Sees big costs for banks to fix foreclosures

WASHINGTON (Reuters) - Banks will have to make "significant investments" to clean up foreclosure practices and some lenders potentially face strong pressure from investors to buy back faulty mortgages, a top Federal Reserve official said on Wednesday.

Fed Governor Daniel Tarullo was hesitant to put a number on the potential costs and told a Senate hearing regulators are trying to get a handle on the threat to the financial system.

Tarullo's comments underline the problem banks are facing now as they wrestle with processing billions of dollars of foreclosures: many do not have the technology or personnel in place to follow proper practices, but are reluctant to invest in these areas while profits are under pressure.

Tarullo told the Senate Banking Committee hearing regulators expanded their probe into foreclosure practices after a preliminary review suggested "significant weaknesses" in how banks dealt with millions of troubled mortgages.

"The industry will need to make substantial investments to improve its functioning in these areas and supervisors must ensure that these improvements occur," Tarullo said.

Regulators and state investigators are probing big mortgage servicers, including Bank of America Corp, JPMorgan Chase & Co, Citigroup Inc and Ally Financial, amid allegations banks used "robo-signers" to sign hundreds of foreclosure documents a day without proper legal review.

Banks are also facing the possibility of greater losses due to demands from investor that they buy back billions of dollars of mortgage bonds, the so-called put-backs, because they misrepresented the quality of the underlying loans.

A congressional oversight panel recently said the banking industry could lose $52 billion from put-backs and some analysts have put the figure at more than $100 billion.

Tarullo said the Fed is following the issue closely.

DRAWN-OUT PROBLEM

Tarullo said the problems with servicers are not close to being resolved and that "we do need more of a national effort to impose standards on everybody."

Regulators have been criticized for not catching the widespread flaws and only learning about them when banks started suspending foreclosures in late September to review their practices. They have since resumed foreclosure sales.

Regulators hope to wrap up their review by the end of the year and publish an analysis in January. State attorneys general have been negotiating a settlement with the major banks and Ally Financial, which may include the banks paying into a fund for borrowers wrongfully evicted from their homes.

But industry analysts have said the put-back risk is the higher potential cost for banks.

Both Tarullo and Federal Deposit Insurance Corp Chairman Sheila Bair said it is unclear how big an issue this will be for banks because of legal questions that have yet to be answered. "With respect to some institutions, there could be a significant exposure," Tarullo said.

Government owned mortgage giants Fannie Mae and Freddie Mac are among the entities applying pressure to the banks.

As of the end of September, they had a combined $13.3 billion in outstanding requests for lenders to buy back mortgages that were not properly underwritten.

DUAL TRACK COMPLAINTS

Lawmakers zeroed in on the so-called "dual track" practice in which mortgage servicers go ahead with foreclosure proceedings even as they negotiate loan modifications.

Acting Comptroller of the Currency John Walsh said his agency, which regulates national banks, has told servicers under its jurisdiction to suspend foreclosure proceedings on borrowers who are in the midst of modification negotiations.

"We agree that the dual track is unnecessarily confusing for distressed homeowners," he said.

Walsh acknowledged, however, that servicers are limited in what they can do because ultimately, he said, it is investors who dictate when a foreclosure proceeding should take place.

Edward DeMarco, acting director of the Federal Housing Finance Agency, which regulates Fannie and Freddie, said the dual track process can be necessary because of the long time frame of the foreclosure process.

THE ROLE OF SYSTEMIC RISK COUNCIL

FDIC's Bair said the new Financial Stability Oversight Council should take the lead in addressing foreclosure paperwork and mortgage servicing problems. She said the problems don't present a systemic risk in the short term but could develop into a larger issue.

The council, which has 10 voting members, is headed by Treasury Secretary Timothy Geithner and includes representatives from the major financial regulators such as the Federal Reserve and the Securities and Exchange Commission.

The council last week broadly discussed mortgage servicing issues but did not reveal any strategy for tackling the problems.

Senate Banking Committee Chairman Christopher Dodd said the council needs to be more aggressive about addressing foreclosure problems. "Good Lord, I'd expect something coming out of this operation, other than what presently is the case," he said.

(Reporting by Dave Clarke, Corbett B. Daly and Rachelle Younglai; editing by Dave Zimmerman and Andre Grenon)