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Forbearance Effectiveness During a Financial Downturn

Financial pain perpetrated by the COVID-19 pandemic has been gentler than it otherwise could have been, according to a newly released research paper from the business schools of Columbia University, Northwestern University, Stanford University, and the University of Southern California, due largely to forbearance programs.

Not only do the plans provide protection from loss of housing, research showed that one third of borrowers in forbearance continued making full payments, suggesting that forbearance acts as a credit line, allowing borrowers to “draw” on payment deferral if needed, according to the authors.

They maintain that many lenders and the federal government may have learned some important lessons from the 2008-09 financial crisis about the usefulness of forbearance.

Something about those lessons emerges from the study's statistics gauging household debt during the pandemic. Last March, as COVID-19 spread and unemployment numbers increased, delinquency rates on mortgage and other loans plummeted, the total opposite of what typically happens during downturns, including the 2008 financial crisis. In fact, the researchers point out that during the last crisis, mortgage delinquencies jumped from 2% to 8% but in the first seven months of the pandemic they dropped from 3 to 1.8.%

This is especially striking,” the researchers note, “given an unprecedented increase in the unemployment rate that reached almost 15% in [the second quarter of 2020] and the strong historical association between the unemployment rate and mortgage default.”

The reason for the anomaly? Forbearance programs. According to an article in Fortune related to the study,  "instead of cracking down on delinquent borrowers—foreclosing on homes, repossessing autos, declaring other debts in default—they offered forbearance far more generously than ever before. Forbearance doesn’t reduce a borrower’s debt. It just permits the borrower to put off some payments until later without the lender declaring the borrower delinquent and denting the borrower’s credit rating."

Fortune's Geoff Colvin concludes from the study that going easier on debtors is a "wise move."

"In the big picture, overburdened households undermine the whole economy—what economists call 'the standard household debt distress channel.' During the financial crisis, the spike in mortgage delinquencies sent home prices into a self-reinforcing downward spiral as homeowners rushed to sell and banks put foreclosed properties on the market, forcing prices down and prompting other homeowners to sell before prices went even lower. Overall demand collapsed, pushing the economy into a hole that took three years to escape."

He says the CARES Act included a section requiring forbearance of federally insured mortgages—the vast majority of all mortgages—for that very reason.

“Most potential delinquencies in the mortgage market were averted because of forbearance,” the researchers wrote in the study, and they deduce “the low delinquencies explain at least in part why the pandemic has not resulted in house price declines.”

According to the study, all sorts of banks and lenders—auto loans, student loans, credit card debt—followed the forbearance suit.

"The private sector and policymakers may have internalized the lessons from the Great Recession pointing to significant costs of widespread defaults and foreclosures and were more willing to provide debt relief,” noted the researchers. "It’s also possible, they note, that “the underlying adverse shock has been perceived as more transitory relative to the prior crisis.”

In summary, massive consumer debt forbearance actions can help explain why, unlike during the Great Recession, the standard household debt channel was largely absent during the first year of the COVID-19 pandemic.” As Colvin writes, one can hope that "this lesson is the one policymakers will carry with them into the next downturn."

About Author: Christina Hughes Babb

Christina Hughes Babb is a reporter for DS News and MReport. A graduate of Southern Methodist University, she has been a reporter, editor, and publisher in the Dallas area for more than 15 years. During her 10 years at Advocate Media and Dallas Magazine, she published thousands of articles covering local politics, real estate, development, crime, the arts, entertainment, and human interest, among other topics. She has won two national Mayborn School of Journalism Ten Spurs awards for nonfiction, and has penned pieces for Texas Monthly, Salon.com, Dallas Observer, Edible, and the Dallas Morning News, among others. Contact Christina at christina.hughesbabb@thefivestar.com.

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