Reviews | Banks should defer household debt to protect the economy

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It is not just a humanitarian imperative. It also reflects a strong and established principle for addressing debt problems, from ancient Mesopotamia to modern financial crises. When borrowers are faced with a “liquidity shock” – a sudden and potentially transient loss of ability to pay – the correct answer is to give more time to repay. The pursuit of repayment in such circumstances produces unnecessary, preventable and lasting harm.

With time to get back on their feet, borrowers not only have a better chance of paying off their debts. They can also participate more fully and productively as consumers and workers than is possible with compromised credit or the threat of bankruptcy.

Defer short-term debt payments

With Americans on the cusp of their most brutal liquidity shock in US history – due to job losses due to the sudden lockdown in economic activity – now is the time to deploy any the range of tools to deal with it. This includes deferring short-term debt payments for those who need them.

Here are the categories of payments that should be available for deferral:

Payments of taxes, student loans and other government obligations. At the federal level, announcements have already been made regarding the delay in 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 small business loans and other lines of credit.

Mortgage payments. Lenders should establish expedited processes to make it easier for troubled borrowers to withhold mortgage payments. The federal government has just ordered lenders who work with mortgage agencies Fannie Mae and Freddie Mac to offer affected homeowners payment flexibility of up to 12 months. Federal guarantees cover any risk of credit losses on the mortgage-backed securities of associated agencies. All mortgage agents in the United States should use as much flexibility as possible to facilitate deferred payments. Landlords receiving mortgage relief on rental properties should pass this benefit on to their tenants by deferring rent payments.

Auto loans, credit card payments and other debts. Financial institutions should work on an expedited basis with vulnerable borrowers to implement interest-free deferrals of payments owed on auto loans, credit cards, and other forms of consumer and business debt. These should be implemented without penalties, fees or negative reports to the credit bureaus.

Streamline the process

Federal regulators have already encouraged financial institutions to work with customers who are having payment difficulties. Control agencies should stress to these institutions that they will look upon these actions positively. Banks have indicated their willingness to implement forbearance programs, citing the natural disaster model.

But history has shown that obtaining relief for borrowers can be difficult and time-consuming. One example is the mortgage loan modification programs following the housing collapse, which had disappointing utilization rates and as a result left many potential beneficiaries in financial distress. Many abstention programs for natural disasters also have a poor track record.

Given the pervasive nature of this crisis and the need for large-scale implementation, postponements should use streamlined procedures that lower barriers to accessing relief. Financial institutions already have a lot of information about their customers. This can be the basis for proactive measures by banks to initiate forbearance. A web interface can take client information, execute it through preprogrammed algorithms, and speed up execution. In this crisis, eligibility criteria should be biased in favor of greater access to relief, not less.

Banks must act now

Thanks to regulatory reforms implemented after the 2008 crisis, banks entered the COVID-19 episode with significant liquidity and capital buffers. Aggressive Federal Reserve operations give banks access to functionally unlimited funding at near zero cost. These safety nets mean that U.S. banks are able to implement forbearance programs that protect the U.S. economy and households from the initial shock without compromising their own financial integrity.

The details of implementing all of the above programs are important and require elaboration. They must be carefully designed to prevent unintended consequences for the capital markets, as well as for borrowers. In particular, we must prevent households from taking on excessive debt during this period, which slows down their post-crisis recovery.

It is certainly possible that the impact of COVID-19 on the economy will be prolonged and not transient. In such a case, additional and more aggressive measures will be necessary. Such uncertainties should not prevent swift action on postponements now. Epidemiological uncertainties do not prevent us from setting up calibrated approaches to manage prospective risks.

Government and financial institutions must be held accountable for their escalation at this critical time. Facilitating abstention is a financial analogue of social distancing. It is not enough to solve all of the economic problems associated with the epidemic, but it is a necessary early part of a response that limits the damage.

The banks were the source of the last crisis. They can be part of the solution to this one.



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