The Obama administration wants Fannie Mae and Freddie Mac, which finance the bulk of U.S. mortgages, to start reducing loan balances for troubled borrowers, but with safeguards to prevent them from purposely defaulting to obtain relief.

Housing and Urban Development Secretary Shaun Donovan laid out the case for a program with such checks and balances to convince the Federal Housing Finance Agency, which regulates the companies, to provide more mortgage aid.

This isn't about force; this is about making the right decision for homeowners and for the taxpayers, Donovan said in an interview taped for C-SPAN's public affairs television that was set to air on Sunday.

The FHFA is evaluating whether financial incentives offered by the White House would be enough to cover the cost of Fannie Mae and Freddie Mac writing down mortgage debt. The agency said it may complete the analysis by mid-April.

We believe that with the changes that we've made over the past couple months that the case is compelling, he said.

Democrats have mounted pressure on the FHFA to use government resources to subsidize the cost of mortgage loan forgiveness. The agency has been criticized by consumer advocates for focusing too much on limiting taxpayers' liability for the housing bailout instead of making more targeted efforts to help borrowers.

FHFA Acting Director Edward DeMarco has blocked Fannie Mae and Freddie Mac from reducing principal amounts owed on mortgages, saying that would drive up the cost of a taxpayer bailout of the two government-run firms, which has topped $150 billion. Fannie and Freddie, the two largest sources of housing money, were taken over by the government more than three years ago as mortgage losses mounted.

By using increased financial incentives, the administration has made it harder for the FHFA to dismiss concerns that allowing Fannie Mae and Freddie Mac to reduce homeowners' loan debt is too costly.

About 11 million U.S. homeowners are underwater - meaning they owe more on their mortgage than their home is worth - and home values have dropped more than 30 percent since the housing bubble began to burst in 2006.

Those opposed to mortgage write-downs also argue that forgiveness would encourage defaults among borrowers who have kept making payments on mortgages that exceed the values of their homes. About three out of every four underwater borrowers with mortgages that Fannie Mae or Freddie Mac back are current on their payments.

This is a reasonable concern in certain circumstances but there are ways to be careful and design around it in order to ensure that it won't be a real issue, Donovan said.

The HUD secretary said the regulator should design a loan forgiveness program that limits any moral hazard of encouraging bad borrowing behavior and the risk that some homeowners might stop making timely payments with an incentive for aid.

We shouldn't punish the vast majority of folks where strategic default isn't really a risk just to fix what may be a risk with a small percentage (of borrowers), Donovan said.

Asked how the administration might respond if the FHFA decides to turn down those incentive payments and avoid creating a program focused on mortgage forgiveness, Donovan did not offer any insight.

The White House cannot pre-judge what we might do if he comes back with a different answer, he said. We'll have to look at that analysis and understand what his concerns are.

(Reporting by Margaret Chadbourn; Editing by Richard Chang)

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