Designing Efficient Mortgage Foreclosure Sale

Lenders with delinquent mortgages recover their lending by foreclosure, which is a legal process to sell the mortgage property via public auction. In the U.S., mortgage lenders are allowed to bid in such foreclosure auctions, and they win in such auctions very frequently. I study the question of why mortgage lenders win in most of those auctions. I develop a theoretical model of ascending auctions with private values. I find that the lender’s optimal bidding strategy is the same as the optimal reserve price of an auction seller, if it is below the debt balance. In other words, the lender exercises monopoly power as would an auction seller, up to the remaining debt. I next derive a mechanism that achieves efficient allocation of the foreclosed property. Finally, I match the model with data for 15,860 foreclosure auctions in Miami-Date County, Florida. The lender’s monopoly power partially explains the reason why the lender wins in 88% of the auctions. I also find evidence that mortgage lenders may have a systematically higher valuation of the mortgage property compared to other bidders.