Mortgage servicers had a financial incentive to foreclose on home owners as fast as possible. 

That wasn’t the case during the earlier Savings & Loan real estate bust.

A lot of early explanations of the 2000s real estate bubble mentioned the principle-agent problem – that mortgage originators weren’t completely honest about the mortgages they sold to Fannie and Freddie and other securitizers. That doesn’t happen when the company that makes the mortgage keeps the mortgage on its own books instead of selling it off to someone else.

A similar problem occurred because the owners of the mortgages often did NOT handle the foreclosures of the mortgages they owned. The owners of mortgages, often Fannie and Freddie, had contracts with mortgage service companies to collect the mortgage payments, and when things went bad, the contracts detailed how the servicers were to foreclose on the house owners. 

The way the contracts were written between Fannie and Freddie and the mortgage servicing companies gave the servicers an economic incentive to foreclose as fast as possible which just drove down house prices faster and further, as we saw. 

When the servicers, not the owners of the foreclosed houses, determine at what prices to sell the houses, and at the same time, the servicers make more money when they sell faster regardless of the sale price, then the servicers are essentially paid to sell fast, not to sell for the highest price possible. Prices can fall fast. 

In earlier times, the S&Ls did all three steps themselves – they originated, held, and serviced their own mortgages. During the S&L bust of the late 1980s and early 1990s, back when S&Ls dominated the market, the S&Ls had an economic incentive to foreclose SLOWLY and to not drive down prices. 

S&Ls often worked with distressed home owners, including modifying their mortgages. S&Ls knew foreclosures drove down the value of all the houses they held as collateral so they were slow to foreclosure and sometimes when they did foreclose S&Ls didn’t immediately sell the houses because they didn’t want to drive down prices further. 

Instead, S&Ls would sometimes after foreclosing, rent out houses for a year or more and then sell them when the market was stronger and such sales wouldn’t drive down house prices and the value of all their collateral as much, if at all. House prices fell less for everyone simply because of the design of the mortgage system – S&Ls kept the mortgages they made on their own books and serviced their mortgages themselves. The interests of the originator, servicer, and owner of the mortgages were aligned because the were all the same S&L.

Any bad mortgages they made were their own problem since they didn’t usually sell their mortgages. And with foreclosures, their goal was to sell them for the most amount of money possible, unlike the mortgage servicers in the 2000s who made more money by selling as fast as possible at any price. 

76 Secrets of U.S. Home Ownership – Table of Contents