Author: RAMIN TOLOUI
Date: March 22, 2020
Opinion: Banks Should Defer Household Debt to Protect the Economy
direct cash payments to American households will be a significant portion of the U.S. government’s response to the coronavirus crisis. The logic is clear: When people can’t leave their homes and businesses shut down, workers lose their paychecks. Cash injections from the government – whether in the form of checks or unemployment insurance – help cushion that blow.
But that is only part of the equation for American families trying to get through this challenging period. It’s not only about cash coming into households, but also the cash going out.
At a moment when some struggling households need every dollar to cover basic necessities, it doesn’t make sense for cash infusions from the government to go right back out the door to make routine monthly debt payments. The present situation is anything but routine. For the most vulnerable, amounts falling due on debt should take a back seat to meeting essential needs in this time of crisis.
This is not just a humanitarian imperative. It also reflects a sound and established principle in responding to debt problems, from ancient Mesopotamia to modern financial crises. When borrowers face a “liquidity shock” – a sudden and potentially transitory loss of ability to pay – the correct response is to give more time to repay. Pursuing repayment in such circumstances produces unnecessary, avoidable, and lasting harm.
With time to get back on their feet, borrowers not only have a better chance at discharging their debts. They also can participate more fully and productively as consumers and workers than is possible with impaired credit or the threat of bankruptcy.
Defer near-term debt payments
With Americans poised to experience their most abrupt liquidity shock in U.S. history – due to job losses from the sudden lockdown on economic activity – now is the time to deploy the full range of tools for addressing it. That includes deferral of near-term debt payments for those who need it.
Here are the categories of payments that should be available for deferral:
Tax payments, student loans and other obligations to the government. At the federal level, announcements have already been made regarding the delay of required tax payments, as well as interest on student debt. Principal repayments on student loans are now also eligible for deferral. Similar relief should be extended to obligations associated with other government programs, such as loans to small businesses and other credit lines.
Mortgage payments. Lenders should establish expedited processes for facilitating forbearance on mortgage payments for stressed borrowers. The federal government has just directed lenders that work with mortgage agencies Fannie Mae and Freddie Mac to offer affected homeowners payment flexibility for up to 12 months. Federal guarantees backstop any risk of credit losses on associated agency mortgage-backed securities. All mortgage servicers in the United States should use maximum possible latitude to facilitate deferred payments. Landlords receiving relief for mortgages on rental properties should pass through that benefit to their tenants by deferring rent payments.
Auto loans, credit card payments and other debt. Financial institutions should work in an expedited fashion with vulnerable borrowers to implement interest-free deferrals of payments due on auto loans, credit cards, and other forms of consumer and business debt. These should be implemented with no penalties, fees, or negative reports to credit bureaus.
Streamline the process
Federal regulators have already encouraged financial institutions to work with customers who are having payment difficulties. Supervisory agencies should stress to these institutions that they will regard such actions favorably. Banks have indicated their willingness to implement forbearance programs, citing the model of natural disasters.
But history has shown that actually achieving relief can be difficult and cumbersome for borrowers. A case in point is the mortgage modification programs following the housing collapse, which had disappointing utilization rates and consequently left many potential beneficiaries in financial distress. Many forbearance programs for natural disasters also have a poor track record.
Given the pervasive nature of this crisis and need to implement at scale, deferrals should utilize streamlined procedures that lower the barriers to accessing relief. Financial institutions already have extensive information about their customers. That can be the basis for proactive steps by banks to initiate forbearance. A web-based interface can take customer information, run it through preprogrammed algorithms, and speed up execution. In this crisis, eligibility criteria should be biased toward giving more access to relief, not less.
Banks should act now
Thanks to the regulatory reforms implemented after the 2008 crisis, banks entered the COVID-19 episode with sizable liquidity and capital buffers. Aggressive Federal Reserve operations give banks access to functionally unlimited financing at almost zero cost. These backstops mean that U.S. banks are in a position to implement forbearance programs that cushion the economy and American households against the initial shock without compromising their own financial integrity.
The implementation details of all the above programs are important and require elaboration. They should be carefully designed to forestall unintended consequences in capital markets, as well as for borrowers. In particular, we must prevent households from building up excessive debt during this period that hampers their post-crisis recovery.
It is certainly possible that the impact of COVID-19 on the economy will be prolonged, not transient. In such a case, further and more aggressive steps will be needed. Such uncertainties should not prevent swift action on deferrals now. Epidemiological uncertainties do not prevent us from implementing steps gauged to manage prospective risks.
Both government and financial institutions must be held accountable for stepping up at this critical moment. Facilitating forbearance is a financial analogue to social distancing. It is not sufficient to solve all economic problems linked to the epidemic, but it is a necessary early element of a response that limits the damage.
Banks were the cause of the last crisis. They can be part of the solution to this one.