A Question for the Finance Types

I’m wondering if any blog readers can explain something to me.

Back in the old days, banks didn’t package and resell the mortgages they wrote. So when a homeowner got into trouble, they could go down and talk with the bank about working out some solution other than foreclosure. For instance, the bank could allow the borrower to pay back the loan over 30 years instead of 15 years, reducing the monthly payment.

Because foreclosure is so costly (I’ve heard estimates that a typical foreclosure costs the lender $60,000 to carry out), avoiding it can prove beneficial to all parties.

Now, most of the mortgages that are written are packaged and resold. Then, apparently, they are stripped apart into pieces so that different parts of a particular mortgage might then be held by multiple entities. If this is true, then it makes renegotiating bad loans extremely difficult, since all of the different debt holders have to be on board in order to make a deal happen.

I have four questions:

1) With mortgage-backed securities, is it really the case that a given mortgage is stripped into multiple pieces held by different entities?

2) If mortgages really are stripped into pieces, how does foreclosure work? If many different firms hold a piece of the mortgage, who initiates foreclosure? Who pays the costs of foreclosure? It would seem to me that many of the same obstacles to working out a refinancing deal would be present for foreclosing as well.

3) If mortgages are not stripped into pieces, are there firms out there trying to scoop up failing mortgages at rock-bottom prices and getting on the phone with the homeowners to try to negotiate deals to avoid foreclosure? If mortgages are not stripped into pieces, I don’t understand why it is so hard to value these mortgage-backed securities.

4) If indeed mortgages are stripped into pieces, weren’t people worried about the complications that would result when these mortgages were divided into pieces? Usually, economists think that smart people won’t write contracts that are incredibly inefficient.