Can Mortgage Forbearance Help Stabilize the Economy?
Is allowing borrowers to suspend mortgage payments an effective way to stabilize the economy during a recession? In a new working paper, Omeed Maghzian and I attempt to answer this question by examining the impact of mortgage forbearances, instituted under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, on labor market stability during the pandemic recession. We find that these measures played an important role in boosting local demand during the economic recovery.
These findings are significant because limited household liquidity can depress aggregate demand during economic downturns. During the Great Recession, for example, the wave of defaults following the housing crisis had destabilizing effects on both local and aggregate economic activity, which persisted for several years. Since then, policymakers and academics have actively discussed how to best prevent defaults and stimulate consumption among distressed borrowers to promote macroeconomic stability during times of crises.
Recognizing households’ countercyclical liquidity needs, the CARES Act allowed federally-backed mortgage borrowers to halt their payments without fees or penalties for up to 18 months. Upon exiting forbearance, borrowers were typically given the option to defer repayment of their missed payments until the end of their mortgage term as a second-lien loan.
Two distinct features of the mortgage forbearance program made it possible to identify the impact of the liquidity provision on local labor markets. First, despite the broad eligibility criteria, enrollment in mortgage forbearance was not automatic; households had to request forbearance. As a result, there were significant regional variations in the uptake of forbearance. Second, in contrast to other forms of fiscal policy, the implementation of the program was carried out by mortgage servicers, which are responsible for collecting monthly payments and facilitating transactions with investors in mortgage-backed securities. We find that there were significant differences in mortgage servicers’ propensity to provide forbearance. Using loan-level data for government-sponsored enterprise mortgages, we further show that these differences cannot be fully explained by observable loan and borrower characteristics. Rather, servicers differed by as much as 7 percentage points in forbearance provision to observably similar borrowers.
We exploited these servicer-induced variations to assess the impact of forbearance provision on regional employment outcomes. Notably, we estimate that during the 18 months following statewide business reopenings, a one percentage point increase in the forbearance rate led to an approximately 30 basis point increase in monthly employment growth in “nontradable” sectors (retail trades, accommodations, and food services). This effect is large enough to suggest that when it was widely available, forbearance helped stabilize local economic conditions during the pandemic-era recession.
Our work also implies that households spent 67 cents of every dollar of liquidity provided through mortgage forbearance in the following year. In the second part of the paper, we note that these estimates are broadly consistent with the range of existing estimates for household-level spending responses. We also compare the effectiveness of forbearance policies with other government policies for stimulating demand during economic downturns and find the direct outlay needed to implement a forbearance policy is small in comparison with the relatively large benefits. In contrast, other fiscal stimulus measures generally have larger costs because they rely on direct transfers from the government to households. Overall, our findings suggest that household liquidity provision through debt forbearance can be a cost-effective fiscal stabilization tool during economic downturns.
Our results also have implications for optimal mortgage design. In particular, our work is closely related to research by John Y. Campbell, Nuno Clara, and João F. Cocco, who examine mortgage design features that enable borrowers to make interest-only payments and extend the maturity of their mortgages during recessions to promote macroeconomic stability. Given the notable similarities between mortgage forbearance under the CARES Act and the state-dependent modification features proposed in their study, our work provides empirical evidence supporting the stabilizing effects of allowing borrowers to suspend mortgage payments during economic downturns.