U.S. Treasury Secretary Henry Paulson said on Tuesday he was talking with housing finance giants Fannie Mae and Freddie Mac about policy options to ease strains in mortgage markets, including possible legislation that could expand their mortgage investment options.

We're talking to a wide variety of participants in that market, including Fannie Mae and Freddie Mac, and we're thinking through options to reduce the strain in the mortgage market, Paulson told CNBC television in an interview.

He declined to say whether the options include raising the size caps on conforming fixed-rate mortgages the government-sponsored enterprises can buy, but said the prime mortgage market was performing very well.

The problems are occurring in markets for non-conforming jumbo loans and in subprime markets, Paulson said.

In order for GSES to participate in the jumbo market or in the riskier market where loan-to-value is high, this takes legislation, Paulson said.

The Treasury, in addition to its long campaign for GSE reform and a stronger regulator, is looking at a number of options and a number of policy levers to address the issues in those markets, he added.

U.S. Rep. Barney Frank, chairman of the House Financial Services Committee, said last week that the current limit of $417,000 on the size of home loans that can be bought by Fannie and Freddie should be raised. Frank, a Massachusetts Democrat, called on the Senate to raise the limit when it takes up its version of a GSE reform bill in September.

Paulson plans to meet later on Tuesday with Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat who will spearhead such legislation.

The Treasury secretary said he was encouraged by signs of greater liquidity in the jumbo non-conforming mortgage market.

Paulson said the Treasury is pursuing options to deal with areas where the market isn't working as well.

We're really focused on the subprime market and we're really focused on the homeowners, the mortgage holders who are in danger of losing their homes and thinking through policy options to address that segment of the market, he said.

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