A proposed settlement would force banks to allow underwater borrowers… (Joe Raedle, Getty Images )
Reporting from Washington and Los Angeles — Major banks may be forced to let severely delinquent homeowners sell their houses for less than the loan amounts owed as part of a broad settlement of federal and state investigations into botched foreclosure paperwork, according to government officials involved in the negotiations.
The requirement to allow so-called short sales would be in addition to forcing mortgage servicers to reduce the amount some homeowners owe on their loans, said two officials, who spoke on the condition of anonymity because negotiations are ongoing.
The goal of short sales would be twofold: provide a quicker and more economical way for banks to dispose of distressed real estate and to help stabilize the real estate market by clearing out a backlog of defaulted mortgages that are poised for foreclosure.
They would be used in situations in which borrowers were so underwater that the more costly and time-consuming process of foreclosure would seem to be the only option.
"Short sales just command a better premium than foreclosures," said Glenn Kelman, chief executive for online brokerage Redfin. "It's like day-old bagels. They never sell for the same price. If they sit there for a while, nobody wants them because houses just break down when they are left alone."
Foreclosures continue to drive down housing values, with prices in 20 major U.S. cities down an average of 3.1% in January compared with the same month a year ago, according to new data from a Standard & Poor's/Case-Shiller index. Prices in Los Angeles were down 1.8%.
The latest proposal is among those to be discussed when executives from the top five mortgage servicers meet Wednesday in Washington with state and federal officials working on a settlement that could range from $5 billion to $25 billion.
Those servicers are Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co., Citigroup Inc. and Ally Financial Inc.
It will be the first face-to-face meeting since attorneys general from all 50 states, along with federal officials from the Justice Department and other agencies, presented the banks with 27 pages of demands calling for sweeping changes to mortgage servicing, including how homeowners are treated when they try to modify their loans.
The banks have given officials a counterproposal on some of the mortgage servicing requirements that includes a single point of contact for distressed homeowners, timelines for considering modifications, an online system for checking the status of applications and a third-party review of rejections, one of the officials said.
Short sales would help accelerate the turnover of homes from borrowers who are months behind on their mortgage payments, Kelman said.
Some sellers are not eager to complete a short sale because it would force them out of their home. And lenders can withhold approval of a short sale if they don't like the price.
Banks often resist such sales because they are difficult to execute, particularly when multiple creditors and other parties are involved. In addition, short sales lock in losses for the lender that might be reduced if the sale is delayed until the market improves.
Requiring banks to allow short sales could fuel further opposition from some Republican attorneys general and members of Congress who already have criticized the broad scope of the proposed settlement.
Some House Republicans have derided possible payments of $20,000 to encourage distressed homeowners — dubbed by some as "cash for keys" — as a bailout for irresponsible behavior.
Seven Republican attorneys general recently wrote to Iowa Atty. Gen. Tom Miller, a Democrat who is leading the negotiations for the states, saying the proposals go beyond resolving damages from foreclosure paperwork problems. Those problems include robo-signing, the practice of bank employees' signing sworn documents without reading or understanding them.
"I think it's morphed into something that's bigger and different than what we talked about in the beginning," said Oklahoma Atty. Gen. E. Scott Pruitt, a Republican who organized the signing of one of the letters.
Pruitt said he might not join the settlement if it is too broad. And with 24 Republican attorneys general nationwide, opposition could limit the size of a settlement and how many people it covers.
Miller has been in contact with some of the attorneys general who have raised concerns, said spokesman Geoff Greenwood.
"We'll do the best we can to reach a comprehensive agreement that is in everyone's best interest," Greenwood said. "At the end of the day, an attorney general must decide for himself or herself whether to sign on to this, assuming we get a settlement."
In Southern California, short sales made up an estimated 19.8% of the market for previously owned homes last month. That was up from an estimated 18.4% in February 2010 and 12% in February 2009, according to DataQuick Information Services of San Diego.
Combined with foreclosures, these so-called distressed sales made up more than half of homes sold in the Southland last month.
Though struggling homeowners escape weighty mortgage debts quickly under a short sale, they don't get away unscathed.
Their credit scores are damaged enough to limit their borrowing capability for years, though the damage is perhaps less severe than in foreclosure. Money for down payments and renovations would be lost, and there may be tax consequences.
The California Assn. of Realtors has been pushing for short sales to be made simpler. Earlier this month, in an open letter in the Los Angeles Times and six other California newspapers, the group called on banks to approve more short sales and for regulators to streamline the process.
The real estate agents argued that short sales are better for consumers and banks.
Times staff writer E. Scott Reckard contributed to this report.