Real Estate Update: Mortgage Servicers Profit While Investors Face Losses

If you really want to learn how the mortgage industry works starting from the servicers to investors I recommend reading this brief essay. The essay addresses what may happen to foreclosure rates given the government plan to purchase mortgages. Click here to read essay on mortgage servicers and the real estate crisis

Article Background (Via RGE)

Much of the attention of the housing crisis has focused on homeowners and lenders. Often, the business press uses the word “lender” to include the role of “servicer” as though the differences between them are inconsequential. These differences do in fact matter.

This paper will shed light on the power of the mortgage servicing industry to determine the outcome of mortgage delinquencies to the detriment of investors and homeowners. An environment of increasing delinquencies provides servicers with incentives to pursue their own self interests at the expense of investors and borrowers. Existing compensation structures, lack of oversight, informational asymmetry and consolidation of the mortgage servicing industry ensure servicers can act in their own interests with limited impunity. This paper further suggests a servicer with restructured incentives aligned with that of the investors would make the government bailout plans more effective in keeping homeowners in their homes.

Article Conclusion (Via RGE)

Once mortgage loans have been made, Servicers influence the outcome of the loan more than anyone else by acting as agents and fiduciaries of the investors. Increased defaults, however, expose conflicts between investor interests and that of the servicer. The servicers, faced with increasing upfront but reimbursable costs, and higher but delayed revenue, have incentives to pursue strategies that are contrary to investor interests.

Servicers are ensured through the contract and market power the ability to act in their self interests to the detriment of the investors. They determine which strategy to use, have informational asymmetry with the investor, and control over the process of executing the strategy. Their senior position in the distribution of proceeds from the disposition of the defaulted loans also secures their ability to act in their own interest.

One aspect of the current $700 billion bailout plan indicates the government may purchase defaulted mortgages and restructure them. Its implementation, however, is unlikely to prevent foreclosures on a significant scale without addressing the incentives and actions of the servicer.

Click here to read essay on mortgage servicers and the real estate crisis