View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Loan forbearance

Crisis and
Debt Relief

and other debt relief
have been part of the
effort to help struggling
households and
By John Mullin


he pandemic’s harmful financial effects have been distributed unevenly — so much so that
the headline macroeconomic numbers generally have not captured the experiences of those
who have been hardest hit financially. Between February and April, for example, the U.S.
personal savings rate actually increased by 25 percentage points. This macro statistic reflected the
reality that the majority of U.S. workers remained employed, received tax rebates, and reduced
their consumption. But the savings data did not reflect the experiences of many newly unemployed
service sector workers.
And there are additional puzzles in the data. The U.S. economy is now in the midst of the worst
economic downturn since World War II, yet the headline stock market indexes — such as the Dow
Jones Industrial Average and the S&P 500 — are near record highs, and housing prices have generally remained firm. How can this be? Many observers agree that the Fed’s expansionary monetary
policy is playing a substantial role in supporting asset prices, but another part of the explanation
may be that the pandemic’s economic damage has been concentrated among firms that are too
small to be included in the headline stock indexes and among low-wage workers, who are not a
major factor in the U.S. housing market.


E c o n F o c u s | s e c o n d / T h i r d Q u a r te r | 2 0 2 0

Share this article:

Policymakers have taken aggressive steps to mitigate the pandemic’s financial fallout. Among the most
prominent have been IRS tax rebates, the expansion of
unemployment insurance benefits, and forgivable Payroll
Protection Plan (PPP) loans for businesses. But these fiscal steps have been complemented by an array of policies
specifically designed to ease private sector debt burdens.
The CARES Act, for instance, mandated debt forbearance
on federally backed mortgages and student loans. And
the Fed — in addition to launching several new lending
facilities — has coordinated with other federal bank regulators to encourage banks to work constructively with
their clients in need of loan restructurings. (See “The
Fed’s Emergency Lending Evolves,” p. 14.) While less wellpublicized than the fiscal steps, these debt relief measures
are arguably no less consequential.
A Role for Debt Relief
The economic policies that have been adopted in
response to the crisis were designed to meet multiple
goals. The most immediate concerns were to provide
safety net aid to those in need and to stimulate aggregate
demand. But there was also a longer-term objective: to
improve the foundation for future growth by helping
households and firms maintain their financial health.
This goal is being addressed partly by fiscal transfers to
households and firms to help them avoid depleting their
assets and increasing their debts. But crucially, the goal
is also being advanced by policies designed to keep the
supply of bank credit flowing and to prevent unnecessary
loan defaults and business failures.
The CARES Act contains several important debt
relief provisions. In addition to allowing for the deferment of student loan debt repayments and providing
debt service forbearance and foreclosure protection for
borrowers with federally backed mortgages, the legislation also mandated the relaxation of certain accounting
standards — making it more attractive for banks to offer
debt forbearance to households and firms affected by the
pandemic. In support of the legislation’s intent, federal
bank regulators at the Fed and other agencies issued
an interagency statement on March 22 confirming that
financial institutions could make pandemic-related loan
modifications without having to downgrade the loans
to the category of Troubled Debt Restructurings (or
TDRs). Since it is costly for banks to recategorize loans
as TDRs, this interpretation helped to remove an impediment to loan restructurings.
Bank regulators followed this up by issuing a statement
in June that outlined supervisory principles for assessing
the safety and soundness of financial institutions during
the pandemic. According to the statement, regulators
“have encouraged institutions to use their capital buffers
to promote lending activities.” Moreover, the regulators
emphasized that they “view loan modification programs
as positive actions that can mitigate adverse effects on

borrowers due to the pandemic.” They sought to assure
bankers that bank examiners “will not criticize institutions
for working with borrowers as part of a risk mitigation
strategy intended to improve existing loans, even if the
restructured loans have or develop weaknesses that ultimately result in adverse credit classification.”
This guidance has been implemented by the Fed’s
regional bank supervisors, including those in the Fifth
District. “We want the banks to be part of the solution
and to continue to lend,” says Lisa White, executive
vice president of the Supervision, Regulation, and Credit
department at the Richmond Fed. “Overall, the banks
were more resilient from a capital perspective heading
into the current crisis compared to the last,” she says.
“The philosophy behind the interagency guidance was
to convey our planned supervisory approach and clearly
communicate what we will be most focused on as we assess
how banks are handling the challenges associated with the
When supervisors evaluate how well banks have performed during the crisis, she explains, “we are going to
assess how well they have managed their deferral and forbearance programs, and we will put more emphasis — even
more than we’ve had in the past — on their underwriting
and risk management practices versus just the results or
how they translate into a particular loan’s performance.”
Loan Forbearance and Households
Prior to the pandemic, the household sector’s credit
metrics appeared to be in good shape. In 2019, the
overall delinquency rate for consumer credit stood at a
post-financial-crisis low of roughly 5 percent, as declining mortgage delinquencies in recent years had roughly
offset increased auto loan and credit card delinquencies.
Moreover, the aggregate data showed no noticeable
upward trend in personal foreclosures and bankruptcies. These signs of health may have partly reflected the
conservative underwriting practices that creditors had
adopted after the 2007-2008 financial crisis, when they
shifted toward making loans to borrowers with higher
credit scores.
But these numbers may not adequately reflect the
financial vulnerability of many low-income households.
According to the research and consulting firm Financial
Health Network, as many as 33.9 percent of those
surveyed in 2019 stated that they were “unable to pay all
bills on time.” The same survey found that, among those
who make less than $30,000, only 34.7 percent stated
that they have a “manageable amount of debt.” These
numbers are consistent with the notion that there is a
significant part of the U.S. population that lives paycheck
to paycheck and is quite vulnerable to interruptions in
These vulnerable low-income households bore the
brunt of the economy’s job losses at the onset of the
pandemic. Based on an analysis of ADP data presented
E c o n F o c u s | s e c o n d / T h i r d Q u a r te r | 2 0 2 0


Forbearance Jumped in April and May


Residential mortgages in active COVID-19 forbearance plans
March 24

April 24

May 24

June 24

July 24

August 24

Source: Black Knight

at a recent Brookings Papers on Economic Activity
conference, employment losses were disproportionately
high among the quintile of employees with the lowest
pre-pandemic wages. That quintile had a greater than
35 percent decline in employment by April, which contrasts sharply with the less than 10 percent decline in
employment for those in the highest-wage quintile.
The notion that many households stand on shaky
financial ground finds support in the rapidity with which
borrowers have sought out debt forbearance. According to
Black Knight, a provider of mortgage data, the number of
mortgages in forbearance increased from close to zero in
March to over 4 million in May. That figure represented
roughly 8 percent of active mortgages. (See chart.)
It appears that banks have generally been receptive
to forbearance requests by their consumer credit clients. “We’ve been very public with statements on the
consumer side, letting clients know that if you are in
trouble, contact us,” says John Asbury, CEO of Atlantic
Union Bank. “What’s happened is the borrowers have
contacted us and said, ‘I’m having financial challenges.’
For borrowers with no previous payment problems, we
have typically granted 90-day deferrals for the consumer,
no questions asked.”
Forbearance programs are likely to help mitigate
defaults and foreclosures, at least in the short run. In a
recent Richmond Fed working paper, Grey Gordon and
John Bailey Jones concluded that mortgage forbearance,
student loan forbearance, and fiscal transfers will keep
delinquency rates from increasing much in the near future.
According to their analysis, the forbearance programs are
likely to have the greatest effect, with fiscal transfers playing a smaller role.
But consumer loan forbearance is no panacea. It does
not eliminate debt but merely provides borrowers with
time to improve their repayment capacity. If U.S. unemployment remains substantially above pre-pandemic
levels, the economy may see a substantial increase in
defaults as forbearance arrangements expire.

E c o n F o c u s | s e c o n d / T h i r d Q u a r te r | 2 0 2 0

Loan Forbearance and Businesses
The negative effects of social distancing have been most
strongly felt among relatively small businesses. In part,
this is because small businesses are disproportionately
represented in many of the hardest-hit industries, such as
hotels, restaurants, and retail trade. But it also reflects the
relative financial vulnerability of small firms. This point
was highlighted in a September 2019 study by JPMorgan,
which found that, in the typical community, 47 percent of
small businesses had two weeks or less of cash liquidity.
In more normal times, insufficient revenue and inadequate access to capital are among the most frequent
reasons for small business failures. During the current
crisis, of course, these problems have become particularly
widespread. According to a recent survey by MetLife
and the U.S. Chamber of Commerce, 70 percent of small
businesses “are concerned about financial hardship due to
prolonged closures” and 58 percent “worry about having
to permanently close.” Two-thirds of survey participants
agreed that minority-owned businesses “have been disproportionately impacted by COVID-19.”
The risk of permanent closure was underscored in a
recent report by the business review website Yelp. Yelp
found that 132,500 of the firms that it tracks were closed
for business on July 10 and that a little more than half of
the closures were permanent.
As with consumer credit, many banks have been
offering forbearance plans to their business clients who
have been negatively affected by the pandemic. Atlantic
Union Bank, for example, has already modified over 700
business loans in segments it has identified as “COVID-19
sensitive.” By the third week of April, Atlantic Union
had already made roughly 4,000 pandemic-related loan
modifications, accounting for 14.8 percent of the bank’s
overall loan portfolio. These modifications have been
particularly concentrated among its loans to hotels,
restaurants, health care, and retail.
“We have offered payment deferrals in cases where
we fundamentally believe there will be an operating company to work with on the other side,” says John Asbury
of Atlantic Union. “Then we can work with them and
monitor their operations. However, if we ultimately lose
confidence in the company’s viability, then we have to
treat it differently and downgrade the loan’s risk rating.
We don’t want to push problems down the road.”
In some cases, forbearance programs for real estate
developers have had favorable knock-on effects. Such
was the case with Lion’s Paw Development, a Richmond
firm that has built many restaurants for “mom and pop”
operators. When Lion’s Paw was offered a real estate loan
deferment by its bank, it gave the firm the flexibility to
offer rent forbearance to its retail tenants. “I’ve worked
out rent forbearance deals with many of my tenants,” says
Charlie Diradour, president of Lion’s Paw. “I’m going to
send the tenants addendums to their leases that acknowledge that rent payments have not been paid for April,

May, June, and maybe July. We’re going to add those
months on the back end of their current terms.”
Yet many small businesses remain vulnerable to being
shut down. This risk presents a major concern for
policymakers, because small-business closures not only
eliminate job opportunities, they also deplete the assets
of business owners — thus damaging their ability to
make future investments.
The Forgiveness Frontier
Some observers have advocated debt forgiveness for the
most vulnerable — not only for reasons of fairness, but
also to remove excessive debt burdens that block the path
to future growth.
For Michael Hudson of University of Missouri,
Kansas City, author of the 2018 book ...and forgive them
their debts: Lending, Foreclosure and Redemption from Bronze
Age Finance to the Jubilee Year, solutions for the current
pandemic and its related debt burdens should draw on
history. For example, in ancient Mesopotamia, under
the Laws of Hammurabi, periods of debt forgiveness
called “jubilees” were periodically invoked after a famine
or other natural disaster created levels of debt that could
not be addressed by regular means. “But Hammurabi
was not a Utopian idealist when he forgave the debts,”
says Hudson. “He recognized that it’s not worth slowing
down the whole economy and putting it into recession
just so creditors can get paid.”
To be sure, such a policy would place the burden of the
crisis on another group, namely creditors. The long-term
effects on the availability and pricing of credit are hard
to predict. But in Hudson’s view, bankers, creditors, and
landlords have done well enough over the past 10 years to
warrant a similar policy today. “They can afford to take a
hit — a write-down — the rest of the economy cannot.”
Other observers have called for more modest debt relief
measures. For example, Joseph Stiglitz offered some ideas
on the topic of debt relief in a recent interview, including
a proposal to lower what he called the “usurious interest
rates” on credit card debt. Observing the unequal impact
of the crisis, Stiglitz added, “And for those businesses that
are getting so much help from the government, part of
that should be used to help the debtors, who otherwise
will sink under a mountain of debt.”
A proposal to address the debt burdens of small businesses was recently published in the Brookings Papers on
Economic Activity by Markus Brunnermeier of Princeton
University and Arvind Krishnamurthy of Stanford
Re a d i n g s

Brunnermeier, Markus, and Arvind Krishnamurthy. “Corporate
Debt Overhang and Credit Policy.” Brookings Papers on Economic
Activity, Summer 2020.

Debt forgiveness was practiced in ancient Mesopotamia. The Laws
of Hammurabi, seen here, laid out situations in which debt slates
could be wiped clean, such as if “a storm prostrates the grain, or the
harvest fail, or the grain does not grow for lack of water; in that year
he need not give his creditor any grain.”

University. They posited that increased debt loads lead
firms to focus on meeting debt obligations rather than
keeping workers employed or pursuing new investment
projects. In their view, rather than stimulating demand,
the government policy’s main aim should be to provide
insurance to firms and workers by injecting “liquidity
into small and medium sized firms that are liquidity
The initial responses to the crisis by fiscal and monetary policymakers and bank regulators have been massive
in scope. Together, they have provided safety net assistance, supported aggregate demand, and helped many
households and businesses preserve their financial health
and avoid default. Despite these efforts, many lower-wage
workers and small businesses continue to struggle financially, and economists and policymakers continue to
consider the best policy responses.
Hudson, Michael. … and forgive them their debts: Lending, Foreclosure
and Redemption From Bronze Age Finance to the Jubilee Year. Dresden:
ISLET-Verlag, 2018.

Gordon, Grey, and John Bailey Jones. “Loan Delinquency
Projections for COVID-19.” Federal Reserve Bank of Richmond
Working Paper No. 20-02, April 15, 2020.
E c o n F o c u s | s e c o n d / T h i r d Q u a r te r | 2 0 2 0