When all 50 state attorneys general launched an investigation into the national foreclosure crisis a year ago, it was specifically aimed at "mortgage servicers" — the companies that process homeowners' mortgage payments, modify loan terms and handle foreclosure paperwork on behalf of lenders. The states accused the servicers of using illegal practices to cheat homeowners and accelerate the already torrid pace of foreclosures around the country.
In practical terms, however, the states' investigation was aimed squarely at some of the nation's biggest and most powerful banks, which not only serve as lenders but control nearly two-thirds of the nation's mortgage servicing market themselves. By training their sights on the some of the very banks that many Americans blame for the housing crisis, the attorneys general ensured that their inquiry would be an unusually high-stakes and politically charged affair from the moment it was launched.
In this explainer, Stateline examines the states' investigation into the banks, as well as its potential outcomes, including a settlement of up to $25 billion that could contain direct relief for struggling homeowners and a new pot of money for states.
What's the investigation about? States accuse banks — through their mortgage servicing operations — of flouting state laws by systematically doing sloppy paperwork to speed up the foreclosure process. In particular, states say banks relied on a practice called "robosigning," in which foreclosure-related paperwork is signed by someone without direct knowledge of the facts outlined in the documents being signed. States also say mortgage servicers used affidavits that were signed without a notary public being present. While 23 states handle foreclosures through the courts and the rest do not, the attorneys general say there is evidence of wrongdoing in all 50 states.
Banks deny intentional wrongdoing, but they acknowledge that paperwork errors were widespread and often had devastating effects on individual homeowners around the country. Shoddy paperwork has led to scores of documented cases of foreclosures being initiated improperly, including cases against homeowners who were not behind on their mortgage payments.
What's the investigation not about? The investigation does not focus on some of the other mortgage practices that banks carried out before the housing bust. These include the widespread practice of giving loans to risky borrowers and the "securitization" of subprime mortgages into toxic assets. "We feel that this should be a homeowner case, not an investor case," says Geoff Greenwood, a spokesman for Iowa Attorney General Tom Miller, who is leading the states' inquiry. "We're afraid that by including securitization into the case it will indefinitely delay it."
Which banks are being investigated? Five banks are in the crosshairs: Bank of America, Citigroup, JP Morgan Chase, Wells Fargo and Ally Financial, formerly GMAC. Together, these five firms control 59 percent of the nation's mortgage servicing market. But the states do not plan to stop their investigation there. "Once we conclude this case," Greenwood says, "we will go down to the next tier of servicers."
Where does the investigation stand now?
Many, but not all, observers believe a settlement between the banks and the states is imminent. For months, a "negotiating committee" of attorneys general from seven states — Colorado, Florida, Illinois, Iowa, North Carolina, Texas and Washington — has been meeting regularly in Washington, D.C., with representatives from the five banks and the federal government. Those involved in the negotiations say many aspects of a settlement have been agreed upon, but that final details are still being worked out.
Once an "agreement in principle" is reached, it will be forwarded to all 50 state attorneys general for approval or rejection; it will be up to each individual attorney general to determine whether to join the settlement. If no settlement is reached, states are likely to take the banks to court; individual attorneys general also would decide whether to join the lawsuit or not.
What might a settlement look like? Broadly speaking, states want to rewrite the rules for the mortgage servicing industry to ensure that past abuses cannot be repeated in the future. They want mortgage servicers to be transparent and fair with borrowers at all stages of the process, from loan modifications to foreclosures.
They also want money. The latest iteration of the proposed settlement has a price tag of up to $25 billion, with that money earmarked for distressed homeowners in a variety of ways. States want a portion of it to flow directly into their coffers in the form of "hard money." That money could be used for a variety of housing-related initiatives that states would determine, including foreclosure hotlines and counseling for distressed homeowners. States also want banks to pay into a separate restitution fund for homeowners who have been wronged.
But the largest portion of the settlement would be so-called "soft money" that would not come in the form of banks writing a check to the states or to homeowners. Instead, banks would be required to offer homeowners loan forgiveness in a variety of ways, including principal reductions and, potentially, the opportunity to refinance for homeowners who are underwater but have not missed mortgage payments.
Would some states benefit more from a settlement than others? Yes. States with higher foreclosure rates and a higher percentage of "underwater" homeowners — those who owe more in mortgage payments than their homes are worth — would be likely to see more assistance under the deal. These states include Arizona, California, Florida and Nevada.
Why is a settlement taking so long? From a legal perspective, the negotiations are extremely complex. Many observers consider the states' investigation the most consequential multi-state action since the 1998 tobacco settlement, under which tobacco firms agreed to pay states a record $206 billion in exchange for a broad reprieve from future lawsuits. This time around, states are trying to reach settlement on some parts of the intricate mortgage-servicing industry — chiefly robosigning — while leaving the door open for future lawsuits in other areas. Thorny, unanswered questions include which homeowners would qualify for loan forgiveness initiatives, how much in loan forgiveness each homeowner would be entitled to and how the entire program would be administered.
Attorneys general also are being pulled in different directions politically. Distressed homeowners want help now, and they see a potential settlement between the attorneys general and the banks as the best way of getting that help. The banks also want a quick resolution, preferring to settle for an up-front cost rather than face lawsuits that could cost them far more down the line. But some attorneys general have grown frustrated with a 50-state approach and are striking out on their own.
Why are some states objecting? Some attorneys general believe that the 50-state investigation has not been aggressive enough, and that banks will be able to negotiate too sweet a deal. In August, New York Attorney General Eric Schneiderman was removed from the states' negotiating team after Miller, the Iowa attorney general, accused him of "actively undermining" the talks by going beyond their original scope. Schneiderman insisted on pursuing banks for their securitization practices as well as for their mortgage-servicing tactics, and shot back at Miller that his inquiry "cannot be shut down to accommodate efforts to settle quickly and give banks and others broad immunity from further legal action."
In September, California Attorney General Kamala Harris walked away from the talks, voicing some of the same concerns as Schneiderman. California, she said, "was being asked for a broader release of (liability) than we can accept and to excuse conduct that has not been adequately investigated."
Other states have potentially complicated the 50-state talks by moving forward with their own lawsuits against banks even as a parallel, national settlement is being finalized. Nevada, for instance, has filed a broad lawsuit against Bank of America over mortgage practices, leaving uncertain what may happen in the event of a separate, multi-state settlement that is reached with the same bank.
With California, New York and other states going their own way, some analysts are skeptical that a settlement is close at hand.
Isn't $25 billion a relatively small settlement? Compared with the vast dollar amounts produced by the 1998 tobacco settlement — funds that the states are still using today — a $25 billion bank settlement may seem tiny, particularly given the extent of foreclosures around the country. But state officials and consumer advocates caution that the foreclosure settlement should not be compared with the tobacco settlement because the attorneys general are trying to address just one part of the national housing problem. In addition, while improper mortgage-servicing practices may have been common, many homeowners are struggling for a more basic reason: They bought homes they could not afford.
"Looking for (the attorneys general) to solve a $700 billion underwater equity problem is absurd," says Ira Rheingold, executive director of the National Association of Consumer Advocates and a close observer of the negotiations. "The money that they're looking for doesn't solve the universe," he says, but is a first step in what could be years of legal maneuvering.