Financially Constrained Mortgage Servicers

Abstract

Financially constrained mortgage servicers destroyed substantial MBS investor value during the financial crisis through their management of delinquent mortgages. Servicers must advance to investors monthly payments missed by borrowers. This paper shows that, to minimize this obligation to extend financing to distressed borrowers, constrained servicers aggressively pursued foreclosures and modifications at the expense of investors, borrowers, and future mortgage performance. It is exactly when the agency frictions between the servicer and the investor are highest that the servicer's financial constraints matter to their decision making. IV regressions suggest that, on average, servicers' financial constraints were responsible for 20.21\% of the total reduction in investor value per defaulted loan during the financial crisis.

JEL Classification: G21