FDIC's bad loan sale program stalling: sources

By John Poirier and David Lawder

WASHINGTON (Reuters) - A program to cleanse U.S. banks of bad loans has been stalled by recovering markets and fears among investors and banks of being hit by new government rules mid-game, sources familiar with the program said.

A pilot sale of $1 billion worth of whole loans by the Federal Deposit Insurance Corp, a U.S. bank regulator, may not take place next month as planned, the sources said.

However, the Treasury Department is pressing ahead with a parallel program to create public-private investment funds that would buy failed mortgage securities from banks.

A Treasury official said the launch of the Public Private Investment Program (PPIP) was on still track for a launch in late June or early July, but declined to comment on whether the whole loans portion of the effort would be delayed.

The Treasury is now vetting fund management firms which would run an initial five public-private funds.

Treasury Secretary Timothy Geithner made the PPIP a central plank of the U.S. government's rescue of the banking system earlier this year, first sending financial stocks plunging by announcing only a vague outline in February before coming up with details in March that sparked a six-week share rally.

The program aims to provide up to $1 trillion in public funds to entice private investors to buy troubled mortgage loans and securities from banks.

But the prospect of audits, possible compensation limits and changing rules have cooled enthusiasm among fund managers and banks toward the public-private investment programs.