As the mortgage servicing settlement talks stall, some observers are wondering whether the two main parties — the banks and the attorneys general — would be better off without making a deal.
In addition to the $20 billion figure being thrown around, many of the initiatives contained in the proposal could cost the banks additional billions of dollars.
Another consideration for the servicers is that if they agree to make principal reductions, investors in MBS might conceivably sue them. That's what happened to Bank of America Corp. after it agreed to do such modifications under a settlement with attorneys general in 2008.
And if the attorneys general enter a settlement that lets the banks off the hook for future litigation, they could antagonize voters and consumer advocates — especially if the settlement does not substantively address foreclosures. (Several federal agencies are also involved in the talks.)
To be sure, there are pitfalls to going without a deal as well. Do the banks want to face open-ended legal warfare in state courts for years to come? And what types of concessions could the attorneys general expect to wring from the banks in state courts?
The key sticking point in any settlement is what the terms are of a yet to be determined legal release or at least some type of assurance that would have to accompany any settlement, said Prentiss Cox, a University of Minnesota law school professor.
"From the attorneys general point of view, I think that it would be very difficult to say they won't look under the rocks of what is going on and at whether anyone was abused," said Cox, a former Minnesota assistant state attorney general.
"On the banks' side, do they want to enter into a comprehensive settlement if they don't get that assurance?"
A settlement that fails to address the interests of investors in the $1.4 trillion private-label mortgage-backed securities market could be open to various legal challenges.
After the 2008 attorneys general settlement with Bank of America over allegations that its subsidiary Countrywide engaged in predatory lending — the largest attorneys general settlement with a bank to date — investors unsuccessfully sued in an attempt to get B of A to buy back the loans that were being modified.
Some of the same investors who were active in that litigation are not mincing words about the latest effort by the state attorneys general.
"The settlement proposal is a train wreck," said William Frey, chief executive of Greenwich Financial Services, whose lawsuit against Bank of America objecting to the Countrywide settlement was thrown out of New York State court six months ago.
Frey, one of the principal figures in the separate mortgage put-back litigation against the banks, said that the current attorneys general settlement proposal failed to adequately address the substantial holdings of second-lien loans on bank balance sheets that he said should be wiped out completely before first-lien loans packaged into securities are modified.
(Although the four largest banks service 56% of all outstanding home mortgages, according to a report last year from the Congressional Oversight Panel for the Troubled Asset Relief Program, those four megaservicers hold less than 10% of the outstanding first-lien residential mortgages in the country on their books.)
Another issue for Frey is the proposed replacement of the existing dual-track process for foreclosures and modifications with a single-track one that would require that the borrower be evaluated for a modification before any foreclosure proceeding could take place.
"It is rational to modify a loan where it is economically feasible," Frey said. "It is silly to delay a foreclosure while modifications are talked about when the modifications are not going to happen."
One of the most formidable challenges to reaching any kind of settlement between the banks and the state attorneys general is that the discussion is so polarized about what the settlement represents.
"I don't like legislating through these types of settlement agreements, and my general concern is that this seems to be an extrajudicial remedy," said Joseph Lynyak, a partner in the law firm Venable who represents banks.
But to Diane Thompson, counsel to the National Consumer Law Center, the main emphasis of settlement is not about changing existing law.
"I think that it is clear that the banks are being vociferous about a settlement that restates existing law and honest principles of corporate dealing," Thompson said. "We believe in fair play in this country — and most of what is embodied in this settlement is about being fair with your customers and not charging them fees you shouldn't be charging them."
According to Andrew Sandler, a banking lawyer and partner in BuckleySandler LLP, the settlement mixes apples and oranges. "It is leveraging collateral enforcement concerns to try to obtain principal reductions that are completely unrelated," Sandler said, "without really relating principal reductions to the underlying concern."
In considering whether or not to settle, both the attorneys general and the banks must also consider what the cost would be to fight it out in court.
"A lot of the AGs offices are overwhelmed and don't have the staff to take on this level of complexity," said Cox from the University of Minnesota Law School.
"A bank can spend easily in excess of $10 million in major litigation with a state attorney general's office," Cox said, noting that when he was assistant attorney general he worked on a case against a bank where the resource ratio was 15 to 1 in favor of the bank.
"You are down to just a few AG offices that have both the resources and the motivation to go after large litigation," Cox said.
Although the banks might be able to use their overwhelming legal firepower to squash or intimidate many attorneys general, they have to consider what the ramifications might be of losing a few pivotal battles.
For example, consumer class-action attorneys and attorneys representing investor groups might be able to build cases around information uncovered in an individual attorney general's investigation.
"How much are banks willing to let the attorneys general use their investigative authority to reveal information that would then allow a class-action attorney to engage in lawsuits?" Cox asked. "You have to look at enforcement in a bigger picture."
However, Sandler, the financial industry lawyer, said that whatever type of settlement gets signed, there undoubtedly will be future lawsuits against the banks stemming from the housing meltdown.
"The banking industry is in for a period of time when they will be subject to consistent scrutiny from the AGs," Sandler said.
"Whether there is a settlement or not, individual enforcement action is something that banks will likely see for the next couple of years."
And although the odds seemed stacked in the banks' favor, "a few AGs can have a tremendous impact," Cox said. "It only took one Eliot Spitzer to make some major changes in Wall Street."
Banks are expected to make a counteroffer to the attorneys general this week.