Henry Paulson, the US Treasury Secretary who controls Washington's $700 billion bailout fund, stuck to his guns yesterday and insisted that his rescue scheme must not be used to save America's biggest car companies, even as the head of General Motors said that without state aid the industry would trigger a “catastrophic collapse” of the entire economy.

Mr Paulson and American car executives were testifying to two separate committees in Washington yesterday, with the Treasury Secretary defending his recent U-turn on using the bailout solely to buy stakes in banks, and car bosses telling lawmakers that without state help both General Motors and Chrysler could go bust.

While Mr Paulson and President Bush think that the car industry should receive assistance, there is a row over who will pay. Some Democrats want Mr Paulson to allow the car companies to tap the bailout fund, but the Treasury Secretary has refused.

Yesterday Mr Paulson told lawmakers in Washington that his bailout fund should not be seen as the answer to all America's economic problems. Addressing the US House Financial Services Committee, he said that the rescue fund approved by Washington two months ago must not be used to bail out America's carmakers and should not be seen as a stimulus package to kick-start the economy.

He said: “It was intended to shore up the foundation of our economy by stabilizing the financial system and it is unrealistic to expect it to reverse the damage that had already been inflicted by the severity of the crisis.”

While Mr Paulson was defending the remit of his bailout scheme, car executives were testifying to the Senate Banking Commitee, pleading for a taxpayer-funded rescue.

As Rick Wagoner, the chairman of General Motors, outlined the perils of allowing the US car industry to fail, Alan Mulally, the head of Ford, said that vehicle sales across the country last month were the worst for half a century. Robert Nardelli, the chief executive of Chrysler, also told lawmakers that his company was in danger of running out of money without federal aid.

Mr Paulson, 62, also defended his decision not to use the troubled asset relief programme (Tarp) to buy distressed mortgage-backed securities but to use all of the cash to take direct equity stakes in troubled banks.

He said: “While I understand the interest in spending Tarp resources on other approaches, the efforts already under way will do more to prevent foreclosures than might have been achieved through very large purchases of mortgage-related securities.”

Some lawmakers criticised Mr Paulson for presenting mixed messages and undermining public confidence in the recovery of the markets. Spencer Bachus, an Alabama congressman, said that he understood the need for flexibility but “changing too quickly, without adequately explaining why you've changed or what you're going to do next, risks sending mixed signals to a marketplace”.

Paul Kanjorski, of Pennsylvania, complained about the Bush Administration's “180 degree change in policy,” suggesting that it could hurt public confidence. “Do we have a plan? Where are we going?” he asked.

Mr Paulson, who will leave office with the Bush Administration in mid-January, said that he would not spend the remaining half of the bailout fund, but would save it for the incoming Obama administration to administer. It is quite feasible that under Barack Obama, the fund may be used to stem the number of property foreclosures.

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