Last Chance for 50-State Coalition to Help Wronged Borrowers

The state Attorneys General need to get a deal done soon, or they — and by extension American homeowners and those who have lost their homes — lose.

Iowa's Tom Miller has led a coalition of all state Attorneys General for about a year in talks with the nation's major lenders to settle potential claims for fraudulent mortgage servicing practices, ranging from robo-signing, in which employees signed foreclosure documents without any review, to the use of MERS to circumvent state recording laws, to general deceptive practices about mortgage, servicing, and loan modification practices.

Massachusetts Attorney General Martha Coakley recently joined those from California, New York, and Delaware in openly pursuing investigations and law suits separate from the unified settlement talks between the states and the lenders.

As prominent states peel away from the settlement talks there is a concern other states will doubt the viability of the coalition, weakening AG Miller's negotiating power, perhaps fatally.

You really have to hand it to the attorneys representing the nation's major lenders. They may have just played the long game well enough to save their clients billions of dollars in state settlements related to mortgage servicing fraud.

Banks are understandably unwilling to sign a settlement unless all signatory states are willing to forgo their own separate actions. The purpose of settlement, after all, is to limit potential exposure. A settlement without significant players like Massachusetts (because of AG Coakley's aggressive style) and California (because of its size) involved makes that exposure all too real and limits what the rest of the states can ask of the banks. If what remains is too small, the two sides may give up all together.

Lenders' attorneys orchestrated this breakdown in April 2011, when they announced that they had entered into a settlement with federal regulators. In early March, the AG's proposal leaked, requiring additional loan modifications and strict servicing standards. On March 28, lenders had sent a counter-proposal to Miller that was widely viewed as inadequate, offering to conduct reviews of their processes with third-party consulting firms and mail letters to borrowers permitting them to request review of their files.

It turns out that just one day later, Bank of America and Citi signed consent orders with OCC and the Federal Reserve, committing to doing the same thing. The third-party consultants were selected and letters to homeowners finally went out in November.

My organization warned that an existing federal settlement threatened a state AG settlement, as a federal settlement would make a state settlement appear superfluous to casual observers, despite the fact that state regulators were pursuing far more meaningful settlement terms.

The longer the banks delayed a state settlement, the more superfluous it would appear — giving them no incentive to move quickly. The AG coalition was already beginning to fracture, and that delay would only put additional pressure on it. That was what lender's attorneys were betting on, and they were right.

In April, we recommended that states refocus efforts on exacting penalties from the banks at or above the $20 billion figure being tossed around at the time. In October, Miller did that, tacking $5 billion for refinancing underwater loans to the proposed $20 billion settlement. The banks responded with a $2 billion offer, but there has been no further movement.

Ironically, Dodd-Frank may have facilitated the fragmentation of the state AG coalition. As we noted in April, before the relevant provision of Dodd-Frank took effect in July 2011, there was a risk that the banks' settlement with the national bank regulator could preempt further action at the state level. Dodd-Frank eliminated that provision, removing at least one defense against actions by individual state AGs.

It is time for the state AG coalition, led by Miller, to step up and get a deal done or step aside. State AGs were hoping this was a "stag hunt," in which they could catch a stag together instead of settling for hares separately and get meaningful relief and redress for current and former homeowners. In real life, however, California, New York, and Massachusetts' hares are much bigger than Iowa's or Minnesota's, so AGs in big states are rightfully getting restless. Meanwhile, Americans in smaller states or those with AGs less inclined to act on their own are likely to lose out if states each pursue their own actions.

If a deal can be done early in the new year on meaningful terms, it needs to be done. Massachusetts, California, New York, and Delaware may have helped in that effort by showing they are serious about pursuing large claims independently, creating risk for lenders that is large and hard to quantify and that might lead to a greater incentive to settle. But if a deal isn't done in January, it will be time to admit that lenders' attorneys outfoxed the state AG coalition and to not wait any longer before letting states look after their own interests.

Alon Cohen is a consultant on housing issues at the Center for American Progress.