WASHINGTON (Dow Jones/AP) — The pace of loan modifications on adjustable sub-prime mortgages is lagging, which could prompt regulatory action on the mortgage industry, US Federal Deposit Insurance Corp. Chairman Sheila Bair warned yesterday.

"Unfortunately, at this point, the available information seems to show that foreclosures continue at an unacceptably high level while true loan modifications are lagging," Bair said in prepared testimony to the Senate Banking. "It is important that servicers demonstrate and document real progress soon or they invite regulatory and legislative action to supplement the industry's actions."

Citing an increase of more than 60 percent in foreclosures during the first three quarters of 2007 from a year earlier, Bair said mortgage servicers need to act more quickly to prevent a bigger wave of defaults over the next two years.

Over 1.7 million adjustable sub-prime mortgages are scheduled to reset through 2009, and that problem could be followed by an additional wave of other non-traditional mortgages — such as interest-only or payment-option loans — starting in 2009. Over 1.7 million of those loans were outstanding as of October, according to the FDIC.

Bair said that for these other non-traditional loans, mortgage servicers should consider the same type of systematic approach that has been developed with the guidance of Treasury Secretary Henry Paulson to deal with the subprime crisis. Under that plan to fast-track modifications, homeowners who can afford their current payments — but not the reset — are eligible to have their starter interest rate frozen for five years.

Noting that the industry has cited concern about legal liability for their hesitancy in modifying sub-prime loans, Bair said she believes "sufficient legal authority" exists to protect servicers from claims by investors who bought securitised assets backed by the mortgages.