Multiple Tranches, Information Asymmetry and the Impediments to Mortgage Renegotiation

The setting of Residential Mortgage Backed Securitization (RMBS) provides an ideal testing ground for theories of debt-structure, agency problems and their effect on debt renegotiation. Through the tranching of cash flows from underlying mortgages, an RMBS transaction creates multiple securities with claims to the underlying collateral. Moreover, tax law mandates the hiring of an agent, the Servicer, to manage the underlying collateral. First, I develop a simple conceptual framework to outline the channels via which multiple claim-holders induce fewer than optimal loan modification by worsening the agency problem between mortgage Servicers and RMBS Sponsors. Then, using within deal variation in the number and structure of tranches, I find that loans in pools collateralizing fewer tranches are more likely to be modified conditional upon being seriously delinquent. I also find that modified loans in such loan pools were likely to receive more aggressive loan modifications. The results provide evidence for one channel via which the securitization of mortgages inhibited the renegotiation of delinquent mortgages in the wake of the housing crisis.