State and federal officials are close to a settlement with the largest U.S. banks over mortgage abuses, with states facing an end-of-the-week deadline to decide whether they will sign on, people close to the talks said.

The final value of any settlement will depend on which states it includes, and could drop sharply if states like California, one of the hardest hit by the foreclosure crisis, do not join.

In another sign the deal is close, negotiators have overcome a sticking point and agreed on Joseph Smith, North Carolina's banking commissioner, as a monitor to ensure the banks comply with the terms of the settlement, these people said.

Talks have dragged on for more than one year but picked up steam last week as the Obama administration announced a new federal-state working group to investigate misconduct in the pooling and sale of risky home loans, a move that signaled the settlement would only allow banks to put behind them a small slice of misconduct. [ID:nL2E8CR8HB]

The banks in the talks are Bank of America , Wells Fargo & Co , JPMorgan Chase & Co , Citigroup and Ally Financial Inc .

The proposed settlement releases the banks only from civil claims of errors in servicing and originating the loans. Those details have been in place for months, but the launch of the working group, the Obama administration said, makes clear its commitment to continue to investigate misconduct that fueled the financial crisis.

In exchange for up to $25 billion, much in the form of cutting mortgage debt for distressed homeowners, the banks will resolve civil state and federal lawsuits about servicing misconduct and faulty foreclosures, and state lawsuits about how they made some of the loans.

President Barack Obama said in his State of the Union speech last week that he directed his attorney general to create the new working group to help turn the page on an era of recklessness.

Left-leaning groups including MoveOn.org had decried the proposed settlement as a sweetheart deal and criticized the administration for what they said was a failure to bring big-ticket cases against Wall Street banks and individuals who played a role in the 2007-2009 collapse.

The new working group, designed to coordinate investigations into the residential mortgage-backed securities market, potentially gives the administration and dissident states political cover to join the settlement.

CALIFORNIA STILL IN QUESTION

In announcing the new working group, housed within an older financial fraud task force, federal and state officials made clear the settlement would cover misconduct that occurred in the aftermath of the crisis, while the group would focus on wrongdoing that fueled the crisis itself.

The attorney general in New York, Eric Schneiderman, who has been a holdout on the settlement, saying that it released the banks from too many claims, is helping to lead the new group.

In an interview with Reuters on Friday, he said the focus of the settlement had become narrow enough to allow a full investigation to go forward, even though he said he was not yet ready to sign on.

California has also been reluctant to sign on.

The state's attorney general, Kamala Harris, withdrew from the talks last year amid concerns that the proposed settlement was too lenient, and her spokesman said again last week she believed the settlement remained inadequate.

But Harris did meet with federal officials last week to press her concerns, people familiar with the matter said, and has not yet officially said her state is out of any final deal.

Separately, Massachusetts filed its own lawsuit against the banks last month, a signal that state may also go its own way in resolving allegations of deceptive foreclosure practices.

States have one week to make a decision, and an announcement of a settlement could come as early as next week, people familiar with the talks said.

The appointment of Joseph Smith as the monitor is also likely to win plaudits.

President Barack Obama nominated Smith, who has long had the respect of both banking executives and consumer advocates, to become the chief regulator of Fannie Mae and Freddie Mac in 2010, but he withdrew from consideration amid objections from Republicans in Congress.

A spokeswoman for Smith said he was unavailable for comment.

(Reporting By Aruna Viswanatha in Washington, D.C. and Rick Rothacker in Charlotte, additional reporting by Karen Freifeld and Margaret Chadbourn)

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