WASHINGTON - Treasury Department officials yesterday appeared to close the door on providing direct assistance to monoline bond insurers as part of their economic recovery programs.

Their rejection of any direct aid to the bond insurers - which had been aggressively sought by at least two troubled insurers - came during a background briefing following Treasury Secretary Timothy Geithner's outlining of a retooled bank bailout plan that calls for up to $2 trillion in assistance from the Treasury, private investors, and the Federal Reserve.

The plan, which Geithner outlined in broad strokes during a 30-minute speech, includes establishing a transparent "financial stability trust" that will conduct stress tests for financial institutions that receive funds through the $700 billion Troubled Asset Relief Program, as well as a $500 billion to $1 trillion public-private partnership to remove tainted - or "legacy" - assets from bank balance sheets.

The plan does not include direct assistance for states and localities, even after 10 Senate Banking Committee Democrats urged Geithner in a two-page letter Friday to use the Treasury's TARP "to purchase, or offer credit or guarantees for, certain state and local bonds." The Obama administration previously said it would provide some sort of federal backstop to the muni market.

Sen. Mark Warner, D-Va., told Geithner at a Senate Banking Committee hearing yesterday: "The municipal market is an area that I would hope be looked at for consideration for some level of credit enhancement" or other assistance.

Geithner said the market has shown some minor improvement, but that Treasury and the Federal Reserve Board are still looking at ways to help it further.

"We are open to suggestions," he said. "To be honest, I have not yet seen a good idea."

Speaking to reporters at the background briefing earlier in the day, a senior Treasury official said that bond insurers would not be eligible for capital infusions from Treasury or to borrow against "legacy" assets from the public-private partnership.

"In terms of institutions and the types of institutions that will be able to sell assets to the public-private partnership, [federally] regulated financial institutions will be able to do that," which do not include insurers, the official said. "In terms of the capital program and the stress testing, this is a bank supervisory program and so that is not an insurance company vehicle."

But, he said, "insurance companies and others would benefit if the steps we are taking do lead to broader stability in the financial markets."

The decision to block bond insurers from direct federal assistance comes as a blow to at least two bond insurers, Ambac Assurance Corp. and MBIA Insurance Corp., which have lobbied Congress and the regulators for assistance through TARP.

For instance, Ambac has sought a $1.5 billion capital infusion into muni-only subsidiary Everspan Financial Guarantee Corp., and also suggested a guarantee program through which the government would step in to cover certain excess losses.

Ambac's pitch for federal help comes as the New York Insurance Department suggested splitting off bond insurers' toxic assets, then recapitalizing the companies' public finance books to support existing policyholders and, ideally, new business.

Ambac and MBIA declined to comment yesterday. Ambac previously said it planned to go forward with a recapitalization of Everspan - which was formerly called Connie Lee Insurance Co. - even if it did not receive a capital infusion.

But a number of critics, including competitor Assured Guaranty Corp., had said that infusing capital into the downgraded insurers would not be a good use of the Treasury's funds. It was unclear if investors would regain confidence in the companies even with a capital injection.

A number of public and private solutions have since been suggested that would not require propping up the downgraded insurers. The Municipal and Infrastructure Assurance Corp., co-sponsored by the Macquarie Group and Citadel Investment Group, has obtained an insurance license from New York, and is still working with rating agencies and other state regulators to gain the necessary ratings and approvals.

And on the public side, a commission formed by the National League of Cities has begun to explore the possibility of creating a national nonprofit mutual credit-enhancement company that would be partially capitalized with federal funds.

House Financial Services Committee chairman Barney Frank, D-Mass., has said he would support some sort of federal guarantee program for munis, though his staff is concerned that it may take too long for a mutual insurer to get off the ground, according to a congressional source.

Meanwhile, Fed chairman Ben S. Bernanke yesterday told members of the House Financial Services Committee that state and local governments are not eligible for direct loans under the Fed's emergency lending authority, but he said Congress could act on the matter.

At a hearing on the Fed's efforts to provide liquidity during the financial crisis, Bernanke was asked by Rep. Gregory Meeks, D-N.Y., if he would support a Fed-sponsored, standby liquidity facility for variable-rate municipal debt. Bernanke said no, citing Section 13(3) of the Federal Reserve Act, which "excludes loans to municipalities."

Section 13(3) allows the Fed "in unusual and exigent circumstances" to provide loans to "any individual, partnership, or corporation." The Fed used this authority to provide emergency loans to Bear, Stearns & Co. and American International Group Inc. last year. Before then, the authority had not been used since the Great Depression.

"So we could not do that, at least directly," Bernanke said, adding that Congress could easily approve legislation that would aid municipalities.

Asked by Meeks if Treasury could use TARP to help the muni market, Bernanke referred the lawmaker to Geithner.

Robert Blackwell, the American Banker's Washington bureau chief, contributed to this story.

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