(Adds details, comments from investor, Geithner, Donovan)
By Patrick Rucker and David Lawder
WASHINGTON, April 21 (Reuters) - The U.S. Treasury Department is considering giving banks and investors billions of dollars in fresh incentives to modify troubled mortgages and save homeowners from foreclosure, sources familiar with official deliberations said.
Under one scenario, investors in second liens would receive a cash payment if they agree to ease the terms of troubled loans and accept a smaller return on their mortgage investment, the sources said.
During the height of the housing boom, some borrowers were able to buy a home with no downpayment by adding a second lien and many of those loans are now failing as the economy and housing market struggle.
Some on Wall Street will likely be angry if Washington doles out money to investors who hold the high-risk end of a home loan.
"Second-lien holders should get zero," said Bill Frey, president of Greenwich Financial Services in Greenwich, Connecticut. "Why should a second lien holder get anything if the first lien holder takes a loss? That's not the way the contracts work, that's not the way privatization works, that's not the way America works."
Officials also envision giving fresh subsidies to encourage 'short sales' in which the lender accepts a payment that does not cover the entire loan amount, according to the sources, who requested anonymity because they are not authorized to disclose details.
Fannie Mae and Freddie Mac, the mortgage finance companies, would administer the new program to resolve problems with second-liens under one plan being considered, they said.
A senior administration official declined to comment on Tuesday, but said the Treasury expected to unveil further details of its homeowner-aid program "soon."
The official said the Treasury Department is also considering ways it could resolve problems in the mortgage insurance industry battered by mounting foreclosure losses.
"We are aware of the difficulties in the industry and we are analyzing different options to deal with" those difficulties, the official said.
In February, President Barack Obama outlined a housing rescue plan that he said could move as many as 9 million homeowners into more-affordable loans by both refinancing and modifying their current mortgage.
Homeowners normally must settle all of a home's debts when they refinance a mortgage but a modified loan may hold the second lien in place.
A bulk of the Obama housing rescue plan involves modifying loans but officials have decided that they will try to ease those second lien payments in order to ease the costs of homeownership, the official said.
"Their debt overhang will be brought down," the official said. "We will have that program shortly."
In testimony before a congressional bailout oversight panel on Tuesday, U.S. Treasury Secretary Timothy Geithner said the Treasury was working on additional measures to keep struggling borrowers in their homes or provide them with "less damaging 'exit strategies' from homes they are clearly unable to afford, even under favorable mortgage terms."
He said these measures include a second lien program and further details on a short-sale and deeds-in-lieu program, as well as reforming bankruptcy codes to allow judges to reduce mortgage debt.
Shaun Donovan, the Secretary for Housing and Urban Development, told reporters on Tuesday that he could envision the government making payments to encourage mortgage investors to ease the burden of second-liens.
"That's a possibility," he said, when asked about government incentives to modify second liens. (Reporting by Patrick Rucker and David Lawder in Washington with Al Yoon in Chicago;)