By Patrick Rucker and John Poirier
WASHINGTON (Reuters) - U.S. Treasury Secretary Henry Paulson said on Monday he hoped a plan to spare homeowners facing mortgage-rate spikes would be ready by week's end and expressed faith the economy would dodge recession despite the deep housing slump.
More than 2 million subprime borrowers took out mortgages with low teaser interest rates that are due to reset sharply higher, and officials fear as many as 500,000 could lose their homes because they will be unable to meet the higher payments.
The Bush administration and federal regulators have been pushing the mortgage industry to temporarily freeze interest rates on some of these loans, which were aimed at borrowers with spotty credit history.
Rising defaults on U.S. subprime mortgages, which were repackaged as securities and sold around the globe, have rattled financial markets in recent months, drying up credit and putting the world's largest economy at risk.
"The government has a role to play," Paulson said at a federal housing symposium at which he also called on Congress to offer more generous tax treatment for local government bonds used to refinance mortgages.
"We are proposing to allow state and local governments to temporarily broaden their tax-exempt bond programs to include mortgage refinancing," he said. Currently, state tax-exempt bonds are limited to programs that aid first-time homeowners.
CALLS FOR MORE
Democratic presidential hopeful Sen. Hillary Clinton has proposed a similar expansion of state housing bonds to include mortgage refinancing.
On Monday, the New York senator said the plan Paulson was pursuing to hold mortgage rates steady should go further and include a 90-day moratorium on home foreclosures to give financially troubled borrowers time to work with lenders and avoid losing their homes.
"The administration and the mortgage industry must reach agreement that matches the scale of the problem," she said in a letter to Paulson.
Financial markets, however, failed to leap on the news, with Wall Street falling on uncertainty over the plan and a report that showed a weakening manufacturing sector. The Dow Jones industrial average closed down 57.15 points at 13,314.57.
"When people see the government getting involved in another program that has good intentions, people tend to get very skeptical," said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.
"Firstly, how is this plan going to be taken advantage of by people who don't have a legitimate call on that help and secondly, when is the government going to step out of their temporary role, if ever?"
Paulson and U.S. regulators have been engaged in talks with mortgage industry executives in an effort to establish criteria that could be used to identify large groups of borrowers who would be unable to bear the cost of higher rates but who could afford to keep up payments if interest rates are frozen.
"An industrywide approach is critical to the effectiveness of this effort," Paulson added.
But some investors said Paulson risks appearing ineffective because the effort to forge a mortgage rescue plan comes of the heels of his involvement in brokering talks with top U.S. banks to form a fund that would bail out structured investment vehicles linked to the subprime mortgage market.
"By launching a second plan, (Paulson) looks like he's thrashing about, trying to put together some deal, and the more plans you launch the less credibility each one has," said Howard Simons, a bond strategist at Bianco Research in Chicago.
Office of Thrift Supervision Director John Reich said banking regulators were largely in agreement on a proposal to modify mortgages for subprime borrowers. "I believe there is general agreement among the regulators," Reich told reporters.
Daniel Mudd, the chief executive of Fannie Mae , the nation's largest source of home finance, told the forum he supported the proposal. In a statement, the nation's second-largest mortgage finance company, Freddie Mac , which like Fannie Mae is chartered by Congress, also said it supported the effort.
In an interview with Bloomberg television, Paulson declined to specify how many homeowners might be helped by the plan and said the plan would by itself not put a floor under the housing market, which has been in a steep decline.
"This is not a silver bullet. This plan, in and of itself, is not going to deal with all of the problems associated with the housing market and bad lending practices," he said.
Paulson repeated his view that the housing downturn would exact a "penalty" on growth but expressed faith the economy would weather the storm. "We have a fundamentally sound, healthy economy and I believe it is going to keep growing," he said.
(Additional reporting by Alister Bull and David Lawder; editing by Leslie Adler)