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Leading Mortgage Firms May Be Forced To Reduce Loan Balances For Distressed Homeowners

Foreclosure Crisis

First Posted: 05/10/11 09:18 PM ET Updated: 07/10/11 06:12 AM ET

The nation's five largest mortgage firms may be forced to reduce loan balances for distressed homeowners as part of an agreement with state attorneys general and the Obama administration to settle claims of faulty mortgage practices, a top state official involved in the negotiations said Tuesday.

The proposal is part of a set of remedies banks would have to agree to in order to settle the state and federal probes launched last autumn, which found that the largest mortgage firms illegally seized the homes of at least dozens of borrowers and engaged in shoddy practices that short-changed troubled borrowers.

Mortgage principal reductions would comprise part of a larger fine levied on Bank of America, JPMorgan Chase, Citigroup, Wells Fargo and Ally Financial. Penalties could reach $30 billion, officials said.

The forced reduction of mortgage principal as a penalty against flawed past practices has proven contentious. Some Republican attorneys general have objected, as have some Republican members of Congress.

On Tuesday, however, a state official told The Huffington Post on condition of anonymity that the option "very much remains on the table."

While officials have not determined how much would be exacted from the banks -- and specific dollar amounts to settle the probes have not yet been discussed between the state and federal governments and the banks -- the proposal to compel financial firms to cut loan balances is part of one of two documents circulated Tuesday at a hotel in northern Virginia, where bankers, state officials and policy makers from the Obama administration began a three-day meeting.

The targeted banks have argued vociferously, both in private discussions and in public, that they opposed cutting distressed homeowners' principal balances.

During meetings two weeks ago, representatives from such banks conducted a presentation which they claimed illustrated that mandating principal reductions would not prevent a significant number of new foreclosures and would be harmful to the general economy.

The banks said "it would trigger a stampede of strategic defaults," an official familiar with one of the two discussions said at the time, referring to instances in which borrowers who can afford to make good on their obligations choose not to. Strategic defaults are much more common in the business world than among homeowners, according to experts who study the issue. Homeowners generally feel a moral obligation to continue making their payments, whereas corporations view the breaking of contracts as pure business decisions.

Government officials questioned the banks' assumptions and fought back against their claims.

The other document circulated Tuesday outlines standards that mortgage firms would have to adhere to for current and future borrowers, like forcing banks to ensure they have the right documentation when they move to repossess homes. The document was revised from an earlier draft first circulated in early March, The Huffington Post reported last week.

The standards are a response to investigations launched last fall after the nation's largest lenders voluntarily halted home seizures when faulty document practices -- like so-called "robo-signing" -- came to light, erupting into a nationwide scandal. Currently, no national standards govern how mortgage firms should treat borrowers who fall behind on their payments or default on their obligations. Congress has taken up the matter, and officials generally agree on how mortgage firms should treat borrowers.

Tuesday's bipartisan meeting included the Washington Attorney General Rob McKenna (R) and Colorado Attorney General John Suthers (R), who called in remotely. Top officials from Florida's and Texas' attorney general offices, both led by Republicans, attended, along with the Democratic attorneys general from Delaware, Iowa, Illinois, North Carolina and Connecticut.

Top officials from the Treasury Department, Department of Justice and the Department of Housing and Urban Development were also present.

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