The U.S. financial system remains fragile a year after launching a $700 billion bailout fund and the government may need to extend the program into next year, a senior U.S. Treasury department official said on Thursday.

Herbert Allison, the Treasury's assistant secretary for financial stability, said credit and securitization markets have not recovered, and U.S. Treasury Secretary Timothy Geithner will consider these factors as he decides whether to extend the program.

A lot of people are still suffering in the American public, there is still concern by many people about losing their homes and losing their jobs, Allison told the U.S. Senate Banking Committee. There are improvements in parts of the economy that are dramatic but we still have a long way to go, he said.

Under the law creating TARP passed nearly a year ago, new investments under the program would be prohibited after December 31, 2009 unless Geithner decides to extend this to October 3, 2010.

Allison said the Troubled Asset Relief Program, or TARP, had helped stabilize an economy that was in freefall when the Obama administration took office in January.

He noted that significant parts of the financial system remain impaired and said falling commercial real estate prices may additionally pressure banks' balance sheets.

In this context, it is prudent to maintain capacity to address new developments. Allison said, a sign that the Treasury may want to keep the TARP funds available for use if needed for some time.

Allison said TARP was intended as an emergency response to a major financial crisis and the Treasury will exit from its investments in banks, insurers and auto makers as soon as it can. In the meantime, he promised, the government would remain a largely passive shareholder, voting only on board and management issues.

BAILOUT DEPENDENCY?

Republican lawmakers expressed concern at the hearing that extending the TARP into next year will enshrine government aid for companies as a permanent fixture in the economy and further increase U.S. debt.

I really feel another moral hazard being created right now, said Sen. Bob Corker, a Tennessee Republican.

He added that he thought some smaller banks were delaying raising private capital in hopes that the government would bail out the struggling commercial real estate sector, which would take pressure off their balance sheets.

Sen. Judd Gregg, the New Hampshire Republican who earlier this year considered joining Obama's cabinet, added: I don't want to see us create a program that goes on forever.

Allison said the Treasury was pressing ahead with some new TARP programs, including a scaled-down version of the toxic asset purchase program that was the original intention of TARP a year ago. He said the first of nine public-private investment funds would be closed before the end of September, enabling it to begin purchasing toxic assets.

Allison said the Treasury would soon launch a new program aimed at aiding small business lending by purchasing up to $15 billion in securities backed by Small Business Administration-guaranteed loans. He declined to provide a start date for the program.

FULL RETURN EXTREMELY UNLIKELY

Not only Republicans expressed skepticism about the TARP's effectiveness a year after its creation.

Neil Barofsky, the TARP's special inspector general, said taxpayers would probably never recover the full amount of these investments.

The progress on meeting the goal of 'maximizing overall returns to the taxpayer' is unclear, Barofsky told the Senate panel. While several TARP recipients have repaid funds for what has widely been reported as a 17 percent profit, it is extremely unlikely that the taxpayer will see a full return on its TARP investment.

For example, he said $50 billion in funds allocated to modify mortgages to reduce monthly payments will never yield a direct return, while full recovery of the more than $80 billion spent to prop up the U.S. auto industry is far from certain.

(Editing by Chizu Nomiyama and Dan Grebler)

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