Oct. 23 (Bloomberg) -- U.S. lawmakers urged the Bush administration to step up aid to struggling homeowners, saying the Treasury's plans to buy stakes in banks won't fix the housing collapse that underlies the financial crisis.

The Bush administration hasn't shown ``the required dedication'' to curb mortgage foreclosures, Senate Banking Committee Chairman Christopher Dodd said at a hearing with policy makers today. Richard Shelby, the panel's top Republican, said that unless the government deals with those fundamentals, ``we're going to be wasting a lot of money.''

Treasury Secretary Henry Paulson is under pressure to spend some of the $700 billion rescue plan enacted this month to help homeowners on the verge of losing their properties, in addition to buying toxic assets and investing in banks. Federal Deposit Insurance Corp. Chairman Sheila Bair said loan guarantees might be a way to influence mortgage servicers to modify their loans.

``We are behind the curve,'' Bair told the panel. ``There has been some progress, but it has not been enough. We need to act quickly and we need to act dramatically.''

Bair said the $700 billion financial-rescue law gives the Treasury authority to set standards for mortgage modifications for participating companies and to offer guarantees for loans that meet those standards.

Carrot, Stick

Bair called for a ``carrot as well as a stick approach'' to push mortgage servicers to rewrite loans, and said the FDIC is prepared to serve as a contractor on the loan guarantees.

``We are looking very hard at'' the proposal to guarantee the loans, Neel Kashkari, the interim Treasury assistant secretary who heads the office overseeing the bailout, said in testimony to the committee.

Paulson acknowledged this week that ``there is clearly more that can be done -- needs to be done'' on housing. He said after an Oct. 21 speech in New York that buying mortgages and related securities will give officials ``more leverage'' to modify loans.

U.S. foreclosure filings increased 71 percent in the third quarter from a year earlier to the highest on record, RealtyTrac, an Irvine, California-based seller of default data, reported today. A total of 765,558 properties got a default notice, were warned of a pending auction or had foreclosure proceedings start.

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

Bank Stakes

The first stage of the Treasury's plan is to inject $250 billion into the banking system by purchasing stakes in financial companies. Kashkari said officials are reviewing more than 100 applications from firms to become asset managers for the government's separate programs to buy home loans and related securities and will make selections ``very soon.''

Today's hearing is one in a series Congress is holding this month to consider ways to alleviate the U.S. financial crisis, restore confidence in the banking system and prevent foreclosures.

Legislators also pushed Kashkari, a 35-year-old former Goldman Sachs Group Inc. banker, to ensure that banks use the new capital to lend, rather than hoard the cash.

``We need more than just begging,'' Dodd said.

Kashkari said the concern about hoarding capital ``worries us'' and the Treasury is ``insisting'' banks put the money to use, through a combination of requirements and recommendations. Banks won't be allowed to divert the new capital into dividends and share buybacks, he said.

Rescue, Dividends

Democratic Senator Charles Schumer of New York, who chairs the congressional Joint Economic Committee, urged the Treasury to tighten guidelines inhibiting banks that get government money from paying dividends. ``There are far better uses of taxpayer dollars,'' he said.

Shelby, an Alabama Republican, questioned why Paulson shifted tack and decided to use the first batch of the $700 billion plan for bank-stake purchases. The Treasury chief originally had asked Congress for authority to buy distressed assets from financial companies.

``Treasury has deviated significantly from its original course,'' Shelby said. ``We need to examine closely the reason for this change and understand how and why'' nine banks were selected for the first $125 billion.

The Treasury last week agreed to purchase stakes with banks including JPMorgan Chase & Co., Morgan Stanley and Citigroup Inc.

`Few Weeks'

Kashkari said ``my expectation is a few weeks'' until the next equity purchases are agreed with banks and savings and loans. Treasury also will proceed ``slowly, methodically'' to purchase the distressed assets, he said.

The White House last week notified Congress that it intended to use the next $100 billion tranche of the $700 billion bailout. That would bring to $350 billion the amount of assets the Treasury can purchase.

While the Treasury has no specific plan to push lenders to merge, Kashkari said that takeovers may be helpful and in some cases it would be a ``good use'' of taxpayer funds to encourage them.

A small, failing bank may not be able to make as many new loans on its own as it would after merging with a larger, healthier bank, Kashkari said. In that example, ``that community is now better served'' after consolidation, he said.

Federal Reserve Governor Elizabeth Duke, Federal Housing Administration Commissioner Brian Montgomery and Federal Housing Finance Agency Director James Lockhart also testified.

Commercial Paper

Senator Bob Corker, a Tennessee Republican, urged the Fed to buy commercial paper rated below the Fed's A1/P1 requirement for a program for backstopping short-term financing, so the central bank can aid manufacturers other than those with top credit ratings.

The program, which starts Oct. 27, is aimed at reviving other parts of the commercial-paper market even though it omits lower-rated paper, Duke told Corker. ``We're aware of a number of different markets where they're having difficulty,'' Duke said. ``We are operating within our own restrictions in terms of credit risk that we can take.''

To contact the reporter on this story: Alison Vekshin in Washington at avekshin@bloomberg.net; Rebecca Christie in Washington at Rchristie4@bloomberg.net.

Last Updated: October 23, 2008 14:26 EDT