Feb. 10 (Bloomberg) -- Treasury Secretary Timothy Geithner laid out what he described as a “comprehensive” attack on the financial crisis, warning that administration’s strategy will “cost money, involve risk and take time.”

“The financial system is working against recovery, and that’s the dangerous dynamic we need to change,” Geithner said in excerpts of his prepared remarks for delivery today in Washington. “Without credit, economies cannot grow, and right now, critical parts of our financial system are damaged.”

The Treasury chief pledged a further round of capital injections for U.S. banks and an initiative, in partnership with private investors, to address the toxic assets weighing down banks. New taxpayer funds come with tighter restrictions on banks, including limits on dividend payments, acquisitions and executive pay, administration officials said.

Today’s overhaul of the Treasury’s $700 billion financial- rescue fund is aimed at addressing the failures of the first phase of the program, which has yet to spur a wave of new lending to companies and consumers. Geithner’s warning about the cost of the effort followed signals yesterday by President Barack Obama that the administration is open to seeking more money.

The administration’s plan is designed to support about $1.5 trillion in new lending and handling of distressed securities, people familiar with the matter said.

Two-Front Campaign

“It is essential for every American to understand that the battle for economic recovery must be fought on two fronts,” Geithner said in the excerpted remarks. “We have to both jumpstart job creation and private investment, and we must get credit flowing again to businesses and families.”

Stocks fell after Obama yesterday warned the economy is at risk of a “full-blown crisis.” The Standard & Poor’s 500 Stock Index fell 1.4 percent to 857.36 at 10:39 a.m. in New York.

Obama yesterday urged Congress to approve a fiscal stimulus that will cut taxes, boost spending on roads, schools and other infrastructure, and provide aide to state budgets. The Senate may vote on the stimulus today.

Geithner at 11 a.m. will lay out his plans for deploying the second half of the $700 billion bank rescue plan, which has been known as the Troubled Asset Relief Program. The administration plans to rename it the Financial Stability Plan.

“This comprehensive strategy will cost money, involve risk, and take time,” Geithner said. The initial bailout effort, which he helped administer in his previous job as head of the Federal Reserve Bank of New York, was “essential” while “inadequate” to support the financial system and the secondary-lending market.

Stress Tests

Regulators plan to subject banks to new tests to determine whether they have enough capital, people familiar with the matter said. The Treasury, Fed and other supervisors in the President’s Working Group on financial markets will develop guidelines for the examinations, which are aimed at ensuring that the country’s largest banks can withstand a worsening economy.

Banks that don’t have sufficient capital will be given additional taxpayer funds in the form of convertible preferred securities, people familiar with the matter said.

The new capital will have tougher conditions than the Treasury’s first round of as much as $250 billion of bank-stake purchases. Participating banks will have their dividends and political lobbying efforts restricted, along with limits on stock repurchases, acquisitions, executive compensation and so-called golden parachutes. Any luxury spending provisions must also be disclosed, administration officials close to the plan said.

Use of Funds

Firms must also show how government aid will expand lending and how they intend to use the funds, the officials said.

“The American people have lost faith in the leaders of our financial institutions” and are skeptical of the rescue spending so far, Geithner said in the prepared remarks.

“In our financial system, 40 percent of consumer lending has historically been available because people buy loans, put them together and sell them,” Geithner said. “Because this vital source of lending has frozen up, no plan will be successful unless it helps restart securitization markets for sound loans made to consumers and businesses -- large and small.”

Geithner’s package includes $50 billion for measures to stem mortgage foreclosures, administration officials said. Banks receiving federal funds will be required to participate in efforts to mitigate foreclosures. The Treasury and Fed will work to reduce monthly payments and establish loan-modification guidelines, officials said.

Toxic Assets

The administration is also aiming to differentiate the next phase of the financial plan by bringing in private investors. It plans a public-private investment fund to take on older toxic assets. Officials have not yet decided on the specific mechanics of the facility, which will be introduced in lieu of the so- called bad bank of earlier proposals.

The scope of the investment fund is expected to be a range of as much as $500 billion, backed by roughly $50 billion in public funding, people familiar with the matter said.

To kick-start new lending, the Financial Stability Plan will expand a Fed program for consumer and business loans to as much as $1 trillion from the current $200 billion. The Term Asset- Backed Securities Lending Facility will be backed by as much as $100 billion of Treasury funds in case of losses.

Fed officials have yet to start up the TALF, which was intended to be under way this month and could now be renamed. It will lend funds to investors in securities backed by student, credit-card and auto loans. Eligible debt will be expanded today to include commercial mortgage-backed securities, and more types of lending may be added later, people familiar with the matter said.

FDIC Guarantees

The Federal Deposit Insurance Corp. is also set to expand its debt-guarantee program, created late last year to ensure banks’ access to credit markets, the people said. The agency is looking at 10-year guarantees for some kinds of assets.

The new approach comes four months after the start of the $700 billion TARP, which both Democrats and Republicans have criticized as ineffective. The task Geithner faces is reviving a U.S. banking system throttled by $752 billion in credit losses and an economy that lost almost 600,000 jobs last month.

Obama yesterday warned that the ultimate cost of the financial bailout is not yet known.

“We don’t know yet whether we’re going to need additional money or how much additional money we’ll need until we’ve seen how successful we are at restoring a sense of confidence in the marketplace,” Obama said in his news conference last night in Washington.

To contact the reporter on this story: Rebecca Christie in Washington at rchristie4@bloomberg.net;

Last Updated: February 10, 2009 10:40 EST