Jan. 23 (Bloomberg) -- Senate Banking Committee Chairman Christopher Dodd proposed creating a federal program to buy ``very distressed'' mortgages at steep discounts as part of economic stimulus legislation being developed in Congress.

The Federal Homeownership Preservation Corp. would buy loans and finance them as 30-year fixed-rate mortgages to help keep borrowers from losing their homes, Dodd said today at a Washington news conference to outline the committee's agenda.

The approach ``would allow us to deal with this foreclosure matter in a very creative way,'' said Dodd, a Connecticut Democrat who ended his bid for the party's presidential nomination this month.

Dodd's proposal, modeled on the Depression-era Home Owners' Loan Corp., came as Democrats unveiled several proposals reminiscent of 1930s-style economic-stimulus programs. Senate Majority Leader Harry Reid of Nevada said today Congress should work on a long-term plan that would pay to build roads, utilities, schools and housing.

Dodd outlined his proposal in a letter to Reid yesterday. The program would ensure lenders and investors ``take a haircut'' and are not being bailed out, Dodd said in the letter.

`Steep Discounts'

The proposed corporation would buy outstanding mortgages at ``steep discounts'' and convert them into loans insured by the Federal Housing Administration or backed by government-sponsored enterprises, he wrote to Reid. Dodd proposed $10 billion to $20 billion to fund the program.

Dodd's idea stemmed from a research paper released last month by the American Enterprise Institute, a Washington-based group that favors limited government.

The program should be temporary, lasting three years, said Alex Pollock, an AEI fellow who wrote the paper.

``You don't want to create a permanent distortion in the market,'' Pollock said in a telephone interview. ``But you do want to create a temporary means of breaking the self- reinforcing downward cycle of falling house prices, constricted credit and increasing supply of houses dumped on the market through foreclosure.''

Instead of creating a new program, the government should offer tax breaks to buyers of distressed real estate, said David Castillo, who trades asset-backed, commercial-mortgage and collaterized debt obligation bonds at Further Lane Securities in San Francisco.

``This seems crazy to me to form another government (taxpayer) corporation to bail out Americans' poor decision making in assuming obligations that they could never have possibly met,'' Castillo wrote in an e-mail.

Fannie, Freddie

The stimulus package should also let Fannie Mae and Freddie Mac, the largest funders of U.S. home loans, temporarily buy mortgages exceeding a $417,000 federal limit, Dodd said. Such a step, if ``consistent with safety and soundness'' at the government-chartered companies, would help ``restore housing markets around the country,'' Dodd wrote to Reid.

U.S. Treasury Secretary Henry Paulson has said an increase of the loan limit for Fannie Mae and Freddie Mac should only accompany creation of a tougher regulator for the government- chartered companies. The Bush administration has sought since 2003 to persuade Congress to pass such oversight legislation.

Loan Modifications

Dodd plans hearings on mortgage-related issues in the coming weeks. The first will focus on ways to reduce foreclosures; another will probe lenders' efforts to modify loans for borrowers facing foreclosure.

``The numbers are way too low, in my view, of these workouts,'' Dodd said. ``I'm not happy about those results, and I want to know why we haven't done better.''

The nine largest mortgage servicers modified loans or set up repayment plans for 370,000 subprime borrowers in the second half of last year, according to a report last week by Hope Now, a Washington-based coalition of banks and mortgage companies.

Americans behind on mortgage payments in the third quarter reached the highest level in 21 years, the Washington-based Mortgage Bankers Association said last month. Foreclosures hit a record.

Dodd said he will also hold hearings on legislation to crack down on predatory mortgage lending and move the measure through the Senate ``at the earliest opportunity.''

The senator said he also will introduce legislation on credit-card practices. His panel will explore other issues including hedge-fund regulation, executive compensation and the globalization of securities markets, he added.

He plans to meet with Paulson tomorrow to discuss market volatility and the U.S. economic slowdown.

Dodd's counterpart in the House, Financial Services Committee Chairman Barney Frank, plans to hold a news conference tomorrow to outline his agenda for the year.

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

Last Updated: January 23, 2008 17:44 EST