COVID-19: Freezing Mortgage Payments Counterproductive; Other Options Better

THE COWEN INSIGHT

The COVID-19 economic crisis is leading to calls for a mortgage payment holiday so borrowers can skip payments without penalty. We see this as a mistake that would do more harm than benefit. Best option is to buttress stabilizers like immediate unemployment insurance and cash payments so borrowers can still pay. Next step is forbearance with Federal Reserve support. MBS market stability is key.

What is Happening

Washington is looking at ways to freeze mortgage payments in order to help individuals deal with the COVID-19 crisis.

Our View

• We believe a mortgage payment holiday is a non-starter that would do more harm to the economy and the mortgage market than benefit it could deliver to individuals.
• The best option is to give individuals the ability to continue making their mortgage payments. This means providing unemployment insurance immediately to those who suffer COVID-19 layoffs and offering cash payments as the Trump administration is proposing.
• The White House and FHFA are calling for forbearance. This is a more traditional way to deliver relief during a disaster but we don’t see how the financial system could offer comprehensive forbearance unless the Federal Reserve establishes a new liquidity facility on Sec. 13(3).
• This is why we believe the Federal Reserve will either establish a new program under Sec. 13(3) or modify existing programs so that servicers can pledge guarantees from FHA, VA, rural housing, Fannie Mae and Freddie Mac in exchange for the liquidity needed to keep forwarding payments to MBS holders. This is consistent with our view that the Federal Reserve will use 13(3) to probably help consumers and businesses deal with the COVID-19 crisis.

As Washington looks for ways to stabilize consumer finances during the COVID-19 crisis, attention is turning to providing payment relief on FHA, VA, rural housing and GSE mortgages.

• We believe a payment holiday is a non-starter. The system is not designed to simply let borrowers skip payments for several months. The broader economic chaos this could trigger would be substantial.
• Automatic stabilizers would be more helpful as they put cash in the hands of consumers. This then allows consumers to continue making mortgage payments.
• The President and FHFA are pushing forbearance, which is the traditional approach to dealing with disasters that leave borrowers unable to pay. Given the national scope of this crisis, we don’t see how servicers could handle the liquidity strain this would impose. It is why we believe the Federal Reserve will create a facility or expand an existing facility to facilitate forbearance.
• This is separate from a freeze on foreclosures. That is easier to put in place in the shortterm so people are not forced out of their homes during the COVID-19 crisis. It is why the White House announced such a policy today. We expect it will be effective.

We note the following:

• The problem with the government simply declaring that borrowers can skip mortgage payments for several months because of a mortgage holiday is that the system is not designed for this outcome. We are not even sure the government could legally interfere with the obligation to make payments that are contractually obligated. And the uncertainty with such a declaration could create even more havoc in an MBS market that already is dealing with accelerating prepayment speeds as borrowers refinance. For instance, does the freeze only impact the consumer making the payment to the servicer? Or does it also impact the servicer making the payments to MBS holders? And if it is just the consumer, then how does the servicer cope? And do the payments get made up at some point? How does that occur? These are all complicated questions that don’t need to be answered as we believe there are better approaches.
• That better approach is to boost the stabilizers so borrowers can afford to keep making their mortgage payments on time. Cowen political strategist Chris Krueger discusses the latest on the stimulus in a note which he published today. The bill includes expanded unemployment insurance, relief to companies that keep employees on payroll, and two rounds of cash payments. We see all of these as helping borrowers stay current on their mortgages despite the crisis.
• The other stabilizer is the ability to refinance the mortgage given that rates are at historic lows. Not only would this reduce the borrower’s monthly payment, but it also can involve having a borrower skip a payment. As we understand it, consumers already are flooding lenders with requests to refinance.
• If those stabilizers are insufficient, the next option would be forbearance, which is what is offered after a natural disaster. This permits a borrower to skip several payments which are then either added as a balloon payment to the end of the loan or which could extend the duration of the loan by the number of payments that are missed.
• President Trump and FHFA Director Mark Calabria today announced that forbearance is an option for borrowers impacted by the COVID-19 crisis. This program could provide up to 12 months of payment relief for those who otherwise cannot afford their mortgages because of COVID-19-related payment losses.
• Unlike a payment holiday, there is a roadmap for forbearance. The FHFA program will require the borrower to contact the servicer. The borrower gets to skip payments but it has to make those payments up. That could either be done as a balloon payment or as a second mortgage that gets paid off when the loan gets refinanced or repaid. We are told that forbearance generally only attracts those who cannot make the payment as those who just want to try to skip a few payments opt out when they realize the will have to make up what they skipped. As such, this is a useful tool for those who still cannot afford payments despite direct government assistance like expanded unemployment insurance.
• FHFA Director Mark Calabria said today in a conference call version of the Exchequer Club luncheon that forbearance should only be for those who are truly in need. He urged those who can afford their mortgages to keep paying and not to overwhelm servicers with requests for forbearance.
• Sen. Sherrod Brown, the top Democrat on the Senate Banking Committee, today proposed legislation that would give borrowers the right to 180 days of mortgage forbearance with the option to get a second 180 days of relief. This would be conditioned upon the borrower attesting that the COVID-19 crisis has impacted their financial situation. There is no documentation requirement. After the first 180-day period, the borrower has the option to extend for another 180 days. Upon the end of the forbearance, the loan gets extended by the duration of the missed payments. There are no fees or deferred interest. We do not expect Sen. Brown’s plan to become law as the White House plan already offers up to 12 months of relief. Yet it matters as it shows the bipartisan focus on forbearance.
• The problem is that we don’t see how servicers — either banks or nonbanks — will have the liquidity needed to provide comprehensive forbearance. This is why there already are calls for the Federal Reserve to establish a facility to provide liquidity to mortgage servicers.
• We believe the Federal Reserve has the power to establish this facility under Sec. 13(3) of the Federal Reserve Act, which allows it to provide emergency credit programs with the consent of the Treasury secretary. Sec. 13(3) programs require borrowers to have collateral. In this case, we believe servicers should be able to meet this requirement as their mortgages are all backed either by FHA, VA, Fannie Mae or Freddie Mac. Those guarantees cannot be pledged under existing facilities. And nonbanks don’t have access to those other facilities.
• This is why we believe the Federal Reserve would need to establish a new facility. We note that this would have a political upside as the Federal Reserve would be helping individuals rather than just large companies. Not only would that help the Federal Reserve politically in the long term, but it also could ensure there is bipartisan support for the programs the Federal Reserve already has unveiled.
• We note that the payment issue is separate from the foreclosure question. There is no one today that is facing foreclosure because of COVID-19. Foreclosure is a long process that in many states is measured in years rather than months. In either case, it is never measured in weeks. That said, there are public health considerations to forcing people out of homes during a pandemic. It is why we believe the White House today announced a foreclosure moratorium for several months until the virus is more under control. This could delay reimbursement to nonbank servicers on Ginnie Mae mortgages and to the enterprises on GSE loans, though foreclosures take so long anyway and are so unpredictable that we have trouble believing this would be a serious problem.