Propped up against a string of vacant, boarded-up houses, a beige-and-blue sign showing restored Victorian homes advertises the ambitious program to transform the lines of run-down row houses in the Bates Street area of Shaw into modern, pastel-painted town houses.

The metamorphosis of Bates Street and its environs, one of the city's best known slums lanquishing abou 20 blocks from the U.S. Capitol, began two years ago.

But after an initial sales surge brought about 60 new homeowners -- ranging from D.C. Police Chief Burtell M. Jefferson to former public housing residents -- to the completely rebuilt, air-conditioned houses with wall-to-wall carpeting and fireplaces, work on the 12-block urban renewal area has virtually stopped.

Bates Street, launched as a showpiece for Mayor Marion Barry's housing program and new opportunities for minority developers, has become a victim of "the hurricane," -- the startling leap in interest rates that occurred just as the houses went up for sale early last year, according to Jack W. White, one of the four Bates Street developers.

High mortgage interest rates have shriveled housing production around the country and left several new Bates Street homeowners such as Emerson Hall, a 28-year-old telecommunications consultant, living on a street with numerous gutted, unrestored homes.

"Because things have not been done, it makes the street look less attractive to other investors," Hall said the other day. "What really upsets me is the trash in the shells."

White said last week that much of the story of Bates Street can be told in the interest rates. "In January 1980 [when the sales began and interest rates stood at 12.5 percent], of the first 89 homes we had 81 under contract, but by March, 95 percent [of the prospective purchasers] were disqualified [for a mortgage] because the interest rates had gone up" to 15 and 16 percent, said White, whose partners in the Bates Street development are George Holmes, John E. Haley and Dennis J. Makielski.

That 3- to 4-percent increase swelled the monthly principal and interest payments on a $72,000 mortgage -- the average for new Bates Street homeowners purchasing without government assistance -- from $769 to $910, or an 18 percent increase.

"We've had one buyer to walk out of settlement twice because the rates went up," White said, adding that another house has had seven contracts on it, all of which fell through because the rates rose before settlement.

Although the developers sold some homes last summer after receiving an infusion of low-interest mortgage money from the Federal National Mortgage Association, the high interest rates triggered a chain reaction that can be seen in the vacant and unrenovated houses, the unfinished sidewalks, the trash-filled yards that blight the renewal area today.

Since less than half of the 133 homes have been sold and the project is a year behind schedule the developers say they:

Cannot pay off a $3.1 million interest-free loan the city gave them to fix up the 163 homes and apartment buildings in the area, which is bounded by North Capitol, Third, P and Q streets NW, with Bates as the spine of the renewal blocks.

Cannot pay off contractors who put roofs on the homes, painted, provided lumber and other construction materials and put down the carpeting. These contractors have filed liens against the developers totaling more than $770,000 and some have stopped work until they are paid.

Are struggling to pay off a two-year-old $936,000 construction loan from the National Savings and Trust Co.

Cannot answer requests from new homeowners to fix construction defects.

The financial crunch also has forced black developers White and Holmes, who won the redevelopment rights, to sell half their company to two white developers. In September 1980, Haley and Makileski bought a 50 percent interest in the development company in return for $796,000 in badly needed cash and recently they paid the company $361,000 in return for tax savings generated by the project.

Despite the problems and uncertainty about when the project will be completed, city housing director Robert L. Moore praised the project.

"I think Bates Street is very successful. It is the largest concentrated rehabilitation program in the nation and the only one getting three different income groups on the same block," Moore said.

"People said you could not sell one house for $44,000 and the house next door for $70,000, but we've done it," he added. The area has a mixture of income groups because some of the refurbished homes were sold at market rates, others were subsidized for sale to lower income families (the subsidized and market rate homes are identical on the outside; both kinds are air-conditioned and carpeted but non-subsidized families can add other features such as dishwashers and fireplaces) and other buildings will be renovated into subsidized apartments.

The four developers refuse to finish the gutted homes on Bates Street because they are afraid of gambling money that can only be regained through quick sales, which now seems unlikely. At the same time, however, they are preparing to build a new housing development, Parkside in Northeast Washington.

In February, while bills from subcontractors were piling up, the Bates Street partnership gave city housing officials a check for $780,000 -- part of the $1.2 million acquisition price for Parkside. City officials envision a $30 million development of more than 300 new homes and a small shopping center with offices rising on that 26-acre site north of Benning Road on Kenilworth Avenue.

City housing officials had held the first mortgage on the Bates Street properties. But they effectively relinquished that position to allow the developers to obtain a $1 million construction loan from the John Hanson effectively now holds the first mortgage on the properties; the city holds the second.

"Bates Street is not as profitable as Parkside," said White. "It never was. Parkside will be like a cakewalk." He explained that the homes will be smaller than those across town on Bates Street, new construction is cheaper than renovation and the homes will be built only when sold.

The developers note they were required by the city to sell the subsidized homes on Bates Street for $39,000 to $45,600 -- less than the cost of the renovations -- which is not required in Parkside. But city officials partially eased that burden with the interest-free loans, which were given to hold down the prices of both the subsidized and market-rate homes so that middle-income families would not be priced out of the project.

The market-rate homes now sell for $83,000 to $99,000.

Meanwhile, the unpaid contractors of Bates Street are waiting. "They used to have weekly meetings with all the contractors and say they'd pay the following week and the week would come and no payment," said Michael Barfoot, owner of Bragg Renovations, which is owed $18,069 for roofing work. "I stopped going because I had a business to run."

According to records at the D.c. Recorder of Deeds, in addition to Broadway Decorators and Bragg Renovations, five other companies have filed liens against the project: Jones and Artis Construction of Landover are owed the most and have filed an estimated 110 liens totalling $378,789.

"We've got bad economic times," said Haley, adding that he thought the subcontractors understand the developers' problems of declining sales.

New homeowners requesting repairs for construction defects in their homes have been told much the same thing.

"We realize these are tough times economically," said Hubert Reid, president of the newly formed Bates Street Citizens Association. "But our main concern is that our individual grievances are corrected as soon as possible."

For example, Reid's air-conditioning system does not cool his second floor. Hall's front and back doors are unpainted, his bathroom doorknob is rusting. Irene Phillips' rugs are buckling and Charles Lewis' backyard sidewalk was left torn up by workmen last October.

Still, many homeowners said that although they are unhappy with small defects, overall they believe the construction work was well done.

Despite the problems, a pleasant neighborhood of old residents and new, blacks and whites, new houses and old ones, is slowly emerging.

Six months ago, Allan Straughan, vice president of the citizens association, and his wife Eileen moved to a new $75,000 Bates Street townhouse. Their next door neighbor is Virginia Carter, 67, who has lived on the street 32 years.

She came in 1949 when real estate agents sold each of the two floors in each house to separate families. They were early city condominiums. She paid $7,500 and remembers when coal was stored in the basement to fuel the kitchen stove and the ice man delivered large blocks of ice to neighborhood iceboxes.

Up the street at 64 Bates Street, Lenora Maddox, 40, who grew up on the block, lives with her grandchildren -- the fifth generation of the family to live in the house.

Showing a visitor pictures of her grandparents sitting on the wooden front porch in the early 1950s, she said, "I never thought this place would look like this," referring to her completely renovated house and the refurbished street.

"Bates Street has a lot of memories for me. I remember when it was very nice and some whites were still here. Then they started letting everything in here."

She married and moved away and returned only to visit her grandmother because the street had become a gathering place for drunks, drug addicts and gamblers.

But after her grandmother's death last year she and her family decided to return. The city loaned her $75,000 at low interest rates to renovate the house and Lenora Maddox came back.

"This is home," she said.