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The FBI and Department of Homeland Security issued a warning yesterday to state and local officials about "uncorroborated but plausible information" received in late September that al-Qaeda might have discussed targeting New York City transit systems, DHS and New York police spokespeople said.

The Federal Deposit Insurance Corp. and the Treasury Dept. are working on a major program to prevent widespread foreclosures that would include government guarantees of home mortgages.

The plan would use $50 billion from the recently passed bailout package to provide as much as $500 billion to $600 billion in government guarantees on up to 3 million at-risk mortgages. It might require banks and savings and loans to offer loans with lower interest rates for a five-year period, while shifting to the government any risk if the home doesn't recover its full mortgage value within that time.

Without giving details, FDIC Chairman Sheila Bair discussed the program on Oct. 29 at an international deposit insurers' conference in Arlington, Va. She said the agency has developed "a federal program to help more borrowers avoid foreclosure.…Such a framework is needed to modify loans on a scale large enough to have a major impact."

Bair said discussions are ongoing with the Treasury Dept., according to wire reports. The proposal could be out as soon as Oct. 30, says a lobbyist familiar with both elements of the plan and negotiations. However, a Treasury Dept. spokeswoman denied that a proposal is ready. "That is simply inaccurate," said Treasury spokeswoman Jennifer Zuccarelli. "We are looking at a number of proposals on foreclosure prevention, but no one proposal has been decided upon." Details of the plan the FDIC is pushing could change as Treasury—which has authority to administer most facets of the banking bailout—evaluates it. The lobbyist said there may yet prove to be friction with the White House over the plan, as well.

Not Enough?

A mandatory mortgage-relief program would be the government's boldest move on behalf of homeowners since the subprime crisis began picking up steam last year. Bair made a similar proposal six months ago, but it was dismissed without much discussion. Until now, a Bush Administration plan that was voluntary for banks has failed to spur enough loan modifications and prevent foreclosures.

Still, critics say that the five-year loan modification program could be putting off the inevitable for borrowers, and that the $50 billion committed to backing it up may not be enough to put a serious dent in the wave of foreclosures.

According to the lobbyist, the program would require banks, savings and loans, investment funds, hedge funds, and other holders of mortgages to restructure the loans based on a homeowner's ability to pay lower monthly mortgage payments. The government would guarantee a second loan on the home, so banks and other lenders would not lose any money in a mortgage modification. The homeowner would get lower payments for the five years. And if the homeowner defaulted and went into foreclosure anyway, the government would have to make good to whoever had issued the loan.

Protesters in Philadelphia call for more action on the subprime crisis Adam Nadel/Polaris

The financial system, perhaps, has been saved. Now, what about homeowners?

So far, attempts to slow the foreclosure epidemic at the center of the crisis have had little impact. Despite "voluntary" industrywide efforts to rework troubled mortgages—efforts that Treasury Secretary Henry Paulson jawboned banks and mortgage servicers into undertaking last fall—the numbers continue to soar. In 2008 some 1.69 million homeowners will lose their houses—double the rate of two years ago, says Rod Dubitsky, managing director for asset-backed securities at Credit Suisse (CS). He thinks 3.6 million more foreclosures could pile up through 2012.

Both Presidential candidates now want the federal government to take a more active role in buying up troubled mortgages and helping homeowners refinance with more affordable loans. Congress has also insisted the Treasury do more. But many of the proposals, which are based on the Depression-era Home Owners' Loan Corp., are likely to run into the same legal woes that have stymied mortgage workouts so far. The government may have to find a more extreme legal solution to get mass workouts going.

The reason: No one has figured out how to untie the Gordian knot created by the mass securitization of mortgage loans. Hundreds of investors may own an interest in the trust that holds any given mortgage. If a loan is reworked, some of those investors would lose more than others. In many cases, mortgage servicers are prohibited from modifying a pool of loans without the consent of two-thirds of the investors; often, the servicers also earn more in foreclosure than in reworking a loan. "The servicer or the lender needs more flexibility to reach a rational economic decision," says John L. Douglas, chair of the banking and financial institutions group at law firm Paul, Hastings, Janofsky & Walker.

What might that mean? Douglas thinks servicers need protection from investor lawsuits. But others say the government may have to nullify or supersede some of their obligations or investors' rights. To give securities holders more incentive to loosen the trust rules that govern them, Georgetown University Law Center associate professor Adam Levitin argues that Congress could reduce the favorable tax status for trusts that don't go along. Or, he says, what's known as the Gold Clause could be invoked. Under this New Deal-era legal precedent, the government, citing the need to preserve gold because of the economic emergency, abrogated private contracts that required payment in bullion. Washington could use the Gold Clause to give trusts leeway to modify mortgages.

Those tactics could spark enormous litigation, however. Uncle Sam might also have to reimburse investors for lost value. That's why many argue it would be better for Congress to change the bankruptcy laws. Currently, homeowners who go belly-up cannot renegotiate their mortgages in court. Democrats have tried to alter the law so bankruptcy judges can trim interest or principal. "It gets around the biggest impediment to workouts without costing taxpayers a penny," says Jaret Seiberg, an analyst for the Stanford Group brokerage.

Republicans have blocked the effort, arguing that if courts were granted these new powers, lenders would see their losses soar and pass the cost on through pricier mortgages. But should foreclosures continue to skyrocket—and should Barack Obama, who backs the bankruptcy measure, be elected President—mortgage holders could find themselves on the losing end of the battle.