Oct. 4 (Bloomberg) -- Federal Deposit Insurance Corp. Chairman Sheila Bair called for payments on most subprime mortgages to be fixed at current levels.

Lenders should extend ``teaser'' rates on all subprime adjustable-rate mortgages if the borrowers haven't missed any payments and they live in the homes, Bair said today in New York. Modifying loans on a case-by-case basis and fixing rates for limited periods won't avert enough foreclosures, she said.

``I don't want to kick the can down the road and just prolong the pain,'' Bair said at a conference hosted by Shelton, Connecticut-based Clayton Holdings Inc., the largest provider of due diligence on mortgages bought by Wall Street firms.

As default rates on subprime loans have surged to record highs, Bair has prodded banks to examine more closely whether borrowers can afford more than the initial payments on adjustable-rate loans. Subprime mortgages are issued to borrowers with poor credit or high levels of debt.

Federal bank overseers last month asked loan servicers to perform more modifications and refinancings on subprime loans with rising rates in order to help banks, consumers and the economy. The regulators aren't working on a formal statement incorporating her latest views, Bair said in an interview today. Companies including Calabasas, California-based Countrywide Financial Corp. and Bear Stearns Cos. of New York have said they plan to do more loan modifications than ever.

Mortgage-Bond Investors

Bair said her modification plan would be best for mortgage- bond investors, even though it would reduce interest payments by most borrowers. She said loan servicers don't have the resources to review each loan and that they may default later anyway if their payments aren't fixed permanently. Lenders generally have granted extensions for between six months and five years.

``In today's housing market you can't make the assumption that they'll have enough equity in five years'' to refinance, Bair said.

The head of the Clayton unit that tracks the work done by servicers for mortgage-bond investors said Bair's proposal may do more harm than good.

``Maybe it'll be better than the worst-case scenario'' of no subprime-loan terms being modified, said Kevin Kanouff, president of Clayton Surveillance Services Inc., ``but I think it's definitely worse than the best-case scenario.''

About 100,000 subprime mortgages a month will reset to higher rates for the first time during the next two years, according to UBS AG analysts led by Laurie Goodman. Rates on the loans typically are fixed for as long as three years, and can then climb every six months. Borrowers' payments usually jump about 30 percent to start, Bair said.

Market Assumptions

Subprime adjustable-rate mortgages with a few years of fixed rates, or hybrid ARMs, were offered because lenders believed borrowers would refinance into new loans or sell their properties, Bair said.

``Let's be honest about it: Hybrid ARMs were never made on the assumption that borrowers could continue to pay them back once the loans reset,'' she said.

Because lenders have tightened standards and home prices are falling, borrowers are no longer able to refinance or sell easily, according to analysts at UBS and elsewhere. That should boost defaults and losses, they wrote.

Home prices in 20 U.S. metropolitan areas dropped 3.9 percent in the 12 months through July, according to the S&P/Case-Shiller index. The default rate on subprime mortgages packaged into bonds hit a record 13.43 percent in June, according to Friedman Billings Ramsey Group Inc. The share of loans at least 90 days late, in foreclosure or already turned into seized property rose from 6.88 percent in June 2006, according the Arlington, Virginia-based securities firm.

Beginning last year, Bair led a drive by the FDIC, the Federal Reserve and the Office of the Comptroller of the Currency to create guidance for banks encouraging tougher underwriting of subprime ARMs.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

Last Updated: October 4, 2007 17:50 EDT