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WASHINGTON (Reuters) - The top housing regulator rebuffed a plan by the Obama administration to cut mortgages held by struggling homeowners, a blow to the White House, which is keen to show voters it can help fix the housing market.
The regulator for government-run housing finance giants Fannie Mae and Freddie Mac said on Tuesday that using taxpayer-funded bank bailout money could encourage defaults and not make a big improvement in reducing foreclosures in a cost-effective way for taxpayers.
"The anticipated benefits do not outweigh the costs and risks," said the Federal Housing Finance Agency's head Edward DeMarco, who has come under intense pressure from the government to agree to the plan.
The regulator's decision drew an immediate rebuke from the Obama administration and Democratic lawmakers. Treasury Secretary Timothy Geithner disputed the agency's conclusions and urged DeMarco to reconsider his decision.
The housing market started deteriorating in 2006 and wiped out trillions of dollars in equity. Although the market has shown signs of recovery, about 11 million homeowners owe more than their properties are worth and the Obama administration has struggled with various taxpayer-funded programs to keep people in their homes.
"I do not believe it is the best decision for the country," Geithner told DeMarco in a letter released to the media.
The use of targeted principal reduction would "provide much needed help to a significant number of troubled homeowners, help repair the nation's housing market and result in a net benefit to taxpayers," Geithner said.
Despite several plans to tackle the country's housing problems, most of which is focused on giving homeowners the opportunity to refinance at lower interest rates, the administration has yet to come up with a plan to stabilize the market.
Obama, a Democrat, is trying to convince voters ahead of the November presidential election that his policies have helped the economy recover from dire days of the financial crisis and ensuing recession. His Republican challenger, Mitt Romney, has said the foreclosure process should be allowed to run its course and hit the bottom.
Geithner pointed out that DeMarco's own data showed that the program would help nearly half a million homeowners and save taxpayers as much as $1 billion.
The housing regulator responded saying that figure only applied to a group of homeowners that had not made a mortgage payment in a year and would assume all those borrowers would win a mortgage write-down -- a scenario deemed unlikely.
Rather, DeMarco's analysis showed that the projected net benefit to taxpayers would be $500 million in the best case scenario and its experience has shown that the likelihood of successfully modifying mortgages was small.
The administration has pressed DeMarco to allow Fannie and Freddie to do more principal writedowns. But DeMarco has maintained that this would needlessly drive up the costs of their taxpayer bailout.
Fannie and Freddie, which have received $190 billion in rescue funds to stay afloat, were seized by the government in 2008 amid threats of insolvency due to losses on subprime loans.
Although the regulator found that using the taxpayer bailout funds could result in about 74,000 to 248,000 borrowers being eligible for the mortgage reductions, it said "nearly all of this benefit is simply a transfer from taxpayers" and would rack up the tab for the public.
Implementing the program "would actually increase taxpayer costs," said DeMarco.
After spending six months studying whether to use the taxpayer funds, DeMarco's agency concluded that the program would not only be costly and time-consuming to implement but could also send the wrong message to troubled borrowers who might choose to default to win a mortgage reduction.
The Obama administration wants to use money from the $700 billion Troubled Asset Relief Program to pay Fannie and Freddie as much as 63 cents for every dollar of mortgage debt they forgive.
Democratic lawmakers blasted the FHFA's decision.
"It is incomprehensible that Mr. DeMarco would reject the chance to save up to a billion dollars in taxpayer funds while helping nearly half a million homeowners stay in their homes," said Representative Elijah Cummings.
Senator Robert Menendez called DeMarco's decision "terrible" and said it underscores the regulator's intransigence when it comes to debt forgiveness for homeowners even as his own analysis shows the benefit to taxpayers.
The Washington Research Group viewed the decision as positive for banks, mortgage insurers and home builders as it removed the threat of a new wave of strategic defaults.
In a letter to lawmakers, DeMarco justified his actions and said borrowers could already obtain relief through programs already in place. The regulator also streamlined its refinancing program and removed certain loan requirements.
It plans to issue new standards in September for the representations and warranties that banks make to Fannie Mae and Freddie Mac about their loans.
Additional reporting by Margaret Chadbourn and Rick Rothaker Editing by Andrea Ricci, Andrew Hay and M.D. Golan