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Barriers to Foreclosure Prevention During the Financial Crisis

The number of modifications to distressed residential loans has been subpar to date compared to the number of foreclosures. This raises concerns about the presence of artificial barriers to loan modifications in situations where foreclosure should be avoidable. Numerous theories have been advanced for the relatively low level of modifications, including restrictions on loan modifications in private-label servicing agreements, threats of lawsuits by private-label investors, servicer compensation arrangements, the high cost of loss mitigation, accounting rules, junior liens, and tax considerations. This Article concludes that servicer compensation coupled with the costly nature of loan workouts, accounting standards and junior liens form the biggest impediments to an efficient level of loan modifications. These factors also distort the mix of loan modifications that are made toward types of modifications with higher redefault rates. Other explanations, such as servicing agreement restrictions, tax consequences, and the threat of lawsuits, either are not at play or are of second order importance.