The so-called mortgage settlement looks to be coming apart at the seams. That does not mean there will not be a deal of some sort. Remember, a hallmark of the Obama administration is to do things simply to have more “achievements” to discuss. But not only, as has been rumored for some time, are a number of Republican attorneys general saying they will not join in the settlement, so are some Democrats as well.

It’s important to recognize that Democratic withdrawals are a far bigger problem for Obama than the Republicans. Given that a number of AGs signed up at the last minute, and some of the Republicans were not even on board with the concept of a mortgage settlement, defections among the GOP participants can be depicted as partisanship. By contrast, repudiation by Democrats, particularly Democrats that have garnered some attention in the national press by taking mortgage abuses seriously, is much harder for the Administration to explain away. And as David Dayen at Firedoglake reports, if enough AGs defect, the settlement becomes a dead letter:

The master settlement agreement with the tobacco industry in 1998 eventually got the agreement of 46 AGs, with the other four coming aboard later. That would be similar to the necessary outcome here; to become the official position of the National Association of Attorneys General, at least 38-41 of the AGs would have to sign on. And even that has no binding force to supersede state law.

As we anticipated, the AGs are unhappy about how the negotiations have been conducted (they have been kept in the dark and are now being railroaded) and the failure to have any serious investigations. Per Dayen, they are also concerned, as we are, that the banks will be given a broad release:

Democrats in AG offices across the country find themselves uncomfortable with the deal, in particular the speed with which it is being ushered through the system and the lack of clarity over what claims they would have to relinquish under the deal…. While the AG investigation was announced last fall, the settlement term sheet arrived with some surprise a couple weeks ago, just prior to a meeting of all 50 AGs in Washington. Democratic AGs and senior staff, who spoke off the record because of Tom Miller’s lead role in the case, said that they only received the term sheet, seen as a first offer to the banks, a couple days before the meeting, and didn’t know until they got to the meeting that it would be a big topic of discussion. And then, not only were the AGs told about the term sheet and the push for principal write-downs to save as many as 3 million homes from foreclosure, they were told they would have to make someone from their offices available full-time to enforce the terms of the settlement. And they were told that all of this would have to come together in a “window of opportunity” over the next 6-8 weeks… The investigation hasn’t done much investigating to this point; no subpoenas have gone out and no depositions taken. Instead, the AG working group is mainly going off of consumer complaints and court findings…. Troublingly, there’s been very little indication from Miller and the AG working group on what they would have to give up in this exchange. That raises the spectre of a final agreement that legally indemnifies the banks while providing too little support to homeowners, just enough to make a big press conference full of back-patting about helping the little guy.

As we said earlier, this smacks of Iowa attorney general Tom Miller negotiating AGAINST the AG group on behalf of the Administration (and ultimately the banks) rather than playing his professed role of acting as lead negotiator/representative. If I were one of the AGs who’d been treated this way, I’d be ripshit.

And why all the haste? Well, it appears that cheerleading, letting the banks foreclose when investors would prefer deep principal mods to viable borrowers, ill-conceived Federal mortgage modification programs, and a head-in-the-sand approach to documentation problems and procedural abuses have done wonders for the housing market, which most experts expect to fall another 10% this year. The Administration appears prepared to redouble its efforts in this failed strategy since it lacks the guts to do anything that might actually be effective. But Team Obama still appears to believe that all problems can be solved via public relations. The fact that HAMP was an embarrassment appears to have led to the bizarre conclusion that the remedy is better modification theater:

That need for speed seems to be coming from the White House, who by all accounts want to move on a settlement quickly, and to use it as a way to promote economic recovery more than anything….The rush to settle, driven by Washington, appears to serve a political function of “doing something” about the housing market, which is rapidly falling apart.

But as we indicated, that’s simply delusional thinking. Even if the banks agreed to $20 billion worth of modifications, that’s insufficient to have any real impact. $20 billion on top of principal mods that would involve investors taking hits (which still leaves them well ahead of where they’d be in foreclosure) would be another matter entirely. But bizarrely, homeowners and investors, the parties who have most at stake, seem even less well represented than the AGs in these negotiations. And Dayen gives a simple example of why the proposed settlement may be a complete giveaway:

In just one case this week, a jury awarded a GI $20 million in a case where Coldwell Banker was accused of mishandling the man’s automatic monthly mortgage payment while he was on active duty overseas, improperly reporting him to credit bureaus with a serious delinquency, and then failing to correct the error. This was a standard servicer abuse case, just one of maybe millions, and it netted $20 million. Just 1,000 cases of this type would equal the $20 billion thrown around as a possible settlement number.

In fact, a lot of states would cut back this settlement amount considerably on appeal (in Alabama, the state Supreme court appears to have made a decision that no consumer matter can ever be worth more than $1 million). But more cases like this generate bad headlines and costly appeals and encourage more borrowers to litigate…..which lead to more fact patterns being established that make it easier for both state AGs and class action lawyers to take up much broader scale lawsuits.

The negotiations also are in disarray among the Federal regulators. The Office of the Comptroller of the Currency is trying to cut its own deal. As Reuters reports (hat tip Matt Stoller):

The primary regulator for the largest U.S. banks is preparing to move ahead on its own settlement with lenders over foreclosure practices and may announce a deal in the next few weeks, according to a source familiar with the process. The Office of the Comptroller of the Currency’s possible split from other U.S. authorities would mark a dramatic shift away from efforts for a coordinated settlement with major mortgage servicers, including Bank of America Corp, Citigroup Inc and Wells Fargo & Co. U.S. authorities — including bank regulators, the Department of Justice and a coalition of 50 state attorneys general — are probing allegations that banks foreclosed with improper documents and cut corners on repossessing homes from borrowers. The OCC is in talks with the banks it regulates to prepare so-called consent orders, requiring the banks to fix faulty foreclosure processes within a certain timeframe, and potentially levying fines for violations, the source said. The OCC, according to the source, has become impatient with infighting over the structure and shape of a coordinated settlement.

This is a more serious threat to the settlement than one might think. The OCC may be engaging in a parallel discussion to pressure the other Federal regulators and give Team Obama a face saving fallback if the AG/FDIC /Elizabeth Warren as member of the Treasury discussions fail. The OCC has been aggressive about preempting state regulation of national banks under the Supremacy Clause of the Constitution. It has said in past regulatory letters (hat tip Lisa Epstein) that its authority does not extend to matters that involve liability to investors in residential mortgages (effectively, in this letter, the trustees were trying to claim pre-emption for the benefit of the securitization certificate-holders; the OCC said that didn’t pass muster).

The open question here is where servicing falls. Geithner claimed that federal regulators have no authority over servicers; it would be interesting to see what theory the OCC uses if it decides to go the pre-emption route, particularly since the Supreme Court has consistently ruled that real estate transactions (as opposed to making real estate loans) is a state matter. Thus the conveyance of mortgage notes might be deemed to be a Federal matter, but it’s hard to see the OCC arguing that foreclosure-related matters are within its purview. But this is over my pay grade; we may see the lawyers duke this one out.

Another indication of disarray are efforts to add more bells and whistles to the proposal. This looks like part of a desperate effort to get to some kind of a deal rather than part of a coherent negotiating strategy. Note that this amounts to the Federal settlement team negotiating against itself; the banks have yet to make a counteroffer. Per the Financial Times:

The five biggest US mortgage servicers were told this week at a private meeting with regulators to consider paying delinquent borrowers up to $21,000 each as part of a broader settlement of the foreclosure crisis. People who attended the meeting, chaired by the Federal Deposit Insurance Corporation on Monday, said the industry-wide “cash for keys” programme would involve the biggest servicers, led by Bank of America, paying borrowers as an incentive to leave their homes. Banks would pay borrowers who are more than 90 days behind on mortgage payments up to $1,000 to seek independent financial advice and up to $20,000 in cash as a “fresh start” payment towards living costs in a new home. They would have to vacate their properties quickly and leave them in good condition…. However, prospects for a single “mega settlement” have worsened because officials disagree on the level of penalty and whether money raised in fines should be used for a principal writedown. The banking regulators, who do not agree among themselves, are nonetheless keen to come to an agreement quickly. One way through the gridlock, which has been discussed among officials, is giving the servicers a menu of options for settlement, which might include principal writedown or a “cash for keys” scheme.

As we indicated, if this deal falls apart, or Obama merely comes up with a Potemkin program that fails to forestall state AG action, the public will be better served. The evidence is that enough judges still care about the rule of law that more and more bank abuses will come to light if the authorities leave matters to the courts.