Yesterday, negotiators with the proposed mortgage servicer settlement sat down with leaders of the biggest banks for the first time. The state Attorneys General and federal regulators set out their position with a 27-page term sheet; the banks responded days before the talks with their own offer. It included two of the major policy changes in the AG term sheet:

Sources familiar with the 15-page proposal said the banks have offered to make significant changes such as ending the “dual track” process that has caused homeowners to receive foreclosure notices even as they are negotiating modifications, and giving borrowers a single point of contact when they are seeking to modify their loans. They also plan to implement a series of new servicing standards such as verifying that affidavits submitted in foreclosure cases are accurate and complete, which banks failed to do in the recent “robo-signing” scandal.

But it did not include any of the monetary penalties for commissions of fraud and abuse, and the third-party overseer it recommended could potentially be a way to get the unending foreclosure cases being fought by attorneys with clear knowledge of the fraud out of the hands of the courts. So this is a proposal from the banks to essentially do the job of servicing that’s within the bounds of the law, with no consequences for past lawbreaking.

Very little information has come out about yesterday’s meeting. Iowa AG Tom Miller called it “the breaking of the ice,” but added that the two sides were far apart on any resolution. The banks are clearly fighting against having to cover any of the losses they caused with the mortgage meltdown, or having to be held responsible for any of the fraud they committed. You could even say that principal reductions are far from a penalty on the banks, but what they should do intuitively. Modifications make more financial sense than foreclosures for everyone involved, and principal write-downs are the most stable form of modification. But Jamie Dimon, in an extended whine yesterday, declared principal reductions “off the table.”

Some of the State AGs, including the lead on the investigation, Miller, as well as federal regulators and administration officials appear to be looking toward principal forgiveness as the punishment the banks should pay. But as recently as last night, JP Morgan Chase’s Jamie Dimon told reporters, “Yeah, that’s off the table.”

This morning the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) put out their quarterly “Mortgage Metrics Report” for Q4. It showed just 2.7 percent of modification made in the quarter by national banks and federal thrifts (that includes Fannie and Freddie) included any principal reduction. The banks did the vast majority of the reduction with Fannie and Freddie doing none. But principal reduction fell dramatically, over 60 percent from year ago as a modification tool, meaning banks are less and less inclined to do it.

(By the way, principal reductions aren’t off the table for military families. Just everyone else.)

Indeed, because the discretion for these modification strategies is entirely on the side of the banks, virtually all federal mortgage assistance programs have fallen short. At a time when foreclosures are still streaming through the system, and home prices are at record lows, literally nothing the banks or the government are doing can arrest that.

And at the same time that the banks go into these negotiations on a settlement, clearly believing they have a strong hand, more evidence of irregularities keeps cropping up.

At Lender Processing Services workers who signed tens of thousands of sworn foreclosure affidavits with someone else’ name were called “surrogate signers”, according to Cheryl Denise Thomas, a former LPS worker who admitted to notarizing as many as 1,000 sworn affidavits daily – often without witnessing the signature.

Thomas said despite “raised eyebrows” her supervisors never used the word “forge” and repeatedly told workers the practice of signing someone else’ name on a sworn affidavit was legal. Thomas detailed the company’s foreclosure document processing practices during a deposition in an Orange county foreclosure case on March 23.

“They didn’t say forge the name. They just said this is legal,” Thomas said. “This person is going to be this person’s surrogate signer because this person has a lot to do.”

More on this from Yves Smith. This is illegal, incidentally. And the revelations will not stop. Neither will the lawsuits. Bank of America is facing one from their own shareholders, for damages relating to their shoddy foreclosure processing. New Jersey now has a foreclosure overseer appointed by the court to crack down on fraud and abuse. There are investor lawsuits seeking putbacks. 60 Minutes will have a feature on foreclosure fraud this weekend, which could be a must-see event.

None of this is going away, and unless some astounding pre-emption in the settlement takes place, individuals and even investors will be able to sue the banks for their fraudulent practices. Jamie Dimon and his colleagues may have a smile on their face. But they have reason to fear everyone outside of that settlement room, if not the ones inside.