By David Lawder

WASHINGTON (Reuters) - The U.S. government's $700 billion bailout program helped stabilize the financial system, but has done little to boost lending or stave off millions of home foreclosures, a government watchdog group said on Wednesday.

The Congressional Oversight Panel's new monthly report on the Troubled Asset Relief Program (TARP) came the same day as Treasury Secretary Timothy Geithner moved to extend the bailout fund into October 2010, although he pledged to deploy no more than $550 billion of it.

The 14-month-old bailout fund, which has propped up banks, automakers and insurer American International Group, has failed to resolve key problems in the financial system, including toxic assets still weighing down bank balance sheets, a sharp contraction of credit and the moral hazard associated with bailouts, the panel said.

"Consequently, the United States continues to face the prospect of banks too big to fail and too weak to play their role adequately in keeping credit flowing throughout the economy. The foreclosure crisis continues to grow," the panel said in its report.

The report concluded that the stability that markets have enjoyed this year was not solely due to TARP, but to an extraordinary mix of government support, including Federal Deposit Insurance Corp and Federal Reserve asset guarantees.

"The removal of this support too quickly could undermine the economy's nascent stability," it said.

The Obama administration has signaled an extension by considering the use of TARP funds to spur small business lending and possible other programs to boost job creation, a move opposed by many Republicans.

Treasury must seek Congressional approval if it wants to funnel some of its $700 billion bailout fund to jobs programs that do not involve financial services firms as intermediaries, a key overseer said on Wednesday.

Elizabeth Warren, chairman of the Congressional Oversight Panel and a Harvard Law School professor, told CNBC television the Obama administration cannot simply spend TARP funds "in a jobs program somewhere else."

The oversight panel's lone sitting member of Congress, Rep. Jeb Hensarling, a Texas Republican, voted against approval of the panel's report but agreed with certain criticisms. He called for TARP to be shut down at year-end.

"One can not help but conclude that TARP is failing its mandate," Hensarling said in a statement. He added that the Treasury's bailout of General Motors, Chrysler and GMAC were "abuses", while TARP's foreclosure mitigation efforts were "misguided."

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