Efforts to negotiate a settlement between state attorneys general and the top five mortgage servicers collapsed Friday after California pulled out the negotiations.

Industry observers said the move effectively kills any chance of a multi-state settlement, leaving the Justice Department and bank regulators to craft a deal with servicers. It follows the actions of New York in August, which also withdrew from settlement talks.

"With New York and California withdrawing, it is hard to see a multistate settlement that would make sense for the banks," said Andrew Sandler, a partner with Buckley Sandler LLP.

Others agreed.

"There's no point to cutting a deal if it doesn't include California or New York, and now both are out of the talks," said Jaret Seiberg, a financial services analyst at MF Global Washington Research Group. "This ends the talks for now. There's little in the short-term that could cause the talks to suddenly have momentum."

In a letter to Iowa State Attorney General Tom Miller, California Attorney General Kamala D. Harris said the deal under discussion was "inadequate for California homeowners." 

After a meeting last week in D.C., Harris said, "It became clear to me that California was being asked for a broader release of claims than we can accept and to excuse conduct that has not been adequately investigated."

"In return for this broad release of claims, the relief contemplated would allow too few California homeowners to stay in their homes," she wrote.

In a statement released Friday evening, Miller said the settlement talks would forge ahead, despite the setback.

"California has been an important part of our team and has made a significant contribution to this case," Miller said. "However, the multistate effort is pressing forward and we fully expect to reach a settlement with the banks."

Miller said that after a settlement is reached, it will be provided to all 50 states so that each attorney general can make a decision whether or not to join.

"This multistate is about foreclosures and mortgage servicing abuse, and we are 100% focused on providing relief to homeowners while it can still make a difference and save homes from foreclosure," Miller added. "Providing relief after the foreclosure crisis is over would be a hollow victory indeed."

Industry observers speculated that the global settlement talks were on the verge of collapse after New York Attorney General Eric Schneiderman was accused of trying to undermine the negotiations and removed from the coalition's executive committee on Aug. 23.

It remains to be seen whether federal officials — including the Justice Department, Consumer Financial Protection Bureau, and the bank regulators — can put together a settlement that banks are willing to accept.

But sources said they may be better-situated to forge a consensus than the state attorneys general, many of whom were facing increased political pressure in their home states.

Some banks may not be upset with that outcome, observers said. The Miller settlement would have been tough for them to swallow on its own, and wouldn't have prevented further lawsuits from New York, which has some of the toughest statutes.

The final settlement amount is also likely to much lower.

California, meanwhile, said it will continue its own investigation. In her letter, Harris referenced the work of her state's Mortgage Fraud Strike Force, which is investigating "all states of the mortgage lending process."

"I am committed to doing as thorough an investigation as is needed — and to taking the time that is necessary — to set the stage for achieving appropriate accountability for misconduct."

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