett, a Texas Democrat, told Bernanke.

Bernanke ticked off areas of the economy that are struggling in a month of turbulence marked by the government's takeover of mortgage companies Fannie Mae and Freddie Mac , the bailout of insurer American International Group Inc , and the bankruptcy filing of investment bank Lehman Brothers Holdings Inc .

"Economic activity appears to have decelerated broadly," Bernanke warned. Labor markets are weak and unemployment is high, he said. Despite an easing of oil and gasoline prices, consumer spending is likely to be sluggish in the near term, he added.

The head of the Congressional Budget Office, Peter Orszag, warned lawmakers of possible "chaos" if Congress does nothing. "You would have a financial market meltdown that would cause very severe dislocations ... maybe on the magnitude of the Great Depression," he said.

That type of rhetoric left many investors jittery.

"The resistance we're seeing in Washington is understandable but frightening at the same time. The longer this drags on and the more bickering we see, the more frightening it is," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago.

Sources said Japan's third-largest bank, Sumitomo Mitsui Financial Group Inc <8316.T>, would not invest in Goldman as has been touted in recent days. Already this week, Japanese financial firms have bought Lehman assets and a stake in Morgan Stanley as they take advantage of global upheaval to expand abroad.

In Europe, EU Economic and Monetary Affairs Commissioner Joaquin Almunia said the European Union does not need a U.S.-style plan to buy up toxic assets with public money to restore confidence, calling Europe's situation "less acute.

As U.S. lawmakers mull the size and content of the bailout, the FBI said it is investigating potential mortgage fraud involving firms and senior executives at the heart of the financial crisis.

The FBI is investigating Fannie Mae, Freddie Mac, Lehman and AIG, expanding its inquiry into corporate mortgage fraud, law enforcement officials said Wednesday.

(Reporting by James Vicini, Mark Felsenthal, Gertrude Chavez-Dreyfuss, Dan Burns, Richard Cowan, Richard Leong and Steven C. Johnson, Editing by John Wallace and Jeffrey Benkoe)