By a vote of 228-to-205 the House of Representatives rejected a compromise plan that would have allowed the Treasury Department to buy up toxic debt from struggling banks.
The plan's defeat sent U.S. stocks down sharply, with the Dow Jones industrial average falling 777 points, its biggest intraday drop ever.
Leaders were expected to try again on the vote later this week.
Automakers and auto dealers stand to benefit from a $700 billion plan aimed at rescuing the nationís troubled financial system, key lawmakers said earlier today.
Under the bailout legislation, the Treasury Department would have the authority to acquire securities backed by automotive loans, said Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee.
Under the existing legislation, the Federal Reserve will be able to make special loans to automakers so they can provide reasonable inventory financing to their dealers, Frank added.
Frank made his remarks during House debate on the rescue plan. The legislation is designed to enable the federal government to buy securities backed by troubled mortgages. The mortgage crisis is blamed for undermining financial firms and stalling the normal flow of credit throughout the economy.
Frank is lead negotiator for House Democrats on the bailout plan. He said the well-being of the auto industry and its dealers is critical to the nationís economy.
Congressional leaders and President Bush say they must enact the rescue plan this week to prevent a financial meltdown.
Separately, Bush is expected to sign today or Tuesday, Sept. 30, legislation that will provide $25 billion in low-interest loans for automakers and suppliers to retool for more fuel-efficient vehicles. Final Senate approval of the loan package came Saturday, Sept. 27.
Reuters contributed to this report