Effectiveness of forbearance during a financial downturn
The financial pain perpetrated by the COVID-19 pandemic has been milder than it could have been otherwise, according to a recently published study paper business schools at Columbia University, Northwestern University, Stanford University and the University of Southern California, largely through forbearance programs.
Not only do the plans offer protection against home loss, research has shown that a third of forbearers continue to make full payments, suggesting that forbearance acts like a line of credit, allowing borrowers to “draw down”. On the deferral of payment if necessary, according to the authors.
They argue that many lenders and the federal government may have learned important lessons from the 2008-09 financial crisis about the usefulness of forbearance.
Something about these lessons emerges from the statistics of the study measuring household debt during the pandemic. Last March, as COVID-19 spread and the number of unemployed rose, default rates on mortgages and others fell, the opposite of what typically happens during downturns, including the financial crisis. of 2008. In fact, the researchers point out that during the last crisis, mortgage delinquencies went from 2% to 8% but in the first seven months of the pandemic, they went from 3 to 1.8%.
This is particularly striking, “note the researchers,” given an unprecedented rise in the unemployment rate which reached nearly 15% in [the second quarter of 2020] and the strong historical association between the unemployment rate and mortgage default. “
The reason for the anomaly? Abstention programs. According to an article by Fortune Related to the study, “instead of cracking down on delinquent borrowers — foreclosure of homes, repossession of automobiles, declaring other debts in default — they offered forbearance much more generously than ever before. forbearance does not reduce a borrower’s debt. the borrower defer certain payments until later without the lender declaring the borrower in arrears and damaging the borrower’s credit rating. “
Geoff Colvin of Fortune concludes from the study that it is wise to go further with debtors.
“Overall, overburdened households undermine the entire economy – what economists call ‘the standard channel of household debt distress.’ During the financial crisis, the surge in mortgage delinquencies sent house prices into a self-reinforcing downward spiral as homeowners rushed to sell and banks put foreclosed properties on the market, driving down prices and pushing them to sell. other owners to sell before prices drop even more. demand collapsed, pushing the economy into a hole that took three years to escape. “
He says the CARES Act included a section requiring forbearance from federally insured mortgages – the vast majority of all mortgages – for the same reason.
“Most of the potential defaults in the mortgage market have been avoided through forbearance,” the researchers wrote in the study, and they deduce that “low defaults are at least part of the reason for the pandemic. did not lead to a fall in real estate prices “.
According to the study, all kinds of banks and lenders (auto loans, student loans, credit card debt) went through the forbearance process.
“The private sector and policymakers may have internalized the lessons of the Great Recession indicating the significant costs of defaults and widespread foreclosures and were more willing to provide debt relief,” the researchers noted. “It is also possible,” they note, “that the underlying adverse shock was perceived as more transitory compared to the previous crisis.
In summary, massive consumer debt abstention measures may help explain why, unlike the Great Recession, the standard household debt channel was largely absent in the first year of the COVID-19 pandemic. . As Colvin writes, one can hope that “this lesson is one that policymakers will take with them in the next downturn.”