Multiple Tranches, Information Asymmetry and the Impediments to Mortgage Renegotiation

Abstract

This paper examines how the creation of asset-backed security tranches disperses ownership of an asset–the pool of mortgages–subsequently impeding renegotiation of the underlying delinquent loans. I describe how multiplicity of tranches worsens the agency problem between a residential mortgage servicer and the mortgage-backed security investors, leading to a sub-optimal rate of loan modification. Using within-deal variation in the number and structure of tranches, I find that delinquent loans in pools collateralizing fewer tranches are more likely to be renegotiated. The results provide evidence for one channel through which mortgage securitization inhibited loan modifications during the Great Recession.

Keywords: Securitization, Mortgage Servicing, Loan Modifications, Financial Crisis

JEL Classification: G1, G21, D14, D82