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Foreclosure Problems Could Be 'Very Damaging' To Housing Market, FDIC Chief Says

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ARLINGTON, Virginia (Reuters) - Litigation arising from foreclosure paperwork problems could be "very damaging" to the housing market, a top U.S. banking regulator said on Monday.

Federal Deposit Insurance Corp Chairman Sheila Bair said she did not believe legislation would be needed to address concerns over whether the paperwork was properly done so long as investigations show the issue was mostly "procedural."

State and federal officials are investigating allegations that for years banks have not reviewed foreclosure documents properly or have submitted false statements to evict delinquent borrowers.

"I fear that the litigation generated by this issue could ultimately be very damaging to our housing markets if it ends up unduly prolonging those foreclosures that are necessary and justified," Bair told a housing conference in Arlington, Virginia.

"The regrettable truth is that many of the properties currently in the foreclosure process are either vacant or occupied by borrowers who simply cannot make even a significantly reduced payment and have been in arrears for an extended time."

Bair argued it is important to move foreclosures quickly because until they have been cleared out of the system, the housing market will continue to struggle.

She said the volume of foreclosures requires a "global solution" that involves all interested parties.

Those parties often include servicers, borrowers, lenders, second-lien holders and investors in securities backed by troubled mortgages. Foreclosures and modifications can be held up when the interested parties do not reach agreement on how to handle a delinquent mortgage.

Bair said one part of a global solution could be extending legal protection, providing a "safe harbor," to foreclosure proceedings if the property is vacant or if the servicer offered a meaningful payment reduction, such as 25 percent, and the borrowers could still not perform on the loan.

MISSED WARNING SIGNS

The state attorneys general are investigating the use of "robo-signers" -- people who sign hundreds of affidavits a day -- by banks and companies that collect monthly mortgage payments. It is alleged they did not properly review the documents they were signing.

Bank of America, JPMorgan and Ally Financial's GMAC Mortgage are among the servicers whose practices have come under fire.

Bair said regulators and market participants missed clues about poor mortgage servicing. She said they should have questioned how mortgage servicers were able to keep up profits without sacrificing quality, even as servicing fees were declining significantly.

"In retrospect, there were warning signs that servicing standards were eroding," Bair said.

She also said the robo-signing controversy underscores how expensive and time-consuming the foreclosure process is, meaning modifications should be actively pursued before foreclosure proceedings.

"We know from experience that reducing the monthly payment through modification raises the chance that the borrower will make good on the loan," she said.

COVERED BOND SUPPORT

Bair expressed qualified support for legislation intended to create a more robust covered bonds market.

Potential issuers of these bonds, including banks like Bank of America, argue that a legislative framework could boost the market and provide a safer method for banks to raise funds to lend to consumers for mortgages and other loans.

Covered bonds are debt securities backed by cash flows from loans but they remain on the issuer's balance sheet and thus are seen as safer than non-guaranteed mortgage securities.

Bair made clear that her support for such legislation depends on losses being covered by investors and not, ultimately, her agency's deposit insurance fund, which guarantees deposits and meets costs associated with the FDIC seizing a failed bank.

"This would result in decreased market discipline from investors who know that their risks are essentially back-stopped by the FDIC," she said.

(Reporting by Dave Clarke; Editing by Leslie Adler and Tim Dobbyn)

Copyright 2010 Thomson Reuters. Click for Restrictions.

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