WRAPUP 2-Foreclosure mess may hurt housing, regulators warn

* FDIC head: Litigation could prolong foreclosures

* Bernanke: Report on foreclosure practices next month

* U.S. existing home sales surpass expectations for Sept

* U.S. says 11 percent of home loan modifications failed

By Dave Clarke and Al Yoon

WASHINGTON/ATLANTA, Oct 25 (Reuters) - U.S. regulators said fixing the foreclosure paperwork mess will take time and could weaken a still-limping housing market, despite banks' hopes that the problem will soon go away.

Sheila Bair, head of the Federal Deposit Insurance Corp, warned on Monday of broad implications from lawsuits accusing lenders of failing to properly vet foreclosure documents.

"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. [ID:nN25276366]

Attorneys general in all 50 U.S. states and bank regulators are investigating whether lenders rushed through foreclosures and evicted borrowers from their homes without properly checking documents, instead using so-called robo-signers.

Lawsuits have already begun to trickle in and banks may also face fines or be forced to repurchase faulty loans, which would hurt profits. (For more stories on the foreclosure furor click: [ID:nN11106777])

Banks put on a brave face last week -- when many of them reported quarterly earnings and faced questions from shareholders about what their liability might be -- saying the problem would likely pass quickly with minimal pain.

Bank of America, the largest U.S. mortgage servicer, began on Monday refiling affidavits in 102,000 foreclosure cases in certain states, after having previously announced a nationwide halt on evictions.

The banks' desire to put the foreclosure paperwork mess behind them will be hindered by the various probes which will last weeks, if not months.

Federal Reserve Chairman Ben Bernanke said bank regulators would issue a preliminary report in November on foreclosure practices at large financial institutions.

"We have been concerned about reported irregularities in foreclosure practices at a number of large financial institutions," Bernanke said on Monday in opening remarks to the housing conference. [ID:nN25259287]

Bernanke pledged an in-depth review of the firms, and said regulators are also looking at the effects the paperwork problems could have on the real estate market.

OCTOBER SURPRISE

The foreclosure problems have not yet filtered through into economic data on home sales. An industry group on Monday reported that existing home sales rose 10 percent in September, a surprisingly strong bounce back from a summer slump. [ID:nN25264142]

"The question remains of the impact of the foreclosure debacle that reared its ugly head in the latter part of September," said Chris Christopher, a U.S. economist with IHS Global Insight in Lexington, Massachusetts. "The impact will be felt in the October numbers."

The problem has put a bit of a chill on mortgage applications, which have fallen in the past couple of weeks.

The head of mortgage financing giant Fannie Mae (FNMA.OB) warned on Monday that banks must rapidly fix errors in foreclosure processes, or risk costly back ups of distressed properties.

Chief Executive Michael Williams, speaking at a conference of the Mortgage Bankers Association in Atlanta, said loan servicing companies are taking the right steps of reviewing procedures but urged speed to reduce an overhang effect.

Although housing represents a small sliver of the U.S. economy, it is typically a family's biggest single asset.

When the real estate market was booming five years ago, consumer spending picked up because home owners felt wealthier. Many homeowners took out home equity loans to bolster their spending, assuming that property values would continue to rise.

Since the bust, which began in earnest in early 2007, consumer confidence has cratered, putting pressure on President Barack Obama to come up with a better plan for repairing the housing market.

Obama's fellow Democrats are expected to face the wrath of voters in Nov. 2 congressional elections, with Republicans expected to gain control of the House of Representatives and perhaps even the Senate.

Programs aimed at modifying loans to keep people in their homes have had limited success. The Treasury Department said 11 percent of loan workouts entered into in the last nine months had ended in default.

In all, nearly 500,000 modifications have been negotiated with lenders, Treasury said. By comparison, there have been roughly 3 million foreclosures since January 2007.

Paul Willen, a researcher at the Federal Reserve Bank of Boston, said it is more profitable for banks to foreclose than to modify, and until that changes, modification programs are destined to fail.

"We can't prevent millions of foreclosures using the tools that people are now using," he said at the Fed and FDIC conference, noting that he was speaking as a researcher, not a representative of the Federal Reserve. (Additional reporting by Corbett B. Daly, Mark Felsenthal, Lucia Mutikani and Al Yoon; Writing by Emily Kaiser; Editing by Leslie Adler and Tim Dobbyn)