interest rates: cutthroat price competition, layoffs, and reeling stock prices.

It is the reality of an inherently cyclical business. But one consultant says mortgage bankers can prepare for such times the same way they guard against the side effects of a boom period -- by hedging.

To offset the drain on earnings that comes from reduced lending volume and the costs of cutting staff, Austin Tilghman advocates the use of derivatives that gain in value when rates rise.

Gains in the hedge could also be used to subsidize pricing, to help a lender compete for the remaining business, says Mr. Tilghman, who is managing director of United Capital Markets, an advisory firm owned by Matrix Bancorp of Denver.

Many lenders use complex financial instruments to hedge against runoff of their servicing portfolios, which occurs when rates fall and borrowers refinance. It is also common for mortgage bankers to hedge against pipeline risk -- the danger that rates will rise before a loan application closes, which can cause a loan to fall through or, if the loan does close, to become an underwater asset.

But the kind of hedging that Mr. Tilghman prescribes is rare. "It's not an idea that's had much play in the boardroom," he said. "It's not generally practiced, but intuitively it makes sense."

The "enterprise hedge" Mr. Tilghman envisions would be to take a "synthetic" short position in U.S. Treasury securities, by selling futures and call options and buying put options. Treasury bond prices move in the opposite direction of their yields, which are the benchmark for mortgage rates.

The puts and calls would vary in strike price, the price at which the option can be exercised. The hedge would be configured this way because the more interest rates rise, the more a mortgage company's production and earnings fall and its costs increase. Using a variety of options with different strikes, the hedge would more closely mirror asymmetrical changes in the company's earnings as rates move than if the company simply took a short position on Treasury bonds, Mr. Tilghman said.

Some lenders questioned how the hedge would work if interest rates rose and then fell again. Unlike the servicing hedge, there is no specific asset that a mortgage banker can use to offset a loss in the value of the "enterprise" hedge. "When it goes against you, there's nothing you can mark up," said James B. Witherow, chief executive officer of FT Mortgage Companies, a unit of First Tennessee National Corp.

What's more, if rates fall, the hedge is likely to drop in value much faster than the resulting increase in production would materialize.

"I don't have room to tell my shareholders, 'I lost in this period, but guess what? I'm gonna get it back in the next accounting period when my production kicks in,'" said William B. Naryka, chief financial officer of Fleet Mortgage Group, the home loan unit of Fleet Boston Corp.

Even Mr. Tilghman concedes that it is late in the current boom-bust cycle to take up enterprise hedging, now that companies have already suffered. "We're probably late to that party," he said. "This is a good time to figure out what you're going to need for the next cycle."

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