WASHINGTON — A rare public rebuke of a rogue attorney general by his colleagues has highlighted the dysfunction among the state AGs and raised doubts about their ability to strike a settlement deal with the largest mortgage servicers.

Banks are operating under the assumption that New York Attorney General Eric Schneiderman will not sign on to a global settlement — and expect a handful of other state AGs to follow suit — after he was accused of trying to undermine the negotiations and removed from the coalition's executive committee on Aug. 23.

His removal was an attempt to get settlement talks back on track, but many said the damage has already been done.

"This confirms the AGs are fundamentally split," Andrew Sandler, a partner with BuckleySandler LLP, said. "With New York and perhaps other significant states not participating, any overall settlement has significantly less value to the banks."

The value is both literal and figurative.

If the settlement does not cover servicing problems in New York — a state particularly hard hit by foreclosures — the settlement amount would likely be much lower.

In turn, if settling is supposed to put the whole foreclosure mess behind the banks, several lawyers asked, what have they really gotten out of it if they still face years of potential litigation with other states?

There is also an increasing risk that the negotiations, which have dragged on for more than a year, are losing momentum, said David Dunn, a partner with the law firm Hogan Lovells.

"Things like Schneiderman pulling out make everyone reconsider their position," Dunn said. "Certainly from the banks' standpoint, a settlement without New York is something everyone is going to have to think twice about. And from the states' perspective, if New York is no longer willing to participate, am I willing to participate?"

The AGs are already exploring scenarios under which New York or others are not party to the settlement, although they won't know the impact of such decisions until an agreement is reached in principal.

For their part, state and federal officials insist that Schneiderman's exit has not derailed negotiations — he was not part of the smaller committee negotiating directly with the servicers — and are still confident that banks see the value in a deal with the majority of states.

"If one state, no matter how big the state is, pulls out of a deal, is that reason to discount the other 49 states?" said one person familiar with the negotiations. "If you do decide, 'Well, no deal,' you run the risk of a raft of litigation. And if you can settle with all but one or all but a small number of states, it may make a lot of sense."

Although they have yet to work out the details, sources on both sides said they are mostly in agreement over new mortgage servicing standards. But the talks have stalled on the issue of future lawsuits — specifically, whether the banks will be released from liability for past servicer-related misconduct.

Schneiderman has launched his own investigations into mortgage securitization, and warned that a narrow release could let the banks off too easily before the full extent of their conduct has been uncovered. AGs from Massachusetts, Delaware and Nevada, have raised similar concerns.

"We will not settle an issue until we know all of the facts and we know all of the damage," Massachusetts Attorney General Martha Coakley said at a press conference earlier this month.

In a statement released Tuesday, Delaware Attorney General Beau Biden said he shared Schneiderman's concerns about the scope of the releases.

"I believe that the events leading up to the mortgage crisis must be fully investigated, including origination and securitization practices, before any broad immunity is granted," Biden said. "The American people deserve an investigation."

Sources on both sides have said the issue is primarily tied to the settlement amount.

Why pay all this money now if they're going to have to pay again later, either through a settlement or in court, banks have asked.

The amount banks pay now could also influence the amount of future settlements or civil penalties, as those plaintiffs will expect to get a similar deal, Dunn said.

"The more you're paying, the more you'd like to be sure you're closing the books," he said. "So I do think the inability to assure closure is an impediment to the banks writing larger checks."

A smaller settlement amount also means less money to be distributed among the states, and each one will have to make their own calculation about whether they're willing to accept less money in exchange for the narrow releases that their colleagues are seeking.

State officials have maintained that there is currently nothing on the table that would impede New York from pursuing securitization cases. Delaying the settlement to fully investigate those claims, however, could take years, and most states are not inclined to do that, either.

"There are some who have kind of set expectations that we are going to address everything under the sun, and we're not," said Geoff Greenwood, a spokesman for Iowa Attorney General Tom Miller, who is leading the negotiations on behalf of the 50 states. "We're focused on foreclosure and servicing practices. This is not a case that's focused on investors, it's focused on homeowners."

Some bank lawyers have speculated that if New York, Massachusetts, Delaware and Nevada do not support the final settlement, it puts increased pressure on California and Illinois — two states with significant foreclosure problems — to withdraw as well. If that happens, they said, the deal would collapse.

Others took a less pessimistic view, and expect that a settlement without some of the major players was still possible, and could even provide leverage in future litigation. But they don't expect a resolution anytime soon, despite reports that state officials have set a Labor Day deadline.

Meanwhile, the Office of the Comptroller of the Currency is reviewing action plans required by consent orders issued in April to the top-14 mortgage servicers.

The Justice Department asked the OCC earlier this summer to extend the deadline for the action plans — which would form the basis for broad mortgage servicing standards — to allow coordination with state and federal officials.

There is still a possibility for coordination, but it becomes less likely the longer the negotiations drag on, dampening enthusiasm for a global settlement, sources said.

"The only issue the AGs have really focused on — so-called robo-signing — is yesterday's news," Sandler said. "Real progress is being made pursuant to the consent orders that all of the major servicers entered into with the bank regulators. Given the delay, the right question is whether there is any continuing relevance to the AG process?"


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