After uncovering significant problems in the foreclosure process, the 50 state attorneys general and several federal agencies delivered a 27-page list of demands to the five largest mortgage servicers, requiring upgrades and changes throughout their systems.
But many have begun to suggest the government went overboard by setting unrealistic goals, a move that could backfire and give the banks involved more leverage to fight some of the most onerous requirements. Bankers note that the term sheet makes no mention of what they did wrong — leaving it unclear what problems some suggested remedies are meant to correct — and that it treats all the servicers exactly alike.
Banks are almost certain ultimately to sign a settlement, but observers doubt it will resemble this opening offer.
"It probably goes too far," said Brian Gardner, a political analyst at KBW. "We now know there were a ton of problems with the robo-signing issue, and those need to be addressed, but it seems they are trying to kitchen-sink everything and shove it all in one, and I don't think that's the right approach."
The term sheet covers virtually every aspect of the servicing business, detailing requirements for mortgage documentation, interaction with borrowers, relationships with active military personnel, loan modifications, principal reductions, bankruptcy proceedings, short sales and technology systems. It even specifies that servicers should start relationships with retailers like Wal-Mart Stores Inc., to provide a way for troubled borrowers to fax in their documents for free.
While the term sheet is undoubtedly a powerful opening salvo in negotiations with the banks, many observers said the government undercut itself.
"It went to a point where I think some provisions would be unconstitutional and certainly subject to a court fight," said Stephen Ornstein, a partner at SNR Denton. "It seems compendium to a wish list of consumer activists and people in the Obama administration. I just don't think it's realistic."
State AGs and consumer advocates disagree, arguing that they are mostly enforcing existing law. Some even suggested the banks were getting off easy.
"This settlement is more than the banks could hope for given the evidence of both illegal and negligence practices," said Julia Gordon, senior policy counsel for the Center for Responsible Lending. "These investigations have revealed that there are huge problems throughout the servicing system, and as a result millions of foreclosures may have happened. Where you stand depends on where you sit. I don't see [the term sheet] as that aggressive."
Iowa Attorney General Tom Miller, who is leading the investigation for the attorneys general, insisted last week that the term sheet was workable. The settlement is on behalf of the attorneys general, the Justice Department, the Department of Housing and Urban Development and the Consumer Financial Protection Bureau.
"It's fair, in my opinion," he said at a news conference. "While a lot of it is comprehensive, a lot of these are things servicers should have been doing years ago. So it's not a new system."
But bank lawyers said there are several new requirements, including a push for principal reductions, the creation of new websites to help borrowers upload modification documents, restrictions on force-placed insurance, and creating a single point of contact for troubled homeowners.
"The proposed settlement terms are very far-reaching," said Lisa DeLessio, a partner at Hudson Cook. "They touch on almost every aspect of servicing. While certain terms may already be in place as best practices — for example, related to affidavit practices — there are other things like that single point of contact that may be unworkable for servicers. Many of the issues raised in the settlement terms would be best addressed through rules or regulations where there is an opportunity for debate and comment and where there is fair notice on application of the requirement. The proposed settlement on some in the industry leaves others uncertain on their obligations."
Tom Deutsch, executive director of the American Securitization Forum, said many servicers would violate contracts if they signed the term sheet in its current form because they are prevented from conducting many of the loss-mitigation efforts outlined in the draft agreement.
"There's no possible way the servicer could sign on to this and comply with their existing contracts for mortgage securitization," Deutsch said. "If any servicer signed on to this settlement, they would have to settle in another year of breaches of this settlement because there are so many terms they can't live up to. In any negotiation you want to talk with a high ceiling. Unfortunately, this is such a high ceiling, it may have impaired some of their credibility in negotiations."
But Michael Barr, a professor at the University of Michigan and a former Treasury assistant secretary, said the term sheet is an appropriate starting point.
"It's not surprising the banks want to push back on it," Barr said. "It's part of a negotiation they are having with the AGs and federal government. The document was clearly a draft … but it struck me as plausible and reasonable basis for conversation."
Many observers said the state AGs were starting off strong in the bargaining.
"This is a negotiating tactic by the regulators to see how far they can go with the banks and force the banks to settle more than just looking at the robo-signing issue," Gardner said. "It's tough to say, because I don't know where the breaking point is for the banks on what they will agree to."
But privately, bankers are adamant they have no intention of signing the term sheet in its current form. Some observers even question whether the state AGs all agree with the term sheet.
"I don't think the banks will sign on to it and I don't think the AGs will sign on to it," said Josh Rosner, managing director of the research firm Graham Fischer & Co. "There's a lot of division in the AGs and a lot of it is justified. There is no clarity in terms of claims. Would this preclude AGs from going after fraud? If it does, I think you will have a hard time getting AGs to sign on to it. If it doesn't, you will have a hard time getting banks to sign on to it. It almost seems like a waste of time."
A spokesman for Miller said the term sheet is simply a starting point.
"Let's keep in mind that there is no settlement and we have yet to meet face to face with the banks," said Geoff Greenwood, a spokesman for Miller. "What we have is our initial term sheet, and we expect the banks will respond shortly. The system is broken, and as attorneys general we plan to exercise our lawful authority, in conjunction with appropriate federal agencies, to address these problems comprehensively. We'll negotiate and try to resolve this in a manner that's fair to the servicers, investors and homeowners."
Servicers are also concerned about language in the term sheet that would make a violation of the settlement an "unfair and deceptive" practice, which raises the potential penalties banks would face.
"The real problem from the servicers' perspective is creating a lot of new legal duties and this is very prescriptive," said Joseph Engelhard, an analyst at Capital Alpha Partners. "The whole point of a global settlement is we are going to resolve this and move forward, but this would create the opportunity for more lawsuits down the road."
Privately, many bankers also note that the term sheet does not spell out what they did wrong. Federal regulators have said they found violations of state foreclosure laws, but the banks have not seen their specific findings. The term sheet also treats the five servicers equally, allowing for no differences among the firms.
"My biggest issue with this thing if this were a sincere approach to outstanding issues, you would think they would have done enough of an investigation to figure out what the damages are on a firm-by-firm basis, and that hasn't happened yet," Rosner said. "We don't know which banks or servicers did what wrong."
While the banks are likely to succeed in watering the term sheet down to a workable compromise, they are unlikely to challenge the settlement in court, observers said.
A Washington lawyer, who could not be named because of a connection to the case, said fighting the settlement in court would be difficult. It would force the attorneys general to bring a notice of charges through an administrative judge and prove how the standards would correct wrongdoing.
But it bears its own risk for the banks, too.
"The bottom line is in the final analysis very few banks want to end up going to court unless they feel they will be 100% vindicated," the lawyer said. "In the history of the universe, is this really a time to go to a court to ask for vindication of these issues given the court cases on these issues? The banks have not been that successful on these issues. Is there anywhere they could get a sympathetic judge on these issues?"
Gil Schwartz, a partner at Schwartz & Ballen, agreed.
"The alternative is to go to court and fight whatever charges brought by the federal regulators or state attorneys general, and no one has the stomach for that," he said.
Still, banks often avoid court for fear of negative publicity surrounding such a case. But with regulators already criticizing the top servicers, the government's ability to embarrass the servicers in the media may be relatively light.
Republicans, meanwhile, are coming to banks' aid. Sen. Richard Shelby, the Senate Banking Committee's top GOP member, accused the state AGs last week of a "regulatory shakedown" to "advance the administration's political agenda." House GOP leaders, including Financial Services Committee Chairman Spencer Bachus and Rep. Scott Garrett, R-N.J., sent a letter to Tim Geithner, secretary of the Treasury Department, expressing concerns over the breadth and scope of the proposed settlement.
In an interview, Rep. Randy Neugebauer, R-Texas, who signed the letter, said the term sheet was inappropriate.
"I think the radical nature of this settlement almost brings a great deal of uncertainty to an area of the economy we are all trying to get back working again," Neugebauer said. "I think the whole thing is a disaster, actually."
It is unclear to what extent the lawmakers' comments can affect the enforcement proceeding. At best, it may give bankers more cover to keep fighting for a better deal.
"It's important in that it gives servicers greater room to say, 'We are not being completely unreasonable here with the ranking member in the Senate and a large group in the House,' " Engelhard said. "I think it's helpful. … It certainly gives the servicers, it encourages them to take a stand on what's onerous on the proposed terms."