As markets tremble and COVID-19 spreads, it’s even clearer that the Fed’s huge rate cut has no meaningful immediate impact even though meaningful immediate impact is urgently needed. The problem with the Fed rate cut is that it encourages borrowing; the real risk now is that millions of Americans may not be able to repay the loans they already have. The last time a significant number of Americans went without pay for a week or two – the 2019 federal shutdown – millions of seemingly-secure middle-class workers suddenly couldn’t make ends meet. The hard truth of post-crisis America is that even upper-income households with solid health insurance often live paycheck to paycheck. As a result, an already-overdue response to the growing pandemic is rapid implementation of guidance laying out how lenders can forbear on loans to borrowers distressed due to no fault of their own.
The 2018-19 shutdown deprived many federal workers of two paychecks, leaving them in arrears as soon as the first paycheck failed to arrive. At the time, this stunned economists – after all, the average full-time federal salary is $85,556, making average-salaried workers denizens of the second highest U.S. income quintile and many doing far better than that. Even so, 62 percent of furloughed employees reported that they experienced significant financial hardship evidenced in struggles to pay rent, meet mortgage obligations, or make even minimum credit-card payments.
This isn’t surprising when one looks at the data. The most recent Fed Distributional Financial Account shows that those in the bottom 60 percent of income earners have about much debt as durable assets. Add in their mortgages or rent, and they are so far under water that only forbearance will prevent sudden drowning.
This is stunning given that federal workers are not only largely middle class or better, but also because they may well be part of two-income households in which one partner worked in the private sector or avoided furlough and all of them enjoyed generous federal health-insurance and even child-care benefits. These benefits are not widely shared even by those who match the level of federal workers pay – 58 percent of American wage-earners are hourly, not salaried, employees. This means not only that they often don’t get paid if they don’t work, but also that few benefits come in tandem with their paychecks. As one study shows, lower-income households are so strapped for even a bit of cash that tax refunds aren’t used for consumption; instead, households get long-overdue health care for themselves and their kids. Overall, forty percent of Americans live paycheck to paycheck and have negligible resources with which to handle a blown tire, let alone a missing paycheck.
Federal employees or not, Americans have no savings to speak of. Try as they might to save – and most Americans do try hard – the most recent savings data show that only half of Americans have even a rainy-day fund. As a result, millions of Americans will suddenly come up short for the bills they already struggle to pay and millions more will join them after exhausting the scant reserves they’ve managed to accumulate.
Clearly, demanding immediate repayment from so many millions all at once will do nothing but make a very bad situation far worse. But that forbearance is essential doesn’t make it easy or inexpensive. Complex decisions have to be made about how long lenders must forego payments, the terms by which borrowers qualify, how to handle the billions in debt outside the reach of federal bank regulators, what to do about mortgage servicers, and even if the Federal Reserve should, as Elizabeth Warren proposed, get into the business of giving COVID-19 affected households direct liquidity support. The extent to which the new big-bank stress test needs a check-up is also critical – scenarios released just last month did not diagnose a pandemic. Are its severely-adverse scenarios nonetheless sufficient? How will Fannie and Freddie fare in a forbearance regime and what might this do to planned restructuring? What of FHA and the Small Business Administration?
Hard questions all, but questions that must quickly be answered. Another week or so of growing COVID-19 contagion, cancelled events, foregone travel, and shuttered businesses will lead to waves of delinquent debt from Americans with no other choice. One longstanding lesson of economic history is that liquidity crises descend into solvency debacles if not quickly resolved. Households fearful of economic disaster will save themselves if they can. It’s thus up to policy-makers quickly to ensure that desperation doesn’t turn into disaster.