Sheila Bair, chairman of the Federal Deposit Insurance Corp., said litigation by the affected homeowners "could ultimately be very damaging to our housing markets" because it could keep people from buying foreclosed homes.
Bair said her agency is working closely with other federal regulators to determine whether mortgage companies used flawed documents to seize homes, during remarks made at a housing finance conference sponsored by the FDIC and the Federal Reserve.
Fed Chairman Ben Bernanke told the conference that regulators are examining whether mortgage companies cut corners on their own procedures when they moved to seize people's homes.
Bair said says eventually a "global solution" will be needed to address the large volume of foreclosures.
Foreclosure should be a last resort, she said, after all legal and procedural requirements have been followed. They should proceed if a property is vacant, or if the borrower defaulted even after the mortgage company had offered a significant reduction in payments.
Still, she said she fears 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."
Lawyers for evicted homeowners have been preparing lawsuits against major lenders based on allegations that they moved too quickly to take the homes without reading documents that contained flaws.