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By RUTH SIMON And NICK TIMIRAOS
Bank representatives and government officials are working on a broad settlement of most state and federal foreclosure-practices investigations that could move forward without the participation of California, long considered a key to any deal, people familiar with the negotiations said.
The terms of the deal remain fluid. Banks have proposed a deal excluding California that would carry a value of $18.5 billion, though the final outcome remains uncertain, people familiar with the discussion said.
Negotiators are continuing to make a push to persuade California to join a settlement valued at $25 billion among federal officials, state attorneys general and the nation's five largest mortgage servicers: Ally Financial Inc., Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co. and Wells Fargo & Co. The talks center on the banks' use of "robo-signing," in which employees approved legal documents without proper review, and other questionable foreclosure practices.
The dollar value would include the value of principal write-downs, interest-rate reductions and other benefits to homeowners as well as cash penalties.
But negotiators now are discussing how to structure an agreement if California remains on the sidelines. Until recently, it seemed unlikely that a settlement would be possible without the participation of California Attorney General Kamala D. Harris. She left the discussions in late September, calling the deal then on the table inadequate. The state accounted for 13.1% of all mortgages outstanding at the end of September and 10.8% of all loans in foreclosure, according to the Mortgage Bankers Association.
"Our position remains the same. We are focused on securing maximum relief and lasting reform for California homeowners," said Shum Preston, a representative for Ms. Harris.
Attorneys general in several other states, including Delaware, Massachusetts, Nevada and New York, also have raised questions about the potential settlement.
Participants on both sides are eager to reach a resolution after months of discussion. Administration officials have viewed the foreclosure settlement as a chance to break the foreclosure logjam, increase the number of reductions in loan principal and provide other assistance to homeowners. Banks, meanwhile, would like to reassure investors and put questions related to foreclosure practices behind them.
Any deal would require banks to use a portion of the penalties to modify mortgages by writing down loan balances, among other actions. In exchange, banks would be released from legal claims tied to servicing delinquent mortgages as well as certain mortgage-origination practices. Government officials still would be able to move forward with other legal claims, including those stemming from the packaging of loans into securities.
The discussions have turned in recent days to crafting a formula to determine how any settlement is scaled depending on which states opt out of the deal. Officials have discussed limiting the amount of loans that could be written down or refinanced in states that don't join the settlement, people familiar with the matter said, in order to provide a stronger incentive for states to join. States that don't join the settlement wouldn't receive any of the funds that will go directly to the states, nor will borrowers in those states receive cash payments for which they might otherwise be eligible, these people said. If California doesn't sign on, the state would lose billions of dollars in potential benefits, the people said.
The participation of California isn't the only item still on the negotiating table. The two sides still must agree on the choice of a monitor, who will be charged with ensuring that banks comply with the settlement, people familiar with the discussions said.
Following the departure of Ms. Harris from the talks, the price tag of a settlement rose by at least $5 billion and negotiators came up with a plan to help certain "underwater" borrowers, those who owe more on their mortgage than their home is worth, to get refinancing assistance.
California has more than two million underwater borrowers, more than any other state, according to CoreLogic.
The refinancing plan will remain in the deal even if California doesn't because it is attractive to other states that have seen large home-price declines, the people said.
Ms. Harris has come under pressure from labor and progressive groups seeking to extract greater penalties from banks for alleged mortgage-related wrongdoing.
Last week, her office issued subpoenas to Fannie Mae and Freddie Mac, the government-controlled mortgage companies, according to people familiar with the matter.
The subpoenas asked the firms to provide responses to about 50 different inquiries, according to these people, including demographic information about borrowers who have missed payments and who have received loan modifications, among other items.
The state also requested information on foreclosed properties owned by the firms, including any evidence of unpaid taxes or drug abuse on vacant properties.
Representatives of Fannie, Freddie, and the Federal Housing Finance Agency, which regulates the firms, declined to comment.
Ms. Harris has a limited ability to bring legal claims related to originations and servicing practices if she decides not to agree to the foreclosure deal, people familiar with the negotiations said.
The statute for filing cases related to loan originations is four years in California, meaning any legal action could cover mortgages originated only in 2007 and after. California allows foreclosures to proceed through a nonjudicial process, limiting the state's ability to argue that banks lied to the courts, these people said.
Separately, the Office of Comptroller of the Currency on Tuesday released a broad summary of the actions financial firms have taken this year to overhaul foreclosure practices. Bank regulators also posted copies of the agreements between banks and thrifts and the consulting firms, which include Clayton Services LLC, Ernst & Young LLP, PriceWaterhouseCoopers LLP and Promontory Financial Group LLC, that have been hired to review millions of foreclosure files for potential defects.
—Alan Zibel and Maya Jackson Randall contributed to this article.Write to Ruth Simon at ruth.simon@wsj.com and Nick Timiraos atnick.timiraos@wsj.com
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