Securitization and Distressed Loan Renegotiation: Evidence from the Subprime Mortgage Crisis

Abstract:     
We examine whether securitization affects renegotiation of loans by servicers focusing on their decision to foreclose a delinquent loan. We show that securitization induces a foreclosure bias in this servicing decision. Conditional on a loan becoming seriously delinquent, we find a significantly lower foreclosure rate associated with loans held by the bank when compared to similar loans that are securitized: the likelihood of a bank-held delinquent loan foreclosure is lower in absolute terms between 3.8% to 7% (18% to 32% in relative terms). Finally, consistent with the economic arguments that suggest that loans of better credit quality are most likely candidates for renegotiation, we find that foreclosure bias is larger among loans of better credit quality as measured by initial creditworthiness of the borrowers. Our findings lend support to the view that foreclosure bias in decisions of servicers of securitized loans may have exacerbated the foreclosure crisis.

Keywords: Securitization, renegotiation, bargaining, servicing, incentives, subprime, crisis, defaults, mortgages

JEL Classifications: G21

Working Paper Series