Second Liens and the Holdup Problem in Mortgage Renegotiation

Charles A. Dice Center Working Paper No. 2014-02

Fisher College of Business Working Paper No. 2014-03-02

45 Pages Posted: 15 Mar 2012 Last revised: 21 Mar 2014

Sumit Agarwal

Georgetown University - Department of Finance

Gene Amromin

Federal Reserve Bank of Chicago

Itzhak Ben-David

Ohio State University - Fisher College of Business, Finance Department; National Bureau of Economic Research (NBER)

Souphala Chomsisengphet

Office of the Comptroller of the Currency (OCC)

Yan Zhang

Government of the United States of America - Office of the Comptroller of the Currency (OCC)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2014

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.

Keywords: Subprime Crisis, Household Finance, Second Liens, Mortgages, Holdup Problem

JEL Classification: G21

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

Sumit Agarwal

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States
202-687-8207 (Phone)

HOME PAGE: http://www.ushakrisna.com

Gene Amromin

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
230 S. LaSalle
Chicago, IL 60604
United States
3123225368 (Phone)
3123226011 (Fax)

Itzhak Ben-David (Contact Author)

Ohio State University - Fisher College of Business, Finance Department ( email )

2100 Neil Avenue
Fisher 700D
Columbus, OH 43210-1144
United States
773 988 1353 (Phone)

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/index.htm

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/

Souphala Chomsisengphet

Office of the Comptroller of the Currency (OCC) ( email )

400 7th Street, SW
Washington, DC 20219
United States
202-649-5533 (Phone)

Yan Zhang

Government of the United States of America - Office of the Comptroller of the Currency (OCC) ( email )

400 7th St. SW
Washington, DC 20024
United States
202-6495492 (Phone)

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