Stanford GSB finance expert Amit Seru warns: the household debt suspension provision in the CARES Act is a ticking time bomb

Faculty profile: https://www.gsb.stanford.edu/faculty-research/faculty/amit-seru

New research, available here and as a working paper released by the National Bureau of Economic Research, sheds light on the extent and potential consequences of suspension of household debt payments (debt forbearance on such loans as mortgages and autos) during the COVID-19 pandemic in the U.S. The related provisions of the CARES Act, originally set to expire in mid-February, have been extended through the end of March--a ticking time bomb for the aggregate economy. 

Our findings, based on millions of consumers, suggests that the majority of forbearance occurred under the provisions of the CARES Act--though a non trivial amount did occur outside the CARES Act. Borrowers in forbearance will be left with a “forbearance overhang” of more than $60 billion in accumulated postponed repayments. This overhang amounts to $1,800 per individual, which is more than half of their average monthly income, and more than 80% for lower income borrowers. 

From a policy perspective, thinking through possible extension of provisions of CARES Act that are about to expire is critical. Moreover, whenever they do expire, unwinding of forbearance--which could be done in several ways such as front loading or  uniformly amortizing or back loading payments--could have first order consequences for household debt distress, and through it, for the aggregate economy.

Other key highlights: 

1) Debt forbearance provided households a very significant financial relief: Loans worth $2 trillion entered forbearance, allowing more than 60 millions of Americans to miss cumulative $70 billion of their debt payments. 

2) Debt forbearance can explain low consumer debt delinquency rates during the pandemic despite record unemployment, with potential significant positive consequences for house prices and consumer spending. 

3) Forbearance rates are higher among the more vulnerable populations: individuals with lower credit scores and lower incomes. Borrowers in regions with a higher likelihood of COVID-19 related economic shocks and higher shares of minorities were more likely to obtain debt relief. 

4) Forbearance has also importantly complemented other stabilization programs by providing significant relief to financially vulnerable individuals with higher pre-pandemic incomes: 60% of aggregate dollar amount of forbearance has been provided to above-median income borrowers, mainly reflecting their higher debt balances.