Forbearance - Barokong - Teknoiot

11 May 2020

Forbearance - Barokong

Peter Wallison has a worthy OpEd in the WSJ, "Forbearance." Continuing my earlier thoughts on the financial response here and here, I don't think he goes far enough.

Let me tell a little story. Andy runs a restaurant. To run the restaurant, and live, he has a mortgage, he rents the restaurant space, and he borrowed money to buy to buy the equipment. Bob is retired. While he was working he lent Andy the money to buy the house and the restaurant equipment, and he owns the building. He lives off the income from these investments.

The virus comes and Andy has no income. He has enough savings to buy food for a while, and other current expenses. But he can't pay rent, mortgage, and debt payments. This is the central problem our government faces right now.

One answer: The federal government prints money and lends it to Andy so he can keep paying Bob. You can see a major problem here. Andy has no income. Eventually the restaurant may reopen, but then from the same profit stream Andy has to keep paying Bob and also pay back the loan that kept things going in the lockdown. Hmm.

Another answer: The federal government prints money and just gives it to Andy. Well, that's a bit better except for the extraordinary amounts involved. We're not just paying Andy enough to buy food and keep the lights on, we're paying all his debts. And all this money is really government debt, which Andy, Bob, Carla, Dave, and Elizabeth will have to pay.

Peter zeros in a third answer: What about Bob here? Why does he get off so easy? Peter's answer is that Andy should be able to simply stop paying rent, mortgage, and debt, at least the interest portion.

Peter wants to add those to the eventual debt, accruing additional interest. If the answer is going to be that Andy borrows to get through this patch, and if debt markets are "impaired" or something so that Andy can't borrow from Bob through financial markets, well, cut out the middle man and let Andy essentially borrow directly from Bob by delaying payments.

I might go a step further. There is a real loss here, a financial hole that is not coming back. Someone is going to cover that financial hole, and presently taxpayers are on the hook. What about Bob? Perhaps the right forbearance is that the rent and mortgage, at least the interest, are not paid at all, and Bob takes the loss. Bob did, after all, invest in a risky business -- home mortgages, restaurants -- and was getting a tidy return on his investment. Why should Bob bear no risk?

You recognize my query from my last post. Just why must every creditor and bondholder be paid in full -- and indeed have the right to sell the bond to the Fed at yesterday's prices -- while everyone else is hurting?

It sounds simple, but of course it isn't Bob really is part of a pension fund that owns debt securities that funnel through a few more intermediaries to the final loans. If Bob is a mortgage service company, Bob can't just stop paying. Working out a delayed or lower schedule of repayments is hard, outside of a bankruptcy court where lender and borrower meet directly. The law and economics tradition that one reinterprets contracts ex-post to have the provisions they might have had ex-ante is tough to follow. Just printing money is easier. But sometimes it's important to keep one's eye on the big picture, and with trillions at stake the principle can be applied here and there.

A colleague says that roughly speaking that's what Argentina does in its various crises. Everyone just stops paying for a while. I don't know anything about Argentina, but I wish I knew more about such cases.  Historically debt jubilees have been a method of adapting to shocks, and I wish I knew more financial history. Comments welcome.

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