Abstract:
This Article argues that a principal-agent problem plays a critical role in the current foreclosure crisis.
A traditional mortgage lender decides whether to foreclose or restructure a defaulted loan based on its evaluation of the comparative net present value of those options. Most residential mortgage loans, however, are securitized. Securitized mortgage loans are managed by third-party mortgage servicers as agents for mortgage-backed securities (“MBS”) investors.
Servicers‘ compensation structures create a principal-agent conflict between them and MBS investors. Servicers have no stake in the performance of mortgage loans, so they do not share investors‘ interest in maximizing the net present value of the loan. Instead, servicers‘ decision of whether to foreclose or modify a loan is based on their own cost and income structure, which is skewed toward foreclosure. The costs of this principal-agent conflict are thus externalized directly on homeowners and indirectly on communities and the housing market as a whole.
This Article reviews the economics and regulation of servicing and lays out the principal-agent problem. It explains why the Home Affordable Modification Program (“HAMP”) has been unable to adequately address servicer incentive problems and suggests possible solutions, drawing on devices used in other securitization servicing markets. Correcting the principal-agent problem in mortgage servicing is critical for mitigating the negative social externalities from uneconomic foreclosures and ensuring greater protection for investors and homeowners.
Conclusion
This Article presents the first comprehensive overview of the residential mortgage servicing business and shows that mortgage servicing suffers from an endemic principal-agent conflict between investors and servicers. Securitization separates the ownership interest in a mortgage loan and the management of the loan. Securitization structures incentivizeservicers to act in ways that do not track investors‘ interests, and these structures limit investors‘ ability to monitor servicer behavior. Monitoring proxies, such as ratings agencies and trustees, are themselves subject to perverse incentives and are limited in their ability to monitor servicer behavior.
As a result, servicers are frequently incentivized to foreclose on defaulted loans rather than restructure the loan, even when the restructuring would be in the investors‘ interest. The costs of this principal-agent conflict are not borne solely by MBS investors. The principal-agent conflict in residential mortgage servicing also has an enormous negative externality for homeowners, communities, and the housing market.
The principal-agent problem in residential mortgage servicing could be addressed by restructuring servicing compensation. Other types of securitizations use measures that mitigate the principal-agent conflict between servicers and investors. There are costs to applying these measures to residential mortgage securitization, which are likely to be borne partly by borrowers in the form of higher mortgage costs. Yet, correcting the principal-agent problem in mortgage servicing is critical for mitigating the negative social externalities from uneconomic foreclosures and ensuring greater protection for investors and homeowners.
SOURCE: http://ssrn.com/abstract=1324023
Full Paper Below…
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4closureFraud.org
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Adam Levitin and Tara Twomey White Paper on Mortgage Servicing
Great report & great comment by Mildred !
Unless and until our government leaders understand AND accept the validity of the factors which are so clearly outlined in this paper, we have no chance of getting reasonable, enforceable and effective solutions to the housing crisis implemented. I have stated in training classes for the past 2 years that HAMP and later HAFA could NOT be successful because:
a. they were voluntary programs, contrary to the best interest of the lenders for the reasons so well articulated in
this paper
b. they sought to get between the parties to servicing contract (as outlined in this paper)
c. there was no effective enforcement in place
d. they completely ignored the financial motivation which was driving lender/servicer behaviors (as aptly
outlined in this paper)
Failure to understand the underlying issue will always lead us to wrong assumptions and consequently, wrong actions. There would have been a much wider recognition of the fraudulent practices of banks by the general public IF consumers had not erroneously assumed that:
1. banks had their best interest at heart
2. that banks would obey the law
3. that banks were trying to help with modifications, etc. but their hands were tied by the ‘invisible and evil
investors’
It took a very long time and many thousands of consumer horror stories before the public was willing to even entertain the possibility that the banks were the cause of the problem, that they had ulterior motives. It has taken an even longer time to grasp that this was all part of what I affectionately call ‘the BANK GAME”. I agree that the banks did not start out with a clear cut intention to engage in robo-signing and other such craziness, but once you have started on a fraudulent trail and things get out of hand, you have to play the hand out the way you set it up.
They can NOT/will NOT back down. They must be TAKEN down. There is no other solution. And while the idea is distasteful and our government officials do not have the appetite for it, it is what it is!
I pray for an orderly take down by government intervention.
I expect a dis-orderly and hugely destructive collapse because our leadership lacks the wisdom and courage to do what is necessary to manage what is inevitable.
If you are reading this and you own a home: Stay put, no matter what, refuse to leave, no matter what. The changes which are occurring will be overwhelmingly consumer friendly, if you can just hold on. Stay informed and keep fighting.
Lots of folks are rooting for you, including me.