The idea that the interests of troubled homeowners and mortgage investors are aligned — and that they conflict with those of loan servicers — is gaining momentum.
The compensation structure of mortgage servicers has led to unnecessary foreclosures, Adam Levitin, an associate professor at Georgetown University Law Center, and Tara Twomey, of counsel at the National Consumer Law Center, wrote in a recent white paper.
"Servicers have no stake in the performance of mortgage loans, so they do not share investors' interest in maximizing the net present value of the loan," the authors wrote. "Instead, servicers' decision of whether to foreclose or modify a loan is based on their own cost and income structure, which is skewed toward foreclosure."
In the paper, published this month in the Yale Journal on Regulation, Levitin and Twomey said they doubt the industry's shortcomings are fixable without government intervention.
"Existing regulatory and monitoring structures are inadequate for ensuring alignment of servicer and investor interests, and the market is unlikely to self-correct because neither investors nor affected homeowners have the incentives or the bargaining power to fix the system," they wrote.
MBS investors are fairly powerless to monitor servicers, the paper said, because they lack sufficient data. Instead, they "rely on trustees to protect their interests, but MBS trustees have very limited contractual duties and little incentive to be more diligent," Levitin and Twomey said.
"Vigorous monitoring could jeopardize trustees' close business relationships with servicers and ultimately result in costs for the trustee if the servicer had to be replaced and the trustee had to step in as standby servicer," they wrote.
The government could ease the industry's ills by changing the compensation structure of servicers. One way to do that is to make a servicer's economic interest dependent on the return on a loan, they said.
Or, compensation could be structured so that a servicer has no economic interest in the particular loss-mitigation approach taken.