Government negotiators plan to squeeze big banks for a larger settlement over mortgage servicing flaws when the two sides meet in Washington on Tuesday.

State attorneys general and federal agencies found an offer of $5 billion from five banks woefully inadequate, according to a person familiar with the talks.

Bank of America, JPMorgan Chase, Citigroup, Wells Fargo and Ally Financial made that offer two weeks ago. The amount was a far cry from the $20 billion the states and federal agencies had been discussing, although not formally proposing.

There was a noticeable chill that went across the room when the banks presented the offer, the person said. State and federal officials plan to describe to banks on Tuesday the scope of claims they believe could be brought against the lenders, to show why they believe $5 billion is inadequate.

Federal regulators and state attorneys general have been investigating bank mortgage and foreclosure practices that came to light last year, including the use of robo-signers to sign hundreds of unread foreclosure documents a day.

The authorities have discussed forcing banks to do principal writedowns for some troubled mortgages, having them pay into a fund to help distressed borrowers, and cleaning up their foreclosure practices.

The states will be joined at the table Tuesday by the departments of Justice and Housing and Urban Development.

To help make their case for a larger settlement, the states and federal agencies have pointed to recent findings by HUD's inspector general, an independent office, that the banks violated the False Claims Act.

The law, that dates back to 1863, is designed to protect the federal government from fraudulent bills.

The IG found that banks did not have proper paperwork in place when filing to have the Federal Housing Administration reimburse them for federally insured loans on foreclosed properties that were sold for less than the remaining balance for the mortgages, according to the person familiar with the talks.

Besides the settlement dollar amount, negotiators are struggling to come to an agreement on whether to include a principal writedown requirement.

Some Republican attorneys general have questioned having principal writedowns as part of the deal.

A spokesman for Iowa Attorney General Tom Miller, who is heading up the state probe, said the meeting is scheduled to last one day.

Geoff Greenwood, Miller's spokesman, said no updated settlement proposal was sent ahead of Tuesday's talks.

In April, U.S. banking regulators separately settled with the 14 largest mortgage servicers, including the banks involved in the talks with the states.

That settlement did not include fines but the bank regulators have said monetary penalties are forthcoming.

The bank regulators required that banks to overhaul their servicing practices, compensate those wrongly foreclosed upon, and hire an outside consultant to review foreclosure actions taken in 2009 and 2010, to look for any errors.

(Reporting by Dave Clarke; Editing by Tim Dobbyn)

Mortgage Settlement