The Obama administration is working to include substantial principal write-downs in the upcoming settlement between the largest mortgage servicers and most state attorneys general. Faulty foreclosure practices surfaced one year ago, prompting regulators and the 50 state AGs to launch a wide-scale investigation. Affidavits were found to be signed en masse and without a review of loan files required under state laws, and many borrowers saw their property foreclosed upon while they were being considered for a mortgage modification. As part of the negotiations, the AGs are working to force servicers to refinance current borrowers into lower-rate mortgages. A source said last week principal reductions were also very much a part of the talks, which some states began to split from, including foreclosure heavy California and New York. “The settlement negotiation is also going to be focused on significantly accelerating the reduction of principal,” Department of Housing and Urban Development Secretary Shaun Donovan said Monday. He was asked why the recently announced changes to the Home Affordable Refinance Program did not include principal write-downs, which many feel could be more effective for homeowners considering strategic default. “The strategic defaults will be driven by their unwillingness to pay $500,000 for a house that is now worth $300,000. No interest rate reduction or payment reduction will change their minds,” said J.T. Smith, chief global economist at Aristar Funding Corp. “Either you get a shared sacrifice through investors and borrowers for principal reduction or you let the market clear.” HUD has been involved with the AG investigation for some time. The department provided a report in September, documenting its findings on the faulty foreclosures. “HUD among other federal and state agencies has provided us information that gives us a very clear picture of what has occurred,” a spokesman for Iowa AG Tom Miller said at the time. The Obama administration has launched a series of principal reduction programs through its $7.6 billion Hardest Hit Fund and the Home Affordable Modification Program. But only a handful of states secured any participation from major lenders, and HAMP principal write-downs have gone to just 10,500 borrowers since January. “The administration has been slow to make adjustments to housing policy in the last several years,” said John Taylor, CEO of the National Community Reinvestment Coalition. “They should evaluate the effectiveness of these changes to HARP in three months. If the changes are not having an impact, then the administration must move more aggressively, such as by mandating servicer participation in principal reduction programs, or by directly purchasing loans and writing them down.” Write to Jon Prior. Follow him on Twitter @JonAPrior.