Nobody Knows How to Ever Get Out of This Mess

“Extend and Pretend” forevermore.

By Wolf Richter. This is the transcript of my podcast last Sunday, THE WOLF STREET REPORT. You can listen to it on YouTube, and you can find it on Apple Podcasts, Spotify, Stitcher, Google Podcasts,  iHeart Radio, and others.

Until a few months ago, most Americans didn’t even know what “forbearance” was. Now, roughly four million home mortgages, or about 8% of all home mortgages, are in forbearance. Those four million households with mortgages in forbearance might still not fully understand what forbearance is, but they know one thing: They don’t have to make mortgage payments for a while, and they get to spend that money on other things instead of sending it to the bank.

There are forbearance deals offered by lenders for credit cards and auto loans. I don’t owe any balances on my credit cards and I don’t have an auto loan, but my inbox gets blasted with offers of forbearance anyway, by every bank I do business with.

My WOLF STREET media mogul empire too. It’s just a tiny business, and it doesn’t owe any money, but sure enough, my bank is offering “assistance” with those debts that my business doesn’t have.

When a lender agrees to grant the borrower forbearance, the lender agrees to not exercise its rights when the borrower doesn’t make the loan payments. There is an agreement both parties sign, and this forbearance agreement determines, among other things, the period of forbearance, and what happens afterwards. And afterwards those missed payments will have to be made up somehow. Forbearance is not forgiveness.

But a forbearance agreement can be extended, if both parties agree to do so. In banker’s lingo, it’s called “extend and pretend.”

So, the borrower is not making payments, and the bank doesn’t receive interest and principal payments, but since the loan is in forbearance, the borrower is not deemed in default and the lender can continue to show interest income on the loan, though no interest is being paid.

That’s the motivation for lenders: Rather than having to show the loan in default, and taking a hit on their earnings, they can continue to book unpaid interest as income, and show the loan as performing.

Some people want forbearance because it would be nice not to have to blow a bunch of money on mortgage payments or credit card payments or auto-loan payments, and instead be able to spend all this money on other things.

Other people want forbearance because they lost their job or businesses, and financially all heck has broken loose in their lives.

Other people again want forbearance because they lost their jobs, and even with the extra $600 a week in federal unemployment benefits, they still can’t meet their mortgage payments. This is a real problem in expensive markets with high salaries.

In its latest report last week, the Labor Department said that nearly 32 million people continued to claim either state or federal unemployment benefits. 32 million people is a lot of people on the unemployment rolls. That’s 20% of the workforce.

So then there is the whole category of unpaid rents. Depending on who is doing the counting, the number of renters who haven’t paid their rents is either huge or just a small-ish increase over normal. No one knows.

According to the National Multifamily Housing Council, which represents landlords with large apartment buildings, 91.3% of apartment households paid their June rent as of July 20. This is down only two percentage points from July last year.

On-time rent payments – meaning June rent paid by July 6 – dropped by 2.5 percentage points, compared to a year ago, to 77.4%.

OK, a couple of percentage points worse than a year ago isn’t the end of the world, but applied to tens of millions of renters, it’s still a large number that are now in trouble, that weren’t in trouble before the pandemic.

Internet-based surveys of renters have been all over the place, many of them with far higher non-payment numbers, but they were just internet surveys.

Extend and pretend works with rents too.

There is rental relief, at the local, state, and federal levels. These generally take the form of eviction bans. Local eviction bans mean that the local government suspended eviction filings and will not process evictions until a certain date, and they may put other restrictions on landlords.

The federal rental relief under the CARES act provided eviction protection for 120 days. But it pertains only to apartment buildings that have been financed with a federally backed mortgage, and buildings covered under a couple of other federal programs. So it doesn’t apply to all buildings.

And there are now anecdotal reports of renters not making several months of rent payments and using the money thus saved, plus the stimulus checks, to contribute to a down-payment for a house.

All these rental relief laws mean only one thing: The landlord of a covered building cannot evict. However, the rent is still owed, and the landlord can still pursue the tenant for the rent. The obligation of paying rent doesn’t go away. The tenant is still on the hook for every month of unpaid rent, no matter what they did with this money. And this will become a huge mess after the eviction bans end.

There are similar rules in some places for commercial rents, and this impacts retail stores, bars, restaurants, nail salons, and the like – and their landlords. In addition, many companies have just stopped paying rent, taunting the landlord with: “Go evict me” – since another tenant for that space cannot be found anyway.

Then this chain of non-payments filters up the pipeline. The landlords don’t receive rental payments. Most properties are leveraged, and landlords have to make mortgage payments.

If landlords don’t receive some rent payments for a month or two, they’re able to work around that. But if they don’t receive any rent payments for four or five months, it gets more difficult. We’re now into the fifth month of this. And then landlords fall behind on their mortgage payments.

So far, delinquency rates of mortgages on apartment properties have risen but haven’t exploded higher – unlike delinquency rates on mortgages of hotel and retail properties that have been packaged into commercial mortgage-backed securities.

These delinquency rates on hotel and retail properties have exploded into the 20% range in June. There too, lenders can agree to forbearance, which would pull delinquent properties off the delinquency list. Extend and pretend.

When borrowers default on mortgages that have been packaged into mortgage-backed securities, both residential and commercial mortgage-backed securities, then the non-payments filter further up the pipeline to servicers that manage those mortgage-backed securities, and then either to investors or government entities, such as Fannie Mae, Freddie Mac, Ginnie Mae, the FHA, and others that guarantee or insure the mortgage-backed securities.

In these cases, the whole payment pipeline has stopped, everything has been put on extend and pretend, and no one knows how to get the payments flowing through the pipeline again and what happens afterwards.

Some of the protections have recently expired. Others will expire soon. Some of those expired protections have already been extended. Others will likely be extended. Forbearance at the household level will be extended to the maximum possible, if the alternative is a default. No one wants a default. So, extend and pretend rules.

As I mentioned a minute ago, 32 million people continued to claim either state or federal unemployment benefits, and they also got the extra $600 a week from the federal government. That $600 is now expiring. And then what?

They will be extended in some form. Congress is currently trying to come up with another stimulus package. In its final version, the $600 a week may be cut down or face other limitations when it’s finally passed into law.

So now, everything is set on extend and pretend. Homeowners don’t default on their mortgages; they just enter forbearance. Renters don’t pay rent – and can’t be evicted. Borrowers with big credit card balances and 30% interest rates don’t even have to make minimum payments after they go into forbearance. Same with auto loans.

But all these missed principal and interest payments will be added to the loan balance, and the problems will be worse in the future.

Subprime auto loans and subprime credit card loans no problem: instead of being delinquent, they’re now in forbearance.

Credit scores reflect loans that are in forbearance as performing loans. So no hit to credit scores.

Landlords cannot make their mortgage payments, and also enter forbearance. Lenders still show all these loans as performing since they’re in forbearance but no payments are being made.

And instead of flowing up the debt pipeline, the cash is being spent on consumer goods and services. This is one of the reasons retail spending has recovered so quickly.

But no one has yet figured out how to get out of this. The path in view is extend and pretend.

These people don’t have the money to catch up on the missed rental payments, because they spent this money on other stuff, and there is a wave of evictions and court cases that loom, unless extend and pretend further kicks the can down the road.

But then landlords are truly toast, unless that can is kicked further down the road.

For homeowners in forbearance, the missed mortgage payments can be added to the principal of the mortgage, which eats up equity in the home, but eventually, the mortgage payments need to restart too, and if not, the mortgage will go into default, unless that can is kicked further down the road.

The mortgage-backed securities that rely on the cash flow from the mortgage payments are already quaking in their boots, and that is why the Fed stepped into the market so massively, trying to kick that can further down the road.

Never in my life have I imagined that I would see such a gigantic mess, with so many bailout deals that cost trillions of dollars in so-called stimulus funding every few months to kick all those cans further down the road, without any plan or idea how to ever catch up with all those missed payments and how to get out of it, and what might happen to consumer spending, if consumers are having to catch up with those missed payments and having to make current payments again.

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