Bert W. Wasserman Workshop in Law and Finance: "The Rise of Non-Banks in Servicing Household Debt" with Berkeley Law Prof. Manisha Paddy '17

ABSTRACT: Servicing rights have become increasingly separated from the financing and origination of loans and are traded after being assigned to the initial servicers. Using a near universe of consumer credit records, we document novel facts about the allocation of mortgage servicing rights (MSRs) and identify the effect of MSR capital regulation on their allocation to servicers. We show that banks are more likely to allocate MSRs to non-banks following increased regulatory cost of holding MSRs, with more transfers of MSRs on subprime and delinquent loans. Our model rationalizes these findings and demonstrates how servicing rights traded in a private market can be allocated to servicers facing agency conflicts, causing welfare losses to borrowers and investors. Our empirical findings support this theoretical argument: loans impacted by the regulatory change have higher foreclosure rates, driven in part by re-allocation to non-banks who foreclose more aggressively than optimal for either borrowers or investors. The results suggest that Basel III’s MSR rules decreased social welfare by re-allocating MSRs to conflicted servicers, with the largest negative effects on subprime borrowers.

The complete paper is available.