Sheila Bair, chairman of the Federal Deposit Insurance Corp., said the plan "falls short of what is needed to achieve wide-scale modifications of distressed mortgages."
With the government spending billions to aid distressed banks, "we must also devote some of that money to fixing the front-end problem: too many unaffordable home loans," Bair said in a statement.
Democrats on Capitol Hill aren't satisfied, either. "When the loan is chopped up into a million pieces and any investor can block a modification from happening, a program like this will only scratch the surface of the mortgage crisis," said Sen. Charles Schumer, D-N.Y.
The economic crisis is still unnerving Wall Street. Stocks fell again as investors found few industries safe from the consumer spending slump. With Starbucks Corp. and luxury homebuilder Toll Brothers Inc. both posting disappointing quarterly results, the Dow Jones industrial average closed down nearly 180 points.
The financial crisis took on a new dimension on Capitol Hill. House Speaker Nancy Pelosi called for "emergency and limited financial assistance" for the battered auto industry and urged the outgoing Bush administration to join lawmakers in reaching a quick compromise during a postelection session of Congress.
The new mortgage assistance plan was announced by the Federal Housing Finance Agency, which seized control of Fannie and Freddie in September, and other government and industry officials.
Officials say they hope the new approach, which takes effect Dec. 15, will become a model for loan servicing companies that collect mortgage payments and distribute them to investors. These companies have been roundly criticized for being slow to respond to a surge in defaults.
James Lockhart, director of the housing finance agency, urged investors to "rapidly adopt this program as the industry standard."
Still, government officials had no estimate of how many homeowners would be able to qualify. Fannie and Freddie own or guarantee nearly 31 million U.S. mortgages, or nearly six of every 10 outstanding. But they have far lower overall delinquency rates - under 2 percent.
To qualify, borrowers would have to be at least three months behind on their home loans and would have to owe 90 percent or more than the home is worth. Investors who do not occupy their homes would be excluded, as would borrowers who have filed for bankruptcy.
Qualified borrowers would get help in several ways: The interest rate would be reduced so that they would not pay more than 38 percent of their gross income on housing expenses. Another option is for loans to be extended to 40 years from 30, and for some of the principal to be deferred, interest-free.
Though lenders have beefed up their efforts to aid borrowers over the past year, their action hasn't kept up with the worst housing recession in decades.
More than 4 million American homeowners, or 9 percent of borrowers with a mortgage, were either behind on their payments or in foreclosure at the end of June, according to the most recent data from the Mortgage Bankers Association.
Indeed, Tuesday's announcement comes too late for Troy Courtney, a 44-year-old San Francisco police officer.
He moved out of his home in Mill Valley, Calif., earlier this month - taking his children, three dogs and one cat with him - after failing at several attempts to get a loan modification or a short sale. A short sale occurs when the lender agrees to receive less than the loan is worth.
Courtney worked overtime and tapped into his retirement account to try to catch up with two loans on his home. But in the end, he couldn't persuade Countrywide Financial, which managed the loan for Wells Fargo, to modify the loan.
"I feel like I missed the boat," he said of the new efforts to help more homeowners. "I'm just mad at the whole system."
One reason the problem has been so tough to solve for borrowers such as Courtney is that the vast majority of troubled loans were packaged into complex investments that have proved extremely hard to unwind.
Deutsche Bank estimates more than 80 percent of the $1.8 trillion in outstanding troubled loans have been packaged and sold in slices to investors worldwide. Most of those loans won't likely be helped by the new plan.
The rest are "whole loans," which are easier to modify because they have only one owner.
Still, after more than a year of slow and weak initiatives, there seems to be a serious effort among major retail banks to get at the heart of the credit crisis: falling U.S. home prices and record foreclosures.
Citigroup said Monday it is halting foreclosures for borrowers who live in their own homes, have decent incomes and stand a good chance of making lowered mortgage payments.
JPMorgan Chase & Co. last month expanded its mortgage modification program to an estimated $70 billion in loans, which could aid as many as 400,000 customers. The bank already has modified about $40 billion in mortgages, helping 250,000 customers since early 2007.
Starting Dec. 1, Bank of America Corp. plans to modify an estimated 400,000 loans held by newly acquired Countrywide Financial Corp. as part of an $8.4 billion legal settlement reached with 11 states in early October.
Associated Press Writers David Espo and Sara Lepro contributed to this report.