State attorneys general and federal banking regulators are reportedly closing ranks in their efforts to reach a settlement with mortgage lenders over alleged shortcomings in procedures employed by loan servicers in foreclosing on borrowers and considering them for loan modifications.

The nation’s biggest mortgage services received a proposal from state attorneys general and federal regulators last week that outlines formulas they would be required to use when considering borrowers for loan modifications, the Wall Street Journal reported, citing anonymous sources.

If accepted by lenders, the formulas would force them to offer more borrowers principal write-downs, the Journal said, which are considered to be more effective in preventing foreclosure than lowering a borrower’s interest rate or extending the loan term.

Anonymous sources told the Washington Post that government negotiators have set a goal of reaching a settlement that prevents 1.5 million new foreclosures.

Banks have objected to mandatory principal write-downs because they could encourage borrowers to default on their mortgage in the hopes of having some of their debt forgiven — an unintended consequence sometimes referred to as "moral hazard."

The 27-page proposal — which did not address the issue of a potential financial penalty — was put forward by state attorneys general, the Journal said, who indicated they had the backing of the U.S. Department of Housing and Urban Development, the Federal Trade Commission, the U.S. Department of Justice and the Consumer Financial Protection Bureau.

But the Office of the Comptroller of the Currency, which regulates the largest banks, was not named as being on board with the proposal. The Post said the OCC has already sent draft orders on loan modifications to banks it has jurisdiction over, and is working on a possible settlement that would govern only those institutions.

The Federal Reserve is conducting a review of alleged robo-signing practices, but would likely support the settlement being negotiated by state attorneys general and HUD, the FTC, Justice Department and CFPB, the Post said.

One issue that’s caused the breach in the ranks of federal regulators is the size of any financial penalty. State attorneys general and some federal regulators are said to support a penalty of at least $20 billion.

The OCC views $20 billion penalty as excessive, the Post reported, while the FDIC and Elizabeth Warren — tapped by the Obama administration to start up the Consumer Financial Protection Bureau — want a larger financial penalty.

Sources told the Post that banks are open to a $20 billion penalty if it is shared by several institutions and takes care of most outstanding foreclosure-related issues.

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