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Sizing up a sweeping mortgage settlement

By Abigail Field, contributor

FORTUNE — The trouble for America’s largest mortgage lenders just keeps mounting. How much will it cost them to make it all go away?

Bank of America, JPMorgan Chase (JPM), Wells Fargo (WFC), Citigroup (C) and Ally Financial violated the federal False Claims Act, according to officials briefed on federal investigations who spoke to the Huffington Post. The unnamed officials say the banks submitted faulty documents in seeking federal reimbursement from the Federal Housing Administration homes they’d foreclosed on.

This comes on top of countless other legal investigations the banks are facing by federal and local regulators, including a wide-ranging probe by all 50 state attorneys general, which also focuses on shoddy mortgage practices. The Department of Housing and Urban Development reportedly has the goods to nail the five banks for their scam and it’s now up to the Department of Justice whether or not to sue.

If the government sues and wins, the banks will face massive, mandatory penalties. Each guilty bank would potentially owe a fine equal to every falsely-paid tax dollar times three, plus thousands more for each careless, defaulted mortgage. Guilty banks would also be banned from ever doing business with the government again. So it’s not surprising that a settlement would be far more likely, according to Patrick Burns of Taxpayers Against Fraud, a False Claims Act advocacy group.

If HUD really did do audits that “read like veritable indictments of major lenders,” according to HuffPo’s sources, will the government lean hard on the banks, the way prosecutors lean on defendants they want to flip into witnesses? The proof will be in the final settlement, and in who signs on to it.

The first signal will be the settlement’s scope: How many possible prosecutions did the government drop in exchange for the punishment the banks accept? How much peace do the banks and their executives get to buy?

One measure of this will be which attorneys general agree to the deal. Burns notes that a bank like Bank of America (BAC) is much too powerful for most states to sue individually. BofA alone could bankroll an army of lawyers that vastly outnumbers the government’s attorneys. However, certain states have the power to make at least a fair fight on their own: California, New Jersey, Florida, Texas, and most of all, because it has special, powerful laws, New York. Getting these states to sign off on a settlement will not be easy. In particular, New York attorney general Eric Schneiderman seems serious about investigating wrongdoing, and surely won’t be bought off cheaply.

Who will be held accountable?

The next signal will be the size of the penalties, and who pays them. Given the scale of the wrongdoing and the possibility of a massive verdict, how much did it cost the banks to buy the peace? The largest number being floated so far is $30 billion. While hefty, that’s still not enough to make a meaningful dent in the banks’ balance sheets. Such a sum would hardly equate to accountability for all the pain the banks’ practices have caused.

Another marker of the government’s seriousness will be whether or not any of the fine is defined as a criminal penalty. Although the False Claims Act itself is usually used for civil penalties, the same facts can give rise to criminal charges. While criminal penalties wouldn’t necessarily change the amount of the fine, seeing the banks admit criminal guilt would be deeply satisfying to the countless homeowners who felt violated by the banks’ practices.

And what about individuals who may be culpable? The government will have leaned hard if any of the executives who reaped riches on the mortgage boom have to pay part of the price. Given the stunning lack of prosecutions of the banks’ leaders, any settlement that buys much peace ought to make those deep pockets much shallower.

Of course, criminal prosecutions could still happen. Sure, the fraud is complex, but we convicted Ken Lay and Jeffrey Skilling of Enron, in really complex frauds. If HUD, in a matter of weeks, can gather enough evidence to bring False Claims charges, surely a thorough investigation could send people to jail. Burns is too much of a cynic to hope for that, however, noting that the banks are too big to fail, and the executives “too rich and educated to jail.”

A final, and crucial signal of how hard the government leaned on the banks will be the change in practices going forward. Will the banks be allowed just to promise to play nice, and swear they’ll own up if they don’t? Or will a settlement require meaningful changes to how the banks originate, service, modify and foreclose on loans backed up by real oversight and penalties?

Unless the Republicans in the Senate stop their efforts to weaken the Consumer Financial Protection Bureau, the only hope of ending mortgage lender and servicer abuse lies with a global settlement.

The Feds ought to wield the big False Claims stick with all the force that the banks have earned – whatever it takes to coerce some real change.