Norman Wishner was building houses around Fredericksburg when he first saw cellulose insulation being used.

Pulverized paper and chemicals are what it's made of, he learned after some study and, unlike fiber glass insulation which is in short supply, cellulose can be produced quickly and cheaply.

Last July - one year and $200,000 later - Wishner's American Cellulose Corp. began manufacturing insulation in Richmond. His is one of hundreds of new cellulose plants started in the past year or now under construction to convert old newspapers into energy-saving insulation.

From 2.6 milliom homes insulated in 1976, the home insulation market grew to an estimated 6 million insulation jobs last year and is expected to reach 8 million homes this year. The result has been severe shortages, particularly of fiber glass insulation, which is produced by only three manufacturers and requires multi-million plants that take years to build.

To fill the gap, cellulose insulation plants are proliferating faster than the government can count them. The industry's production capacity nearly will quadruple from 736 million pounds in 1976 to 2.7 billion pounds by the end of this year, according to Department of Commerce estimates.

Commerce counted 140 manufacturers last June and now puts the number at 350. But the Federal Trade Commission estimates that there are close to twice that many. Between Baltimore and Richmond, there are at least a half dozen.

The new plants range from highly automated operations like the $1.5 million facility opened in Princess Anne, Md., in November by Cellutron of nearby Parsonsburg to $6,000 units that mount on the back of pickup trucks.

The smallest plants are little more than compost grinders or modified farm feed mills says Phil Stern, a Boulder, Colo., prosecuter probing fraud in the rapid expansion of the cellulose industry. He will testify at Federal Trade Commission hearings next week.

"They don't make insulation, they make time bombs," warns Stern. Improperly manufactured insulation often isn't fireproof and sometimes is made with corrosive chemicals that can turn into sulphuric acid, eat into wiring and destroy homes.

Unsafe insulation is a time bomb not only for home owners, but also for the booming cellulose manufacturing industry which has been pleading for government standards that will eliminate what are called "the suede shoe boys" by Greg Fitzgerald of the Society of International Cellulose Insulation Manufacturers (SICIM) here.

Fitzgerald says the industry's viability and reputation are threatened by the lack of U.S. rules governing the safety and heat-keeping qualities of insulation. He said the industry is powerless to stop fast-buck artists who are selling both inadequate insulation and the plants to make it.

Businessmen entering cellulose manufacturing say they face the same problems as consumers in getting good products. Bernard Bohager, a Baltimore scrap-paper dealer who began making insulation in December, says "there is a lot of bad machinery around and most of it comes from Denver."

A half dozen manufacturing and marketing companies in the Denver area are selling "turnkey" insulation plants - and bringing complaints to both the District Attorney's Office and the Better Business Bureau.

One Denver firm, Empire Insulating, opened its doors last September and has been advertising in the Wall Street Journal almost daily since then.

"We sell everything you need to manufacture cellulose insulation, except the old newspapers," said Lew Casbon, an Empire spokesman, in a telephone interview.

He said Empire has sold "30 or 40" plants, which cost about $75,000, with discounts for cash in advance. Empire is a marketing company, selling machinery made by another Denver area firm, Easy Engineering Co. Easy Engineering's equipment is also sold by a company called Modern Energy.

The Denver Better Business Bureau said it has had "inquiries but not actual complaints" about Empire, and formal complaints about Modern Energy, which BBB said has been sued by some customers.

The Empire spokesman said the company "designed small plants so people could get into the business on a reasonable scale." Its insulation "factory" comes on one flatbed truck and can be set up and production insulation in two or three days, Casbon said.

He said Empire's buyers are "about evenly divided among three types of customers - investors who see the profit potential, (insulation) installers who can't get materials, and the man on the street who sees an opportunity."

The Empire spokesman said, "We think the insulation business is going to be strong for the foreseeable future," predicting, "a very strong market for five to 10 years."

Other industry sources are less optimistic, predicting the proliferation of plants will result in overbuilding, overcapacity and the failure of some small producers.

"There's going to be some kind of a shakeout," predicted Chris Chapman, general manager of the new Commonwealth Insulation plant in Charlottesville, which is a spinoff of Allied Concrete, a block maker that decided to diversify into a related building materials line.

"It'll be survival of the fittest. We hope to be among the fittest." added Morton Goldman of Goldman Paper Stock in Richmond. When he gets his machine in April or May, Goldman will compete with crosstown rival Wishner.

Like Bohager Paper Co. in Baltimore, Goldman Paper Stock decided to get into insulation manufacturing because it was already dealing in the raw material - old newspapers, said Morton Goldman, the owner.

For years, Goldman, Bohager and most paper dealers sold the bulk of their old newspapers to wallboard manufacturers. (Because of the difficulty of removing ink, relatively little waste paper is recycled into newsprint. Media General Corp. of Richmond owns the biggest East Coast maker of recycled newsprint, Garden State Paper Co.)

Other new plants in the Washington area include a major facility expanding the operations of Davenport Insulation Co., a subsidiary of Washington Gas Light, and a Fredericksburg plant being built by a private investor, Walter Banks.

The demand for insulation sent used paper prices soaring last fall. The price jumped from $35 a ton to $85 or $90 in two months, and some buyers paid as much as $120 in November. Now insulation makers are paying around $85 a ton, and scrap dealers are offering about $35 for small purchase.

Because paper is highly flammable, cellulose insulation has to be treated with chemicals. The preferred fire retardant is a formula using borax and boric acid, said SICIM's Fitzgerald. Prices of those chemicals also have soared - to 40 cents a pound - and there have been spot shortages, so some manufacturers have switched to other chemicals, among them fertilizers and sulphate compounds. Fertilizers can encourage growth of mold on the insulation, and sulphates can turn into suphuric acid when moisture is present.

But there are no federal rules banning use of these chemicals, nor are there any specifications about how much flame retardant must be used or how it is applied. Industry sources agree that the recommended practice is 20 to 25 percent chemical.

The other critical factor in the quality of cellulose insulation is called "fluff." The newspapers are supposed to be not merely shredded, but pulverized, exposing the individual fibers with their tiny insulating air spaces. "If you can read a whole word, it's not fine enough," is the rule of thumb.

All the insulation makers interviewed in the Washington area say they use a pair of hammermills, operating in tandem, to smash the paper apart. Smaller plants, however, use a single hammermill, because it is the most costly piece of equipment in the process.

These small plants probably will be put out of business if the federal government ever adopts cellulose standards, said Noel Lane, a technical instrument maker who is head of SICIM's technical committee.

He said small plants "simply can't do the job," and estimated that manufacturers with less than $250,000 invested can't afford quality control. Mandatory government standards and independent third-party testing - by an outfit such as Underwriters Laboratory - are "the absolute minimum" needed to assure quality, he said.

"You've got to have a full-time quality assurance man," said Lane. "You're talking about $15,000 for the laboratory alone."

Empire's Casbon dismisses criticism of small manufacturers as attempts "to scare the little guys out of the business." A $150 chemistry set is adequate for testing, he said.