Sen. Chris Dodd (WDCpix)

Voluntary mortgage-reduction programs are insufficient to curb the spreading blight of national foreclosures, the head of the FDIC said Thursday, and the federal government should step in to help folks keep their homes.

The Bush administration and the finance industry have long resisted proposals forcing lenders to modify the terms of mortgage loans. But appearing before a Senate panel, Shiela C. Bair, chairwoman of the Federal Deposit Insurance Corp., said that leaving those renegotiation decisions to the banks has failed to solve the foreclosure crisis.

“Some of the voluntary efforts have helped,” she said during testimony before the Senate Banking Committee, “but they have clearly not helped enough.”

Illustration by: Matt Mahurin

Asked by Sen. Charles Schumer (D-N.Y.) if there is “any hope for a voluntary model” of mortgage write-downs, Bair responded without hesitation. “No,” she said. “There needs to be a package of carrot-and-stick incentives.”

Supported by housing advocates, congressional Democrats have long pushed for new rules allowing bankruptcy judges to force lenders to renegotiate the terms of primary mortgages — a power those judges currently have to alter loans for second residences, like vacation homes, and virtually all other types of debt. Bair said the FDIC has not taken a position on the bankruptcy proposal, but Washington must do something to protect homeowners and bring stability to the sinking housing market.

Sen. Christopher Dodd (D-Conn.), chairman of the Banking Committee, said during the hearing that he will take another shot at passing such reforms, perhaps as early as next month.

Under the $700-billion financial bailout bill enacted Oct. 3, the Treasury Dept. must craft a plan to prevent foreclosures. The legislation also authorizes — but does not require — the agency to encourage mortgage modifications through federal loan guarantees and credit enhancements.

FDIC Chairwoman Sheila Bair (FDIC.gov)

Bair recommended that the Treasury take advantage of that optional authority. “The government could establish standards for loan modifications and provide guarantees for loans meeting those standards,” she said. “By doing so, unaffordable loans could be converted into loans that are sustainable over the long term.” She said the FDIC is working closely with the Treasury Dept. to craft such a plan.

Neel Kashkari, the Treasury Dept.’s Interim Assistant Secretary for Financial Stability, would not immediately endorse the strategy, saying only that the agency is exploring those options. The administration’s plan, Kashkari added, will be unveiled within “a few weeks.”

The comments arrive as the focus of Washington’s financial rescue strategy shifts from a massive bailout of the finance industry to the rising tide of struggling homeowners. Lawmakers and Bush administration officials have, in recent months, committed $30 billion to catalyze the takeover of Bear Stearns; fronted more than $120 billion to take over American International Group; pledged $200 billion to prop up Fannie Mae and Freddie Mac; and enacted a $700-billion bailout of Wall Street designed to thaw out frozen credit markets. But they have as yet done little to help homeowners facing foreclosures.

Those industry-focused actions, many experts agree, were necessary to buoy the sinking financial system. But without addressing the underlying issue of foreclosures, many contend, the troubles will only fester. Dodd said that Washington’s efforts up to now “have largely addressed the symptoms of the credit crisis rather than its cause.”

“The longer we allow foreclosures to erode family wealth, neighborhood stability and financial market liquidity,” Dodd said, “the longer our economy will take to recover from this crisis.”

In that diagnosis Dodd has significant support from across the aisle. Sen. Richard Shelby (Ala.), the highest-ranking Republican on the Banking Committee, agreed that lawmakers need to turn their attention to the housing crisis.

“Unless we do something, or can do something, to address the underlying fundamentals of dealing with the mortgage foreclosures in real estate,” Shelby said, “we’re going to be wasting, perhaps, a lot of money.”

Dodd said he hopes to push mortgage-modification reforms as early as mid-November, when the Senate is slated to return to Washington for a lame-duck session. “We’ve come to the point, once again, where I think legislatively, we have to try this,” he said.

The Democrats will likely have a tough road ahead. Many Republicans, already frustrated after being forced to swallow the Wall Street bailout, have a long history of opposing direct federal intervention in mortgage negotiations. They argue that such efforts — aside from encroaching on free markets — would hike mortgage rates for everyone.

Then there’s the financial-services industry. Though Democrats are widely expected to pick up seats in both the House and the Senate in November, the powerful finance lobby has, historically, held remarkable sway over legislative decisions. Indeed, no other business sector donates more to Congress. In the current election cycle alone, the finance, real estate and insurance industries have given $373 million to federal candidates and political parties, according to the Center for Responsive Politics, a campaign-finance watchdog group.

Congressional inaction, however, might not be an option. Foreclosure filings for the third quarter of 2008 totaled nearly 766,000 — a 3-percent increase over the quarter before, and a 71-percent jump over the 2007 figure, according to Realty Trac, an online foreclosure database.

Some lawmakers maintained that banks are doing too little to keep those numbers down, and in some cases are exacerbating the problem. Sen. Robert Menendez (D-N.J.) relayed the tale of a New Jersey homeowner facing foreclosure on a $175,000 home. With the help of a community group, the homeowner offered $160,000 to the lender, who turned down the offer. When the community group went to the foreclosure sale to pay the full $175,000, Menendez said, the bank bid the price up $5,000 higher.

“We can no longer sit back and hope that lenders do the right thing,” Menendez said.

The foreclosure mess has rippled through the rest of the economy. Lack of investor confidence has sent stock markets fluctuating wildly. Consumers, without access to home equity, are spending much less on retail goods. On Wednesday, Wachovia announced a $23.9 billion third-quarter loss — the largest bank loss since the financial meltdown began. And Thursday, as Kashkari, a former Goldman Sachs vice president, was testifying before the Senate panel, Goldman announced that it will slash 10 percent of its workforce.

Foreclosures were not the only topic of contention during Thursday’s hearing. Many lawmakers are also concerned about how the Treasury Dept. plans to ensure that those banks getting help under the bailout package actually lend the cash, rather than just hoarding it.

“Why,” Shelby asked, “did Treasury not attach a requirement to increase lending as a price for receiving the government money?”

Kashkari, charged with implementing the rescue plan, replied that the department “didn’t want to be in a position of micromanaging our banks.” He argued that certain contractual prohibitions — like one preventing participating banks from hiking dividend payments to shareholders — would nudge the institutions in the direction of lending.

There were other suggestions. Schumer urged Kashkari to adopt non-binding guidelines to steer the process. Among these guidelines, Schumer said, the agency should set lending goals for participating banks to prevent hoarding; push for stricter limits on executive compensation; adopt a streamlined approach for loan modifications to prevent foreclosures, and discourage banks from making the same risky investments that led to the crisis.

“We aren’t investing in these institutions,” Schumer said, “just to see the financial wizards go back to playing their high-stakes game.”

Without committing to guidelines, Kashkari said the administration hopes to have $250 billion “out the door” and to the banks by year’s end. Only time will tell how effectively the 35-year-old manages that spending — which represents a high-stakes game all its own.

Bush went first, explaining to the American people that Washington will invest $250 billion in the nation’s banks. The Treasury Dept. will take equity stakes in banks, which have been pressed into accepting partial nationalization in return for an investment of taxpayer money. The FDIC is set to talk about launching an insurance fund to guarantee new issues of bank debt.

Bush defended the move, saying it’s not an abandonment of the free market.

Angry Bear puts it this way:

I’ve always wanted to have my very own bank…

The Big Picture has a rundown of which banks will get the money – and how much they’ll get. And a little commentary on the fact that, as unthinkable as partially nationalizing banks may seem, it should have happened far sooner:

But some people are going to come out of this mess just fine, The New York Times says. And guess who that might be?

Departing chief executives Daniel Mudd at Fannie Mae and Freddie Mac’s Richard Syron could leave with lucrative pay packages totaling milions of dollars. All this despite the fact that the companies they headed failed so spectacularly the government had to step in.

From The Times:

Under the terms of his employment contract, Daniel H. Mudd, the departing head of Fannie Mae, stands to collect $9.3 million in severance pay, retirement benefits and deferred compensation, provided his dismissal is deemed to be “without cause,” according to an analysis by the consulting firm James F. Reda & Associates. Mr. Mudd has already taken home $12.4 million in cash compensation and stock option gains since becoming chief executive in 2004, according to an analysis by Equilar, an executive pay research firm.

Richard F. Syron, the departing chief executive of Freddie Mac, could receive an exit package of at least $14.1 million, largely because of a clause added to his employment contract in mid-July as his company’s troubles deepened. He has taken home $17.1 million in pay and stock option gains since becoming chief executive in 2003.

It’s nice to know that Syron, in the midst of a meltdown of his company that threatened the stability of the housing market and of the U.S. economy itself, took the time to redo his contract to ensure he would be enriched should Freddie Mac fail. It’s so inspring to have someone at the top looking out solely for himself while mortgage rates were going up and millions of Americans faced losing their homes.

That little tactic, in and of itself, should give the government more cause to step in and say: No way. We own the place now – and we no longer have to put up big salaries for no-talent executives to enjoy cushy retirements while everyone else pays for their mistakes.

Here’s hoping the government makes an example of these two — and quickly — before top executives at all those failing banks get the same idea and start rewriting their own employment contracts.