By Paul Kane and Lori Montgomery

Washington Post Staff Writers

Monday, September 29, 2008; 2:14 PM

In a narrow vote, the House today rejected the most sweeping government intervention into the nation's financial markets since the Great Depression, refusing to grant the Treasury Department the power to purchase up to $700 billion in the troubled assets that are at the heart of the U.S. financial crisis.

The 228-205 vote amounted to a stinging rebuke to the Bush administration and Treasury Secretary Henry M. Paulson Jr., and was sure to sow massive anxiety in world markets. Even during the Just 11 days ago, Paulson urged congressional leaders to urgently approve the bailout. He warned that inaction would lead to a seizure of credit markets and a virtual halt to the lending that allows Americans to acquire mortgages and other types of loans.

As it became apparent that the measure was heading to defeat, stock markets took a steep dive. The Dow Jones industrial average fell more than 600 points but then rebounded a bit.

After a week of intense debate in both party caucuses, House members opposed the bill just five weeks before they face voters in an election that is shaping up as a referendum on the economy.

"Today's the decision day. I wish it weren't the case," said Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, who kicked off three hours of impassioned debate just as the opening bell sounded on Wall Street this morning.

Global markets have followed the congressional negotiations closely since Paulson's dire warnings to congressional leaders in a Sept. 18 nighttime meeting in the offices of House Speaker Nancy Pelosi (D-Calif.). As debate began today, news broke that Citigroup was purchasing another troubled bank, Wachoiva, and an hour into the debate the Dow Jones industrial average had dropped by 285 points.

The bailout plan would have allowed Paulson to spend up to $700 billion to relieve faltering banks and other firms of bad assets backed by home mortgages, which are falling into foreclosure at record rates. Paulson, and his successor in the next administration, would have given the government broad latitude to purchase any assets from any firms at any price and to assemble a team of individuals and institutions to manage them. Paulson and others hoped to contain a crisis that already has caused the failure or forced the rescue of a half-dozen major Wall Street firms and unnerved markets around the world.

Before the debate started, Bush issued a final public plea urging lawmakers to support the plan, acknowledging that the vote will be "difficult" in the face of opposition from taxpayers and voters, but necessary to protect the economy. "A vote for this bill is a vote to prevent economic damage to you and your community," Bush said, attempting to undercut arguments that the proposed legislation bolsters Wall Street at taxpayers' expense. "This is a bold bill that will keep the crisis in our financial system from spreading through our economy."

Frank said no lawmaker wants to approve such a large bailout that was made necessary by the mistakes of Wall Street financiers and the mortgage industry, but inaction risked a more widespread financial meltdown. If nothing is done, he said, "the consequences will be much more severe."

Democratic and Republican leaders frantically pushed for votes this morning among their rank-and-file members to assure passage. During early morning votes on other noncontroversial matters, Pelosi hurried around the chamber floor, button-holing rank-and-file members, asking for their support.

Speaking on the floor of the House, in the final minutes before the close vote, Pelosi tried to assure her most liberal colleagues that further bailout hearings and legislation would come next year. Knowing that her party was fearful of how many Republicans would support the bill, Pelosi noted the bipartisan talks over the last week and the pledges made among both side's leaders to rally support. "I know that we will live up to our side of the bargain, I hope the Republicans will, too," she said.

On Sunday, Rep. Roy Blunt (R-Mo.), a lead negotiator and the GOP's top vote counter, hauled the nearly 30 retiring Republicans into his office to plead for what may be their final vote in office, warning that it will shape their legacy. James Nussle, the director of Bush's Office and Management and Budget and a former House member, worked the Capitol's halls and the House cloakroom in search of votes, cautioning beforehand of a very narrow vote.

Leaders met strong resistance from a liberal wing that opposed bailing out Wall Street's corporate executives and a conservative wing that denounced the measure as an abandonment of free-market principles.

Arguing that the country was on a "slippery slope toward socialism," Rep. Jeb Hensarling (R-Texas) urged his colleagues to oppose the bill because of the "unintended consequences" to come. "If we lose our ability to fail, we will soon lose our ability to succeed. If we bail out risky behavior, we will soon see even riskier behavior," said Hensarling, the leader of a conservative caucus.

"It's not sustainable and we know it won't solve the underlying problem," said Rep. Peter DeFazio (D-Ore.), likening the proposal to the Bush administration's "surge" of troops into the Iraq war last year.

Many lawmakers cast the vote as the equivalent of a war resolution or a presidential impeachment. Their speeches invoked 19th-century Russian novelist Fyodor Dostoyevsky and King Henry.

The House vote had been regarded as the most risky, because restive Republicans balked at the emerging proposal last week at a White House summit with Bush and the presidential candidates, Sens. John McCain (R-Ariz.) and Barack Obama (D-Ill.). And Democrats warned that dozens of their members, hailing from poor and liberal districts, would never endorse such a bailout.

But the Saturday negotiations produced a few compromises that brought a full-throated endorsement from GOP leaders, most particularly a provision that requires the Treasury secretary to establish a new federal insurance program, funded by the banks, that would protect firms against losses from troubled assets. Although Paulson and Federal Reserve Chairman Ben S. Bernanke had concluded that such a program would not pump needed cash into struggling firms, House Republicans said it offered an alternative method for shoring up companies at no cost to taxpayers.

After the legislation was unveiled Sunday, both McCain and Obama endorsed it as a necessary step to avert economic disaster, in a signal to skittish lawmakers that the political risk of backing the bill might not be as dire as they feared.

On Sept. 20, Paulson presented Congress with a three-page economic rescue plan that would have granted the Treasury nearly unfettered power to shore up the nation's financial system, unchecked by federal or judicial review. By yesterday, the measure had grown to 110 pages, many of them devoted to the creation of myriad oversight agencies, including an independent inspector general. Still, the measure would give Paulson broad authority to create an Office of Financial Stability within the Treasury, to hire its staff and to direct their activities. The head of the office would be subject to Senate confirmation and would be required to quickly publish guidelines for identifying, pricing and purchasing troubled assets.

Money for the program would be released in segments, with the Treasury secretary receiving $250 billion immediately. Paulson has said he expects to spend about $50 billion a month on the program. To protect taxpayers, participating firms would be required to give the government warrants to buy stock so taxpayers could benefit if they return to profitability. If the government does not regain all of its money after five years, the president would be required to submit a plan for recovering the money "from entities benefiting from the program."

The measure also would require federal officials to rein in excessive compensation for corporate executives who participate in the bailout program.