NEW YORK (Reuters) - Sheriff Leo McGuire presides over foreclosure auctions in Bergen County, New Jersey, where the bidding for a home reached $1.2 million last June -- a record for one of the wealthiest counties in the nation.

Homes sold on the auction block for as much as $852,000 this month -- more than quadruple the median home price in the United States. County officials believe they are close to setting another record soon.

In Troy, Michigan, Dorothy Guzek, a credit counselor since 1988, has also seen the changing face of foreclosure.

Her clients, while predominantly poor and minorities, increasingly are neither. Nowadays, homeowners holding professional careers with six-figure salaries regularly drop by her office. More and more they come from upscale Michigan communities such as Independence and Clarkston -- once the summer retreat for Henry Ford, founder of Ford Motor Co.

"Because of the financing that was possible, so many people bought the bigger house, the million-dollar house with the bowling alley or the tennis court outside," says Guzek, who works for GreenPath Debt Solutions, a nonprofit service based in Farmington Hills, Michigan. "People across all income brackets are having financial hardship."

For those on the frontlines of the growing U.S. mortgage crisis, these are the early signs that the explosion of subprime loans made to mostly poorer borrowers is reaching higher ground. The damage is hitting homes financed through jumbo loans for more than $400,000 and so-called Alt-A loans that are a notch above subprime and a step below prime.

Americans already are facing foreclosure at a record pace, according to the Mortgage Bankers Association. Lenders started foreclosure actions against more than one in every 200 U.S. mortgage borrowers in the last quarter of 2006.

About 2.2 million foreclosures due to bad mortgage loans may cost U.S. homeowners $164 billion, mostly from lost home equity, according to the Center for Responsible Lending, a Durham, North Carolina-based research group.

In the last three months, the percentage of foreclosures for U.S. homes valued at more than $750,000 has climbed to 2.5 percent, the highest since early 2005, when RealtyTrac, a online marketplace for foreclosed properties, began tracking data. The overall rate of foreclosures also is on pace to increase by a third this year.

"Everyone's looking at subprime. The rock they aren't looking under are the adjustable rate mortgages and teaser rates and low money-down loans," said Mark Kiesel, a portfolio manager for Pacific Investment Management Co., the world's biggest bond manager. "It's going to affect prime as well."

Kiesel said he sold his Newport Beach, California, home for more than $1 million in May last year after the property appreciated more than 20 percent in two years. He believes delinquencies and defaults will rise, weighing down most of the housing market.

California, with 3,384 foreclosures of higher-scale homes since December, is leading the nation, followed by Florida and New York, according to RealtyTrac. The MBA doesn't track foreclosure data by home value.

ICEBERG

Josh Rosner, managing director at investment research firm Graham Fisher & Co., says the growing numbers of foreclosures outside the subprime market is just the start.

"To define the problem as a subprime problem is short-sighted," Rosner said. "It's really seeing the tip of the iceberg as the iceberg."

Compounding the risk is the nature of homebuyers of higher-end homes, says Rosner. About 40 percent of homes bought last year were second homes or investment properties. Speculative buyers may be more at risk, he said.

Standard & Poor's said on a conference call on Thursday that foreclosure rates are likely to surpass levels last seen during the 2001 recession.

"That giant ATM you've been living in has just shut down," said David Wyss, chief economist at S&P in New York. "Consumers are in debt and we've been living beyond our means for some time."

CDOs

The latest foreclosure data also may spell trouble for Wall Street, where pools of bonds may be susceptible to nonperforming

loans that underpin debt vehicles known as collateralized debt obligations.

CDOs group debt based on credit quality and are similar to mutual funds in packaging securities to help diversify risk. In CDOs, the strongest debt is at the top of the capital structure, helping to smooth out any drag on performance from weaker debt, such as subprime loans.

Just as more expensive homes are beginning to fall through the cracks, the fear is higher-rated bonds within CDO structures may be vulnerable.

The declining performance of subprime loans have resulted in CDOs losing about $20 billion in market value, according to investment bank Lehman Brothers.

UBS Securities said in a report last month that rising delinquencies may cause losses within some subprime mortgage bonds rated as high as the "A" category.

FRAUD-FUELED

At the Justice Center in Hackensack, New Jersey, on Friday, the wood-paneled room is filled with about 40 people and the auction is routine. The first property on the sales sheet lists a Korean homeowner with $509,000 of outstanding debt. There are no bidders. Deutsche Bank, holder of the busted loan, buys the property with a quick $100 bid.

Sheriff McGuire calls the process "one of the most distasteful parts of my position." He places most of the blame on bankers who allowed questionable lending practices.

"This might not have happened if not for these new type of loans," McGuire said, minutes before the auction. The loans also have helped millions of Americans purchase new homes, he concedes.

"The banks took a chance on the future, and the homeowners took a chance so there's enough blame to go around," McGuire said. Still, "the banks and lenders have largely set them up for this downfall."

Adding to the grief, mortgage scams and con artists trying to take advantage of distressed homeowners abound, boosting foreclosure rates, county workers said.

"It's not the American Dream anymore," said Fran Napolitano, a county clerk in Hackensack. "It's 'who can I stab next.'"

In Detroit's suburbs, hit hard by the U.S. auto industry downturn and financial troubles at General Motors Corp. and Ford Motor Co., the story strikes home each day for GreenPath's Guzek.

"It's sad. It's just an awful feeling," she said. "You hope that you can come up with a financial plan to help people remain in their homes, but sometimes it's not the best thing for them."

These days, her calendar of eight counseling sessions a day, 40 a week, remains full. Increasingly, she offers different advice than devising financial plans to save her clients' homes.

"If they can't afford it, sometimes the best thing for them is to walk away," Guzek said

Sacrifice can solve the entitlement crisis

By Peter Peterson

Published: March 20 2007 02:00 | Last updated: March 20 2007 02:00

Undeniable. Unsustainable. Untouchable. Those are the clichés that surround America's looming entitlementcrisis. They are clichés because they are true.

Why undeniable? Let us begin with Social Security. The 78m baby-boomers, twice as many as in the current elderly generation, begin to qualify for retirement benefits next year. Their promised benefits are clearly defined, so projecting future costs is straightforward.

Still, many try to deny reality. The most common soporific is the so-called "Social Security trust fund". We are assured this trust fund will keep the system "solvent" until 2040 or even 2050. The problem is that this trust fund is a fiscal oxymoron: it should not be trusted and it is not funded.

It contains nothing but piles of special US Treasury bonds that are essentially IOUs from one arm of government (Treasury) to another (Social Security). These are not genuine savings and are thus an unfunded obligation for future taxpayers. With or without a trust fund, the choices that face us cannot be dodged: either borrow the money, increase taxes or reduce the benefits.

What matters is not the trust fund balance but the programme's cash flows. Over the next 10 years, Social Security provides a cash flow surplus of about $800bn. After that, this pay-as-you-go system turns sharply negative. Between 2017 and 2040, we would need to borrow about $5,400bn in today's dollars to pay promised benefits. Does that meet your definition of solvency?

That does not include the truly big elephant in the living room: Medicare, whose unfunded obligations are more than five times larger than Social Security's and whose costs are rising three times faster. Social Security and Medicare together leave our children and grandchildren with about $39,000bn in present value of unfunded obligations. That is about $350,000 of hidden debt for every working American and about three times the gross domestic product of the entire country.

Why unsustainable? It is projected that spending for entitlements by 2040 will grow by 9 per cent of GDP. That is more than twice US total defence spending and about nine times the size of the Bush tax cuts. Some say we could grow our way out of these obligations. David Walker, US comptroller-general, America's chief accounting and auditing officer, estimates that this would require double-digit real annual growth over the next 75 years. That is entering fantasy land.

What about tax increases? Official estimates project that if we continued on our present path, our children and grandchildren would have to confront payroll taxes of 30 per cent of payroll - twice what we pay now - to meet promised benefits on a pay-as-you-go basis.

What about benefit reductions? In the case of Social Security, these include gradually increasing retirement ages, means-testing and reducing or eliminating wage-indexing, whereby benefits increase not just by cost of living but also by average wage increases. If wage-indexing were done away with entirely, Social Security's unfunded liabilities would vanish.

Medicare reforms present far more difficult issues. Medicare evolved like no other healthcare system in the world: an open-ended, cost-plus system. We now have healthcare costs more than twice as high per capita as the rest of the developed world, with questionable differences in health outcomes. We spend far more in the last few months of life. We have far more high-cost high-technology surgeries and equipment. We tolerate inexplicable regional differences such as six times as many back operations and prostate removals in some regions as in others.

However promising information technology and so-called "best practices" may be, there is a question we have not dared to confront: meaningful Medicare reform will require some of us to give up some medical treatments that may have some benefit.

Why are entitlements untouchable, politically speaking? Any real reform will require many of us to give up something or to pay more for it. However, we do not want to give up anything. Shared sacrifice for the longer-term good is something people support in the abstract and fiercely resist in the particular. Thus the entitlement meta-stasis presents us with a basic philosophical question: can our media-dominated, democratic society, fixated as we are on the short term and the next election, deal on a timely basis with silent, slow-motion, longer-term challenges or does it require a crisis? A costly crisis it would be.

What is to be done? First, it requires an article of faith. I do not believe we parents and grandparents have become so selfish that we are indifferent to our children's and grandchildren's future and, indeed, America's leadership role in the world. If Americans understood the realities and felt the required sacrifices were fairly shared, they would respond. Bold and honest political and bipartisan leadership is another must.

It is time to remember what the German theologian, Dietrich Bonhoeffer, said: "The ultimate test in moral society is the kind of world it leaves for its children." It is time for us to become worthy and moral ancestors.

The writer is senior chairman and co-founder of The Blackstone Group, chairman of the Council on Foreign Relations and chairman of the Peterson Institute for International Economics

Straight talk from Carlyle Group founder William Conway is sure to prick up ears in the financial world when he speaks of the big letdown coming. In a memo that appears to have been leaked to many a media source, Conway warned that the cheap debt private equity firms have been thriving on is likely to be history in the not-too-distant future, saying, "The longer it lasts, the worse it will be when it ends." Conway, directing his memo to his p.e. peers at Carlyle, stated, "Frankly, there is so much liquidity in the world financial system, that lenders are making very risky credit decisions. This debt has enabled us to do transactions that were previously unimaginable, and has resulted in generally higher exist multiples than entry multiples." When Conway says "us," he literally means deals involving his own firm, including the $15 billion buyout of Hertz and the $18 billion Freescale deal. In preparation for the eventual fall, Conway offered three recommendations:

--"If the excess liquidity ended tomorrow, I would want as much flexibility as possible – are our covenants loose enough? Have we hedged against a sharp upward move in rates? Can we draw down on our revolving credit loan facilities?" he asked.

--"Second, liquidity has led to a significant reduction in risk premiums – most investors in most asset classes are not being paid for the risk being taken. Our strategy should evolve to take lower risk deals and earn lower returns."

--"Third, we should redouble our focus on deals with downside protection – asset coverage, multiple and early exit paths, strategic partners, government protection, consumer needs, controllable capital expenditures and defensible market positions," he said.

Diversification into European currencies would be a mistake from both a Chinese and systemic standpoint. The euro and other European monies may still be modestly undervalued against the dollar but most of their needed rise against it has already taken place over the past five years. Hence a Chinese shift from dollars to euros would have little systemic benefit and would not produce much capital gain to China.

By contrast, Chinese diversification of several hundred billion dollars into yen would promote both systemic and Chinese national interests. It is almost universally agreed, including in Japan, that the yen is substantially undervalued against all currencies, except the renminbi itself and perhaps a few other Asian monies, even after its recent modest rise. Adjusted for inflation, the yen is weaker today than in 1998, when the US and Japan intervened jointly to reverse its precipitous decline, and in 1985, when the Plaza Agreement initiated intervention by the Group of Five leading industrial countries to weaken the dollar, especially against the yen. This yen weakness persists despite the five-year recovery of the Japanese economy and the country's record current account surpluses that are exceeded globally only by China's.

Chinese purchases of yen with a significant portion of their dollar hoard, by strengthening the yen against the dollar in an orderly manner over a sustained period, would thus help correct one of the most important currency misalignments now contributing to the global imbalances. This particular form of diversification would probably minimise the inevitable capital losses that China will experience in renminbi terms because the yen is one of the few currencies that needs to rise in value almost as much as the renminbi itself.

China has never formally consulted the US about its massive purchases of dollars and would be under no obligation to consult Japan as it shifted into yen. The political tensions between the two countries have not precluded their co-operation on monetary matters, however, including participation in the Asia-wide network of bilateral swap agreements (the Chiang Mai Initiative) and nascent steps toward an Asian Monetary Facility. Hence China might want to discuss its plans with Japan and even suggest complementing its own diversification with a shift of some of Japan's similarly large dollar balances into renminbi assets, promoting the needed adjustment of its owncurrency.

There are of course other ways to achieve the desired rise of the yen. Japan could simply sell dollars for yen from its own reserves. The US authorities could buy yen, probably in co-operation with their Japanese counterparts, as they did in 1985 and 1998 (and many other occasions). The Group of Seven could replicate the Plaza Agreement, presumably with respect to the renminbi and other undervalued Asian currencies as well as the yen. But Chinese diversification into yen would serve multiple purposes and would certainly be viewed as a natural monetary operation.

Such Chinese diversification would not solve the fundamental problem concerning the renminbi. China should promptly let its currency rise to a level that would no longer require intervention. This would both reduce its external surpluses, countering the growing protectionist backlash against Chinese exports, and halt its wasteful reserve build-up. But the $1,000bn legacy from the past would still have to be managed and China could refurbish its image as a responsible leader in the world economy by doing so in a manner that constructively promoted global adjustment and stability.

The writer is director of the Peterson Institute for International Economics in Washington