Worrying About Mortgage Servicers' Fate

Mortgage servicing is hot. Goldman Sachs is looking at buying the C-Bass servicing unit, and there are many other deals going through as well, such as Wilbur Ross paying $435 million for the servicing business of American Home, and Carrington Capital Management buying the servicing business of New Century Financial for $184 million.

I have to say this worries me. Joe Giannone explains that loan servicing is an attractive business to be in during a housing bust:

Litton makes changes to mortgages that can help struggling borrowers pay their debt, a business that would do well as delinquency rates rise.

Ideally, however, loan servicing isn't a standalone business – certainly not one which should be levered up by Wall Street and then bought with the intention of selling it later at a large profit. If you simply have a lender and a borrower, then often the servicing arm of the lender can be incredibly valuable to both sides: a good loan servicer will find a way to keep the borrower in their house, and maximize the value of the loan for the lender, which otherwise might have to write it off or go through a painful, expensive, and protracted foreclosure process.

What happens, however, when the servicer is a for-profit entity not connected with the lender? Suddenly, there's a conflict between saving money for the lender, on the one hand, and making money for itself, on the other. A simple mortgage renegotiation is not very lucrative, for a servicer; a fully-blown foreclosure, on the other hand, provides much more in the way of opportunities to profit.

More generally, any savings from the negotiation now have to be split three ways (between the lender, the borrower, and the servicer) rather than just two ways (between the lender and the borrower).

In other words, if servicers get bought up by financial investors, that's bad news for borrowers. What's needed now is more common sense in the mortgage world, and less profit motive. But the banks and hedge funds who are buying up the servicers have nothing but a profit motive – and I can't say that I've seen a great deal of common sense from them of late.