2011

Mortgage Servicing

Adam J. Levitin
Georgetown University Law Center

Tara Twomey
National Consumer Law Center

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.

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Please visit her website at MortgageStudy.org

The Mortgage Study is an empirical study of homeowners in financial distress. The co-principal investigators, Tara Twomey and Katherine Porter, began the project in 2004 to explore the intersection of homeownership and bankruptcy. With funding from the Endowment for Education of the National Conference of Bankruptcy Judges, they constructed a sample of over 1700 chapter bankruptcy cases, coding over 100 data points for each case on each homeowner’s mortgage obligations. The first paper to use Mortgage Study data, Misbehavior and Mistake in Bankruptcy Mortgage Claims, was published in the Texas Law Review in 2008 and was featured in a front-page story in the New York Times. Porter and Twomey are frequent speakers on mortgage issues and continue to release new research using the Mortgage Study data.

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