Servicing Securitisation through Excessive Foreclosure

How does securitisation distort the foreclosure decision of non-performing mortgages? In a model in which informed securitisers raise liquidity by jointly designing the mortgage-backed security and the foreclosure policy, the authors find that securitisers optimally adopt an excessive foreclosure policy while retaining the junior tranche to signal positive information to investors in the senior tranche. In order to commit to the optimal foreclosure policy, securitisers can either outsource the foreclosure decisions to mortgage servicers who are intrinsically “tough" or offer the servicers “biased" servicing contracts. Policies that aim to restore ex post efficient foreclosures may inadvertently reduce mortgage originators' screening effort