While the effective demise of settlement talks between the state attorneys general and the top mortgage servicers has its downsides, it may ultimately turn out to be a good thing for banks.
On the one hand, bankers have lost a chance to make a clean break with the past by settling charges of improper servicing practices and now face a host of separate investigations and lawsuits by dozens of individual states.
But sources close to the situation said many are privately relieved that the talks have failed, arguing banks would have been forced to agree to a higher settlement than they felt the situation deserved and are now free to cut a less onerous deal with federal officials.
"Nobody should underestimate the extent to which the banks feel that the dollars involved are way out of line with what would ultimately be recoverable in case-by-case litigation," said Ellen Marshall, a partner with Manatt, Phelps & Phillips.
Since the spring, the state AGs have been pushing for a settlement of more than $20 billion — a figure bankers had rejected as far beyond their actual liability. Still, servicers were at least interested in cutting a deal, hoping to put the issue behind them quickly and avoid ongoing reputational damage.
"The literal cost and the psychological cost and the reputational costs and all the other costs associated with having all those separate litigations is daunting enough that it's worth it to them to spend a lot of money," said Marshall.
As time wore on, however, servicers felt they had progressively less incentives to settle, at least not for the sums the state AGs — led by Iowa Attorney General Tom Miller — wanted. When New York Attorney General Eric Schneiderman was removed from the process, vowing to pursue his own separate litigation, there was even less reason to cut a deal.
"The Miller process was going to result in a settlement that would have been tough for them to swallow," said one source close to the situation. "They've already taken the maximum political hit, and they were going to be litigating against Schneiderman anyway."
The final straw came Friday, when California Attorney General Kamala Harris said she would not be party to a deal.
Although Miller insists settlement with the remaining states is still viable, the potential for a significant deal is minimal, observers agreed.
"I don't think there will be a number that will be acceptable to the smaller AG's and the banks," Marshall said. The banks "could offer a much smaller dollar figure, but it probably wouldn't be acceptable to the state AG."
The servicers now expect that the Justice Department, which has taken the lead on behalf of federal officials, will pursue their own settlement, sources said. That may prove to be a much easier lift and help remove some of the tarnish on servicers.
For one, Justice has fewer forces to corral, and faces less political pressure.
Observers also expect the Consumer Financial Protection Bureau, which is already working with federal regulators to revamp mortgage servicing standards, will take a larger role in the negotiations.
"To the extent that the CFPB gets in there first and cuts a deal, which has always been a looming threat to the AGs, that would probably lend more closure and relief to the servicers in the end than some kind of ongoing sideways negotiations with the AGs," said Tim Rood, a partner and managing director at the Collingwood Group.
A settlement with federal officials could also provide some uplift for the market, one source said.
The big question for the servicers remains: how much of a discount will they get from a federal settlement?
Not everyone was convinced that it would be so quick or easy.
"In a perfect world, one would think that Congress, the Fed, regulators, might be able to step in and get some of this resolved, and they may," said Ira Reingold, executive director of the National Association of Consumer Advocates. "The problem is the foreclosure crisis is not ending, and each day we wait, more and more people suffer."
To be sure, the absence of a global settlement has its drawbacks for the banks and the AGs.
People who have less faith in federal regulators to affect meaningful changes to servicing believe both sides are losing a big opportunity.
"One would think that if they want to move forward, they have to remedy all the things that they did wrong, but they also need a roadmap for moving forward, and a multistate settlement could provide that roadmap," Reingold said. "That's what, if this thing does fall apart, they lose."
They also face the continued threat and cost of litigation, although some bank lawyers believe that states are too cash-strapped to pursue the kind of widespread investigation that these types of cases would require. Perhaps more likely are lawsuits initiated by private plaintiffs and supported by the state AGs.
Either way, those would take years to resolve.
Ronald Glancz, a partner with Venable LLP and the former director of litigation at the Office of the Comptroller of the Currency, said he expected banks may wait to see how courts decide the first few cases. Those decisions could eventually bring both parties back to the negotiating table.
Others remained convinced that some kind of multistate settlement is still possible.
Glancz said he envisions federal officials perhaps taking back the reins from state officials, but not necessarily crafting a separate deal.
"When you do have these legitimate interests, and everyone has their own timetables, it's really hard to get everyone in the room," Glancz said. "It's never over until it's over. I've been in settlements where everyone's yelling at each other, they walked out the door, and lo and behold a week later we settled the case."
The negotiations have dragged on for more than a year now, however, and the possibility of achieving such a settlement decreases by the day, sources said.
"The whole nature of the discussions have been two gorillas — two groups of gorillas — going against each other, both of whom have very legit perspectives on how a settlement could or should be structured," Marshall said. "It just may be that there isn't a settlement to be had."