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A lawyer for some of the country’s biggest mortgage lenders says that even though attorneys general in all 50 states are investigating their lending practices, the potential response of forced loan modifications is definitely off the table, but the states are saying, "we’ll see about that."

Against this backdrop, the pace of loan modifications remains slow. The government’s Home Affordable Modification program (HAMP) helped 434,716 homeowners get permanent loan modifications through the first seven months of 2010, while the Treasury Department cancelled temporary loan modifications for 616,839 American homeowners.

Banks still don’t want to pick up the slack, and no strong-arming by the government seems to work. But one idea picking up steam among economists and state attorneys general is more widespread mortgage loan principal reductions for homeowners who make their monthly mortgage payments, but are having difficulty with it.

Yves Smith, the author of the book, Econned: How Unenlightened Self-Interest Undermined Democracy and Corrupted Capitalism, sums this idea up nicely in an Oct. 30 op-ed in The New York Times.

“One measure that both homeowners and investors in mortgage-backed securities would probably support is a process for major principal modifications for viable borrowers; that is, to forgive a portion of their debt and lower their monthly payments.

This could come about through either coordinated state action or a state-federal effort.

The large banks, no doubt, would resist; they would be forced to write down the mortgage exposures they carry on their books, which some banking experts contend would force them back into the Troubled Asset Relief Program. However, allowing significant principal modifications would stem the flood of foreclosures and reduce uncertainty about the housing market and mortgage securities, giving the authorities time to devise approaches to the messy problems of clouded titles and faulty loan conveyance.”

Smith contends that loan modifications are the only ‘sensible” way to get out of the foreclosure crisis, but banks aren’t buying it, even as they are probed by attorneys general across the country over their foreclosure documentation practices.

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Attorney Andrew Sandler, from the Washington D.C. law firm BuckleySandler, represents several large mortgage lenders. He told Reuters that any forced principal reduction programs are off the table. "That's where servicers will draw a line in the sand," he said.

Lawyers for the big mortgage lenders want to go in a different direction – cash fines against banks and lenders who screwed up foreclosure cases or a fund to help homeowners are two ideas advanced by mortgage firms.

But as the robo-signing scandal widens, don’t expect the attorneys general to give an inch. Many, like Ohio’s Richard Cordray, want banks to be more accommodating about helping struggling homeowners. He said in a statement on Oct. 19.

“While I would not presume to speak for all 50 state attorneys general, from my own standpoint, we will want to be very careful in reviewing whatever their revised process purports to be. I would caution that they still have significant financial exposure in many, many cases if they are now acknowledging that the evidence that they previously submitted to the courts was fraudulent.

“Those previous submissions remain subject to possible sanctions and penalties by the courts, and so Bank of America would be well-advised to consider aggressively pursuing loan modifications as a means of resolving those cases by agreement rather than pushing toward a court order that may involve sanctions and penalties for their prior misconduct.

“You have to remember, these are the same people who have essentially acknowledged that they committed fraud in perhaps tens of thousands of cases. Now they tell us that they have fixed the problem in a matter of weeks. We are certainly not just going to take their word for it.”

With both parties coming out swinging, expect more verbal fireworks from both sides. Meanwhile, the growing number of delinquent homeowners will hope that the 50 state attorneys general get their way.

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