NEW YORK (CNNMoney.com) -- The federal government, which has been criticized for not doing enough for Main Street while coming to the immediate aid of banks, is working on a new plan to help troubled homeowners.
The plan was discussed Thursday at a Senate Banking Committee hearing that probed the federal response to the credit crisis.
Lawmakers repeatedly urged Treasury to act with dispatch and draw up clear guidelines to ensure that banks that receive taxpayer funding begin lending again and do all they can to prevent foreclosures.
Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., told the Senate Banking Committee that her agency and the Treasury Department are working closely to find ways to prevent avoidable foreclosures. The plan would use the Treasury Secretary's new authority under the Emergency Economic Stabilization Act to provide guarantees to lenders and companies that service mortgages.
"Loan guarantees could be used as an incentive for servicers to modify loans," Bair said. "Specifically the government could establish standards for loan modifications and provide guarantees for loans meeting those standards."
That way, she said, "unaffordable loans could be converted into loans that are sustainable over the long term."
Bair said one way loan guarantees can be used to prod loan servicers to modify more mortgages is for Uncle Sam to guarantee that the government would compensate servicers for losses in cases of re-default - that is, when a borrower receives a modified loan but then ends up becoming delinquent on the new mortgage.
Re-defaults have been a concern for loan servicers, who must make the case to investors that a modification is a better deal for them than a foreclosure.
The risk of re-default "is one area where greater certainty could be provided," Bair said, noting that it could make the option of modifying a loan "irresistible" to a servicer.
Bair is taking the lead in shaping the government's next step on preventing foreclosures, but the Treasury is charged with creating such a program. Bair said Treasury is doing its due diligence and "is moving in a timely way."
Neel Kashkari, the Treasury's interim assistant secretary for financial stability, told lawmakers Thursday that "we are looking at [the loan guarantee idea] very closely. It's something we're seriously considering."
Loan guarantees as incentive for servicers to modify loans? . . . even greater inducement for mortgage servicing fraud! "Hey servicers, it's guaranteed so let's just keep piling on our bogus fees and ratchet up servicing fraud a notch! because NOW we've got nothing to lose and EVERYTHING TO GAIN !"