The state attorneys general and several federal government agencies sent a 27-page term sheet last week to the servicers outlining their demands, including pressuring them to offer principal reductions while revamping foreclosure proceedings, borrower records and technology processes.
While the term sheet amounts to an opening salvo in negotiations, bankers were already protesting the creation of de facto servicing standards through a punitive action, arguing that in some cases regulators are asking for changes that had little to do with faults uncovered at the companies.
"I have always had a visceral dislike of regulating through enforcement, because the settlement will affect these major parties but won't affect others and therefore creates an unlevel playing field," said Ernest Patrikis, a partner at White & Case LLP and a former counsel at the Federal Reserve bank of New York. "That's not the way things should be done. They should be done through comment from regulations. When you are dealing with enforcement matters, you are not really negotiating. One guy has a gun to your head."
But it is unclear whether bankers have much leverage to fight back. While some industry sources are hoping for support from Republican lawmakers that may share their concerns, winning the debate is an uphill battle.
"I don't know if they have the right to do it," said Paul Miller, managing director of FBR Capital Markets Corp. "The government is suddenly inventing new regulation without congressional approval. The banks have a legit complaint. They are going to have to fight it. They may not have a lot of leverage."
Rep. Patrick McHenry, R-N.C., said in a statement he was already concerned. "It does seem that the administration is looking at this settlement to revamp their failed foreclosure mitigation programs, which I find very troubling," he said.
So far, the settlement with federal banking regulators, 50 state attorneys general and other government agencies are running on different tracts. The bank regulators sent 14 servicers draft cease-and-desist orders three weeks ago outlining steps they want servicers to take. Last week's term sheet, delivered Thursday to only the top five, is from the attorneys general, Consumer Financial Protection Bureau, the Department of Justice and the Department of Housing and Urban Development.
Both regulators and enforcement officials are hoping to finalize both in a single global settlement. While the details of each have to be worked out, however, the other open question is how much money the servicers will have to pay. Regulators still disagree on that issue, and have yet to bring the issue to servicers.
Some bankers say the entire process is unfair. Regulators are working on multiple tracks asking them to agree to a series of reforms without also simultaneously negotiating on a civil money penalty. They argue everything should be hashed out at the same time.
Others complained that the term sheet does not say exactly what servicers are alleged to have done wrong, making it difficult to know how to respond.
Some industry representatives are quietly urging bankers to push back, pointing to court precedents where judges have said federal agencies went too far by trying to establish standards in an enforcement action.
"I think it makes a mockery of the legislative and rulemaking process that permits significant public input," said Laurence Platt, a partner at K&L Gates. "It somewhat defies explanation why the administration isn't using more traditional methods to create policy of such material magnitude. … What's so fascinating here is the concept of national servicing standards is an area where reasonable people can differ and it raises fair-lending issues, investor issues, Fannie, Freddie issues. The notion the political process is not being used to develop that either through rulemaking or legislation to me is very bad public policy."
But Patrikis questions whether the banks will challenge the deal, even if it is far-reaching.
"Do the banks have the stomach to do that in this environment, with all the hostility toward the banking industry?" he said.
Gil Schwartz, a partner at Schwartz & Ballen, said new standards should not be written this way.
"It's inconsistent with due process to require institutions to do things without having opportunity to provide notice and opportunity for comment," Schwartz said. "The argument can be it's enforcement, but it's really setting down for all what they would like the behavior to be. It's part of the trend toward substantive regulation rather than establishing some general principles and implementing it how you think is appropriate for an institution."