Second Liens and the Holdup Problem in Mortgage Renegotiation

Sumit Agarwal, Gene Amromin, Itzhak Ben-David, Souphala Chomsisengphet and Yan Zhang
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Sumit Agarwal: National University of Singapore
Souphala Chomsisengphet: US Office of the Comptroller of the Currency
Yan Zhang: US Office of the Comptroller of the Currency

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: Loss mitigation actions (e.g., liquidation or renegotiation) for delinquent mortgages might be hampered by the conflicting goals of claim holders with different levels of seniority. Although similar agency problems arise in corporate bankruptcies, the mortgage market is unique because in a large share of cases junior claimants, in their role as servicers, exercise operational control over loss mitigation actions on mortgages owned by senior claimants. We show that servicers are less likely to act on the first lien mortgage owned by investors when they themselves own the second lien claim secured by the same property. When they do act, such servicers' choices are skewed towards actions that maximize the value of their junior claims, favoring modification over liquidation and short sales and deeds-in-lieu over foreclosures. We also show that such servicers find it more difficult to avoid taking actions on second lien loans when first liens are modified and that they do not modify their second lien loans on more concessionary terms. We show that these actions transfer wealth from first to second liens and moderately increase borrower welfare.

JEL-codes: G21 (search for similar items in EconPapers)
Date: 2014-02
New Economics Papers: this item is included in nep-ban, nep-ger, nep-sea and nep-ure
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2014-02

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