Charles A. Dice Center Working Paper No. 2014-02
45 Pages Posted: 15 Mar 2012 Last revised: 21 Mar 2014
Date Written: February 2014
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.
Keywords: Subprime Crisis, Household Finance, Second Liens, Mortgages, Holdup Problem
JEL Classification: G21
Suggested Citation: Suggested Citation
Agarwal, Sumit and Amromin, Gene and Ben-David, Itzhak and Chomsisengphet, Souphala and Zhang, Yan, Second Liens and the Holdup Problem in Mortgage Renegotiation (February 2014). Charles A. Dice Center Working Paper No. 2014-02; Fisher College of Business Working Paper No. 2014-03-02. Available at SSRN: https://ssrn.com/abstract=2022501 or http://dx.doi.org/10.2139/ssrn.2022501