Officials Disagree on Penalties for Mortgage Mess

By Nelson D. Schwartz and David Streitfeld

Even as state attorneys general and regulators in Washington approach the end of their investigation into abuses by the nation’s biggest mortgage companies, deep disputes are emerging over how much to punish the banks as well as exactly who should benefit from a settlement.

The newly created Consumer Financial Protection Bureau is pushing for $20 billion or more in penalties, backed up by the attorneys general and the Federal Deposit Insurance Corporation.

But other regulators, including the Office of the Comptroller of the Currency, which oversees national banks, and the Federal Reserve, do not favor such a large fine, contending a small number of people were the victims of flawed foreclosure procedures.

As the negotiations grind on, there are signs that the banks still have not come to grips with the problems plaguing the foreclosure process. These problems burst into view last fall with accounts of so-called robo-signers processing thousands of foreclosures at a time without the required legal safeguards. The resulting furor prompted the attorneys general and other government officials to step in. Some banks suspended foreclosures to review their processes before resuming.

On Monday, though, HSBC disclosed that it had suspended foreclosures after regulators found “deficiencies” in its handling of them. These included problems with court affidavits, notarization, mortgage documentation and oversight of law firms, a spokesman for the lender, which is based in London, said. HSBC declined to say how many homeowners were affected.

“The events of the fall really uncovered and provided a degree of focus on fundamental problems in the way banks service and foreclose on mortgages,” said Paul Leonard of the Center for Responsible Lending. “Regulators have a great opportunity to come up with some serious fixes.”

Assuming, that is, they can agree. As difficult as it is to decide on a figure for any broad settlement, the question of what to do with the money could ultimately prove more vexing.

If only victims of problems at the servicers are helped in a settlement, that would cover a small portion of homeowners who are in default and even fewer of those whose homes are valued at less than they owe.

All the regulators declined to comment publicly on just how close they are to wrapping up a global settlement that would be presented to the banks. But signs of the differences have emerged in public testimony as well as in private conversations with government officials.

The acting comptroller of the currency, John Walsh, testified last week that while there were widespread problems with documentation and oversight of law firms and other crucial links in the foreclosure chain, only a “small number of foreclosure sales should not have proceeded.”

Despite skepticism on the part of the comptroller’s office, other regulators would like a broader plan to help pay for modifications of mortgages that are delinquent or in default, even if homeowners cannot point to a specific example of wrongdoing on the part of servicers. In other cases, the money might be used to help mortgage holders whose loan principal exceeds the home’s current value.

What’s more, the Obama administration, as well as the F.D.I.C., sees any broad settlement with the servicers as an opportunity to do more than just fix the foreclosure process. They want to stabilize the housing market, where prices are continuing to decline, and try to help bolster the economic recovery, which is facing newer threats like higher oil prices.

Some two million American homes are in foreclosure, a third of which are vacant. Another two million households are behind on their payments and facing the prospect of foreclosure this year. To make matters worse, roughly a fifth of the nation’s home loans exceed the value of the underlying house, raising the risk that homeowners will simply walk away, further weakening the housing market.

Right now, the Obama administration argues, the housing market is facing the worst of both worlds — a big back-up in foreclosures as procedures are reworked, and a similarly long wait to get a mortgage modification in which the principal or the interest rate of the loan is lowered, easing monthly payments.

Any settlement would include provisions to streamline the modification process, which has proceeded at a snail’s pace at many servicers, frustrating many homeowners. The money from the banks, in turn, would help cover the cost of reducing principal and interest payments, paving the way for more modifications. Advocates argue that would finally get the housing market moving again.

But even if these proposals make it past all the regulators, they face fierce opposition from the banks, which argue that what the administration and the attorneys general have in mind is a back-door bailout for delinquent homeowners.

“It’s like taking money that should be paid to the Treasury and using it for an unappropriated social program,” said a lawyer for one of the top servicers, who spoke anonymously because the negotiations were still fluid and the banks had yet to be presented with a proposed settlement. “This is a bad idea, no matter who pays for it.”

The nation’s largest mortgage servicer, Bank of America, is already readying what will be among the industry’s main arguments: that it is unfair to reward homeowners who are delinquent or underwater but cannot point to specific errors in their case.

“The question is one of fairness, who should receive a modification and who should not,” said Jim Mahoney, a spokesman for the bank. Too broad a rescue package, he said, “could forestall the housing market recovery or even create perverse incentives.”

One possibility, industry insiders and banking lobbyists suggest, is that homeowners might deliberately become delinquent on their loans to get a principal reduction. Housing activists counter that homeowners seeking modifications are often told by their lenders to stop payments, and then end up in foreclosure.

The debate reflects some degree of weariness with foreclosure, as the administration’s signature mortgage modification program is under attack by both House Republicans and housing activists as a failure.

“There has been a tension in this country during the financial crisis,” said Michael S. Barr, a former Treasury official now at the University of Michigan Law School. “People want those who are in economic trouble to get a fair shake. But they don’t want them bailed out for making their own mistakes, like buying too big a home.”

While regulators worry about how punitive any eventual settlement should be, lawyers and other advocates for the foreclosed who were hoping for criminal charges are set to be disappointed.

That sanction, everyone seems to agree, is off the table. In testimony in December about the improper foreclosures by banks, Daniel K. Tarullo, a Federal Reserve governor, floated the notion of imposing fines on individuals found responsible for violations or banning them from banking, but officials involved in the talks said this idea had not gotten much traction either.

“The fact is, when the banks prepared their foreclosure paperwork for the courts, they lied about the credentials of their witnesses,” said Thomas Cox, a Maine lawyer who works with foreclosure assistance groups. “Criminal sanctions would act as a deterrent.”