* Lawmakers press Paulson to use bailout to aid homeowners
* Paulson says need to reserve bailout funds, be flexible
* Bair says "essential" to tap funds to stem foreclosures
* Bernanke offers qualified endorsement for FDIC plan (Adds quotes, details)
By Glenn Somerville
WASHINGTON, Nov 18 (Reuters) - U.S. Treasury Secretary Henry Paulson and members of Congress clashed on Tuesday over the best use for the $700-billion financial bailout fund, with lawmakers demanding money to stem a national wave of mortgage foreclosures.
At a U.S. House of Representatives Financial Services Committee hearing where he was grilled over his handling of the program, Paulson said the bailout plan wasn't "a panacea for all our economic difficulties" and would be more effectively used by investing in financial companies to shore up the system.
"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," the Treasury chief insisted.
Under stiff questioning from lawmakers who charged Treasury was making up strategy as it went along, Paulson conceded he hadn't totally ruled out using bailout funds to help homeowners, but said he had "reservations" about a proposal put forward by the Federal Deposit Insurance Corp.
Rep. Barney Frank, the Massachusetts Democrat who chairs the panel, lectured Paulson, telling him mortgage relief was spelled out as an option under the bailout passed by Congress.
"The fundamental policy issue is our disappointment that funds are not being used out of the $700 billion to supplement mortgage foreclosure reduction," Frank said. "There, I believe, is an overwhelmingly ... powerful set of reasons why some of the ... money must be used for mortgage foreclosure."
FDIC Chairman Sheila Bair, at the same hearing, told lawmakers it was "essential" Treasury offer loan guarantees and credit help to slow foreclosures, and warned that 4 million to 5 million mortgages will enter foreclosure over the next two years if nothing is done.
The FDIC says its plan could avert about 1.5 million foreclosures by encouraging lenders to restructure loans by having the government share in the cost of defaults. It is estimated the plan could cost the federal government about $24 billion.
"We are clearly falling behind the curve," Bair said. "Much more aggressive intervention is needed if we are to curb the damage to our neighborhoods and broader economic health."
FED ADDS ENDORSEMENT
Rising U.S. mortgage defaults have touched off a credit crisis that is weighing on economies around the globe and threatening to push the United States into a deep and long recession.
Federal Reserve Chairman Ben Bernanke endorsed the FDIC's approach to ease foreclosures, but with some reservations, noting it could expose the government to substantial costs.
"I want to say this is a very promising approach," he said. "A very strong point of the FDIC program is it's simple and it's run by the (loan) servicers rather than the government."
The financial bailout program approved last month was originally intended to buy bad loans from banks to free them up to make fresh loans, but Treasury has scrapped that plan and has focused on using it to buy equity in financial institutions.
Some lawmakers were clearly upset at the change of course.
Democratic Rep. Gary Ackerman of New York said Congress was caught by surprise by what "seems to be the second-largest bait-and-switch scheme that history has ever seen, second only to the reasons given us to vote for the invasion of Iraq."
Even the banking industry seemed puzzled. "It's been very confusing and very difficult," Edward Yingling, president of the American Bankers Association, told the committee. "It's confusing for bankers ... customers don't know how to react."
Some $290 billion of the first $350 billion authorized under the program already has been used or committed for use, and Paulson said he wanted to reserve the balance for the incoming administration of President-elect Barack Obama, who takes office on Jan. 20.
"This financial crisis is unpredictable and difficult to counteract," Paulson said. "So early last week, we concluded it was only prudent to reserve our ... capacity, maintaining not only our flexibility, but that of the next administration."
LITTLE HELP FOR AUTOMAKERS
Paulson was also pressed about possibly tapping bailout funds to help distressed U.S. automakers but again ruled that out. He said any solution for automakers, who are pressing their case in Congress on Tuesday, should be one that helped them to re-tool to make more energy-efficient vehicles, and that wasn't what the bailout fund was set up to do. See [ID:nWBT010150] and [ID:nN18548335]
He said Treasury was working with the U.S. central bank on a potential program, to be run by the Fed, that could be used to buy highly rated debt backed by auto loans, which could help automakers and make it easier for consumers to obtain loans.
Paulson said the bailout had "turned a corner in terms of stabilizing the system" but added that falling housing prices were the root cause of the current downturn and a correction in the housing sector may be prolonged by a weakening economy.
A real estate trade group on Tuesday reported that U.S. single-family home prices in metropolitan areas plunged 9.0 percent in the third quarter from a year earlier, pressured by the high number of foreclosed and other distressed properties on the market.
Bernanke said continuing to inject capital into banks "will be critical for restoring confidence and promoting the return of credit markets to more normal functioning." [ID:nN18184922]
He said there were some signs of a return to more normal conditions but said markets were still unsettled and many banks continued to restrict their lending through October.