Cities searching for innovative ways to cushion the effect of federal budget cuts can take a lesson from a new housing program here in the Twin Cities.

Neither private industry nor the government is the force behind this program. Instead, the catalyst is the Minneapolis-based McKnight Foundation, which used its assets as the bait to lure the two city governments and local labor unions into an unusual partnership that eventually will build 3,200 subsidized housing units for low and moderate-income families.

The program is proving popular in the two cities and is drawing attention around the country.

The program offers home buyers mortgage interest rates of 11 7/8 percent as well as equity loans, interest-free down payment loans and graduated monthly payments for young families whose monthly payments increase over time as their incomes rise. Families with incomes of less than $28,600 can qualify. For families whose incomes are too low for homeownership, the program provides rental assistance.

"The purpose of the homeownership program is to serve families who are working people and have traditionally been able to buy a house, until interest rates rose," said Tom Fulton, executive director of the Twin City Family Housing Fund, which was established by the McKnight Foundation.

At present about 1,850 units--ranging from single family homes with as many as five bedrooms to town house projects--are under way in the homeownership program. "I've been to groundbreakings all fall," said St. Paul Mayor George Latimer.

Everyone involved in the project credits Russ Ewald, executive director of the McKnight Foundation as the man who came up with the idea. The foundation takes an active interest in social welfare projects, and because its assets grew from $9 million in 1974 to $360 million in 1981, Ewald was looking for a way to get the foundation involved in solving one of the area's problems: affordable housing for moderate-income families.

In late 1979, Ewald contacted Latimer and newly elected Minneapolis Mayor Don Fraser. He told them that the foundation would help underwrite a housing program, but only if the two cities would work together--something that had never happened--and if they could persuade local labor unions to use their pension money to help underwrite the program.

The McKnight Foundation has put up $17 million, of which $5.9 million was dedicated to the fund that subsidizes home purchases. Other financial aid came in the form of an urban development action grant, worth more than $2 million. The labor unions originally pledged $20 million to $30 million.

For mortgage financing, the cities decided to sell $235 million in revenue bonds and to bring down the cost, sought and received a change in the federal tax law to allow them to sell the bonds as tax free. Fraser, a liberal member of Congress for 16 years, takes pride in getting the exemption into the tax bill in Washington.

"I talked to former House Ways and Means Committee chairman Al Ullman about getting that into the tax bill," Fraser said.

To date, the city has sold $120 million in those bonds. The remaining $135 million will be sold to finance a second phase in the project.