Fed's Kohn says use bailout for homeowners and banks

WASHINGTON (Reuters) - The Federal Reserve's No. 2 official said on Tuesday the second half of the government's $700 billion financial bailout fund was "essential" to restore credit flows and he backed the idea of using money to reduce foreclosures and further bolster banks.

"Preventable foreclosures harm not only the affected borrowers and their communities but also, through their effects on the housing market, the broader economy and the financial system as well," Fed Vice Chairman Donald Kohn said in testimony prepared for delivery to a U.S. House of Representatives Committee.

Kohn said additional funding could help expand the size or scope of a Fed program aimed at supporting consumer credit, the Term Asset-Backed Securities Loan Facility. The program, if it works, could provide financing for commercial mortgage-backed securities, he said.

The Fed official said the bulk of remaining government bailout funds would likely be used to strengthen financial institutions, possibly through more capital injections.

Echoing comments made earlier in the day by Fed Chairman Ben Bernanke, Kohn said troubled assets continue to clog financial institutions' balance sheets and inhibit investment and lending. The Treasury Department should consider measures that could include buying such assets directly or establishing banks that would buy the assets, he said.

(Reporting by Mark Felsenthal; Editing by Andrea Ricci)