UPDATE 3-Toxic assets still threaten banks -US bailout panel

(Adds Warren comments from conference call, background)

By David Lawder and Kevin Drawbaugh

WASHINGTON, Aug 11 (Reuters) - Toxic assets on the books of banks still threaten the financial system, 10 months after the government targeted hundreds of billions of dollars to attack the problem, Congress' bailout watchdog said on Tuesday.

Smaller banks, in particular, face mounting losses on commercial real estate loans and their issues need to be addressed, said the Congressional Oversight Panel for the Troubled Asset Relief Program (TARP) in a monthly report.

By focusing its efforts narrowly on toxic, securitized mortgage loans held by big banks, TARP is neglecting smaller, second-tier banks with large portfolios of troubled whole mortgage loans, said panel chairman Elizabeth Warren.

"There are some significant worries about the banks that are just below 'big,'" Warren said on a conference call.

Despite the $700 billion devoted to TARP, little progress has been made in addressing toxic assets, she said, other than a relaxation of mark-to-market accounting rules that has allowed banks to mask the assets' true values for now.

"That may make their paperwork look better, but it doesn't change the underlying reality. ... Toxic assets posed a very real threat to our economy 10 months ago and they have not yet been resolved," Warren told reporters on the call.

The panel's report came as the White House sent a draft bill to Congress on Tuesday proposing new rules for over-the-counter derivatives in a broad crackdown on financial markets of the sort that created and sold toxic assets.

The Obama administration and congressional Democrats are also seeking changes in how mortgages and other loans are securitized, or bundled and sold by brokerages to investors.

NO FIRM ESTIMATE

Over-aggressive issuance and securitization of subprime mortgages is widely seen as a key cause of the financial crisis of 2008-2009, the worst in generations. Even today, no firm estimate is available of the value of toxic assets created during the real estate bubble before the crisis, Warren said.

"No one has a good handle how much is out there," said Warren, a Harvard Law School professor. "Here we are 10 months into this crisis ... and we can't tell you what the dollar value is."

Estimates of the total write-downs banks could face on the assets range widely from $600 billion to $1.2 trillion.

The panel said Treasury needs either to assure a robust program is available for handling toxic assets as they default, or consider another way to restart markets for the assets.

The report came as the Treasury prepares to launch a scaled-down version of its toxic asset program -- a series of public-private investment funds to purchase toxic mortgage securities with $30 billion in government subsidies.