The Federal Housing Administration is prepared to underwrite loans that have sunk in value if the lender will first erase a share of the existing loan, according to the prepared remarks of Brian Montgomery, the FHA director.

Democratic lawmakers have called for the FHA to be expanded so that it can underwrite a large share of failing loans but Montgomery does not go that far, according to a draft of his remarks obtained by Reuters.

“I really want to stress this last point … the financial solvency of the fund must not be compromised,” Montgomery says in the remarks, emphasizing that the fund has always been self-funding and should not take on undue risk or be fundamentally altered.

Montgomery is due to testify on Wednesday before the House Financial Services Committee, which is considering legislation that would open the door to troubled borrowers if the original lender agrees to erase at least 15% of the original loan amount.

Washington policymakers have faced increasing pressure to help staunch increasing foreclosures that are threatening to drive the US economy into a deep recession.

During the recent housing boom, many marginal borrowers turned to the easy terms and lax underwriting of subprime loans. As home prices began to decline, many of those loans failed, hurting borrowers and the Wall Street firms that made big bets on those investments.

The Federal Housing Administration is a Depression-era program that underwrites a borrower’s monthly mortgage payments and so helps him win more favorable loan terms. The program was conceived to help low-income borrowers but policymakers have lately seen its potential to get today’s troubled borrowers out of sinking loans.

While the Bush administration has been willing to loosen FHA underwriting standards, it has resisted calls to transform the government enterprise into a massive federal backstop for troubled loans.

While Democratic committee chairman Rep. Barney Frank has called for a cash infusion to transform the FHA, Montgomery resisted that suggestion and said that the program should stay intact.

Sen. Christopher Dodd, chairman of the Senate Banking Committee, has his own plan to expand FHA and the Connecticut Democrat has planned a hearing on the issue on Thursday. (Reuters)