The Mortgage Forbearance in the CARES Act Is Seriously Flawed

Houses in a suburb of Denver, Colo. (Rick Wilking/Reuters)

Applicants should be required to provide at least basic documentation for their claim that COVID-19 has affected them.

The government response to the COVID crisis will be subjected to analysis and critique for years to come. Even in the present, as governmental actions play out in real time, clearly effective and needed actions can be seen by many, just as other decisions are already met with skepticism. The fiscal-stimulus price tag is now very close to $3 trillion, and monetary stimulus is not far behind that level (and growing). Big actions have been taken — and unsurprisingly, history will likely judge many of them favorably (perhaps quite so), and others not favorably.

One such action in that latter group deserves scorn in both the present and the future. This utterly mystifying nugget is section 4022 of the CARES Act (H.R. 748):

During the covered period, a borrower with a Federally backed mortgage loan experiencing a financial hardship due, directly or indirectly, to the COVID-19 emergency may request forbearance on the Federally backed mortgage loan, regardless of the delinquency status, by —

(A) submitting a request to the borrower’s servicer; and

(B) affirming that the borrower is experiencing a financial hardship during the COVID-19 emergency.

Okay, so far, so good (more or less). The “directly or indirectly” language is another way of saying “or not at all,” but I digress (and so did the lawmakers, as you shall soon see). And “regardless of delinquency status” means that those already not paying their mortgage pre-COVID are given a hall pass during COVID, sort of undermining the intent to help people who have been hit by this pandemic. But I will put those two phrases aside for a moment. The bill goes on to establish the criteria by which servicers must grant this forbearance to borrowers:

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Upon receiving a request for forbearance from a borrower, the servicer shall . . . with no additional documentation required other than the borrower’s attestation to a financial hardship caused by the COVID-19 emergency and with no fees, penalties, or interest . . . provide the forbearance for up to 180 days. [Emphasis added]

That 180 days of forbearance can be extended for an additional 180 days by simple request of the borrower. So essentially what this section has done is allow home borrowers to not pay their mortgage for a full calendar year, with no penalties or interest, just by saying that COVID-19 has indirectly affected them.

Do you know anyone not “indirectly” affected by COVID-19? It is universal language on its face, and there is a significant problem with this that is already doing far greater harm than good and that, if not addressed, will continue to do so.

I do understand that included in those with “Federally backed mortgage loans” (these include loans sponsored by Fannie Mae, Freddie Mac, and the Federal Housing Administration, so roughly 65 percent of all American mortgages) are some who would genuinely and perhaps even desperately need mortgage forbearance. Even after the direct infusions to American taxpayers, the unemployment-benefits premium, and the support to small business via the Paycheck Protection Program, there will surely be some whose economic circumstances would make servicing their mortgage painful. My guess is that that number is quite low, net of all other support and programs, but I acknowledge existence of that need and concern.

However, where such legitimate need exists, the actual codification that they not be required to document their need whatsoever is simply surreal. It was language begging for a crisis of responsibility. Why not require simple demonstration of hardship to be given interest-free relief from one’s mortgage responsibility for a full calendar year? A simple bank statement, a letter from one’s employer, evidence of mounting credit-card debt — some written support along with an attestation to support the claim of hardship?

By not requiring basic documentation and support, the government has made the claim of hardship and appeal of forbearance irresistible. The number of borrowers claiming this right under the CARES Act surged 60 percent this week over the prior week; they now represent a stunning 5.95 percent of total serviceable loans. A significant increase in such requests is widely expected again in the weeks ahead, when May mortgage payments are due.

We learned in the 2008 financial crisis that too many Americans do not need to be encouraged not to make their mortgage payments; for a substantial portion of the population, when some economic calculus suggested not paying their mortgage (generally because the value of the home was lower than the debt on the home), far too many were quite comfortable breaching contract and not making payment. In chapter 4 of my book Crisis of Responsibility, I addressed this very systemic phenomenon.

But in 2008, borrowers were at least breaking contract law to violate their mortgage responsibility. This provision of the CARES Act is a legal and warm invitation for them to do so. I do not refer to the allowance of forbearance with documented hardship — I refer to the explicit requirement that no hardship be documented whatsoever. This is a stunning form of moral-hazard generation, and it was not only entirely unnecessary. It is creating cost and pain far higher than what it sought to relieve.

The jumbo-loan market is entirely frozen in our country now (the 35 percent of mortgage borrowing not within Fannie and Freddie guidelines). Servicers who have now been legally told they must grant forbearance to any who request it without demonstration of hardship have to make the payment for them (as the loans have been sold to investor pools, and servicers are the first line of defense in those mortgage pools, called agency residential mortgage-backed securities, RMBS). Those servicers who are seeing their liquidity positions and balance sheets collapse are necessarily fleeing from any extension of credit to otherwise worthy borrowers. Big banks don’t want to touch this space. And the cost of obtaining a mortgage has moved higher even as underlying interest rates are at all-time lows. Warehouse lines have been tapped and now are being shut down entirely.

One solution would be for the Federal Reserve and the Treasury Department to backstop the economic damage they have caused for servicers. Guidance this week from the Federal Housing Finance Agency (FHFA) that servicers will be on the hook only for four months of missed payments helped in some measure, as at least servicers can now measure the damage being done to them by government policy, rather than face an undefinable, potentially limitless number floating out there. But four months of mortgage costs on 5.9 percent of American mortgages (and climbing) is an unfathomable amount of money, and it has decimated capital markets for those non-bank lenders and financial institutions. Qualified borrowers end up bearing the brunt, through either a total evaporation of available credit or a substantially higher cost of obtaining credit.

But the far easier and cheaper solution would simply be to require documentation. Forbearance is not forgiveness (not yet, anyway). People who have the means to make their payment may be willing to attest to indirect hardship, but surely the number would become a mere fraction of present levels if actual demonstration of hardship was required.

Beyond the two aforementioned solutions, the Treasury Department and FHFA will need to launch a massive public information-effort to explain that “forbearance is not forgiveness.” The system cannot afford for that 5.9 percent to grow to a higher figure, and informing people of the cost of having to “make up mortgage payments later” is vital. The short-term allure of free money is too strong if not counterbalanced with a clear and daunting case that greater liability would result later.

The most frustrating part of this unforced error is that it cuts into what is largely a good legislative effort. We often say “too soon” when the subject of various uncomfortable or unpleasant memories comes up. For a nation just over a decade removed from our last mortgage debacle, the moral hazard of this part of the CARES Act is just “too soon.”

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