Tuesday, April 21, 2020


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.



  1. The other solution is to reopen the economy by looking at the actual statistics. A good example is Connecticut where I live. Of the 1300 Covid deaths, 733 are people over 80. 300 are people 70-80. I suspect many had preexisting conditions. We also have roughly 500 suicides per year which certainly will grow. I have no desire to "kill elderly people" - they should clearly shelter themselves. But shutting down an economy and perhaps ruining Andy and Bob's finances is a dereliction of political duty

  2. https://michael-hudson.com/2018/08/and-forgive-them-their-debts/

    1. Though I'm not a financial historian either, my understanding is the debt jubilees often a) occurred when a new ruler came to power and were used to gain favor with the ruler's new subjects and b) was debt that was owed to the state, not to private lenders.

  3. Hi, John. Curious your take on something. When it comes to people who have 0 income right now, and the subsequent liquidity issue this causes... I have seen some suggest banks raising credit limits/access for all Americans. They wanted to base it off their previous income. For example, if you were making 3k a month before the pandemic, the banks should give you a 9k (3 month) credit line increase to assist.

    Where do you stand on this?

  4. Bob didn't invest in a restaurant or a mortgage--he invested in Andy. Andy invested in the downpayment on the house and the equity in the restaurant. There is no conflict here between Andy and Bob. Andy is a successful restaurant owner who just happened to be dealt a seemingly mortal blow by the government's lock-down order of business operations deemed non-essential. That lock-down order created an uncompensated government induced negative externality for both Andy and Bob. It is appropriate that the government compensate Andy and that Andy shares a portion of that compensation with Bob for the duration of the lock-down order. Andy employs Sue, and continues to pay her compensation arising from the lock-down order; Sue also receives compensation from the government for the harm that the order has done to her livelihood. Andy and Bob are hatching a plan to reopen "Andy's" as a take-out restaurant with on-line ordering. Sue will be rehired, albeit at reduced hours until the reconfigured restaurant venture has gained a solid footing. Andy's commercial arrangement with Bob is a 'triple-net' lease and Bob has agreed to pay the property taxes and lower the fixed rate land-rent charges for the duration provided Andy continues to operate the restaurant (in its reconfigured format) from its present location; the variable revenue sharing arrangement is unchanged, but because it is based on a percentage of net receipts, Bob's income from the property is proportional to Andy's net revenue take. As to the house mortgage, Bob is a reasonable guy (he can afford to be) and he continues to believe in Andy, the entrepreneur, and Sue, the employee. Andy, Bob, and Sue, are confident that the lock-down will be temporary and should be lifted in 9 to 18 months from now. Bob also knows that as the investor, he has no better alternative opportunity to employ his assets in that time frame. As a private investor, Bob invests in people first and foremost; he takes and perfects a registered security interest in key assets (bricks and mortar, land, a debt instruments, soft assets such as intellectual property and trade marks &c.) but rarely crystallizes those security interests.

    As to the larger firms, mostly financial operations, risk and losses are the meat and potatoes of their businesses--they like any other common punter bear the losses win or lose. Portfolios are down 30% in the course of the six weeks ended March 31st?--no problem, the economy will return and with it the portfolios will rise in value as long as the managers are competent and conservative. One needs faith and patience. Meanwhile there are new opportunities arising from the contagion, and money to be employed at risk.

    Every recession has created a hole that ends up not being filled. One need only check the GDP trace on a FRED-generated chart for the U.S.A. since 1950 to see this. Not that there aren't casualties on the way. As to money printing, we can say that we've been there and done that through the 1960s, the 1970s, retrenched in the 1980s and 1990s, and then we did it again in the 2000s and the 2010s. So what's new? They've lowered the interest rate so the new debt is not a burden on the government; they've committed to buy plain vanilla and fancy strawberry ripple ice cream cones and many other flavors of debentures and notes to diversify their portfolio and become more representative of the economy as a whole, bully for us!; they'll mop it up and immunize it by paying interest on excess reserves; and then raise the interest rate to contain it all. Inflation may blip; it may soar. It won't hurt us. Better that than a repeat of the 'Dirty Thirties', I'd warrant.

    1. Soaring inflation "won't hurt us". You might want to take a look at the Terrible Twenties...

  5. These costs are really piling up. The transfer from the upcoming generation to this one is starting to look very larger indeed. I wonder what the cost per life-year saved will turn out to be in the end, factoring in both direct costs and the foregone growth. How much future consumption of our children and our children’s children is worth the extra safety today? I don’t know, but I do know that they don’t get a say.

    Honestly, I find this all a little strange. We are waiting for a vaccine, but society went about its business long before Salk, and long before antibiotics. We built railways across the country and skyscrapers in our cities under what today would be considered prohibitively dangerous working conditions. Life was more hazardous in the past. I’m not suggesting that we return to 19th century standards, but Covid-19 has made life just a little bit more dangerous again. Instead of living with it, as previous generations did, apparently we are willing to destroy the opportunities of the generations coming up so that we can keep our safety as absolutely as high as possible.

    It’s a good thing that our ancestors didn’t think that way; after we are done with Covid-19, while standing in the ruins of a once great nation, maybe our children won’t either.

    1. The problem is - there is a hole we cannot fill - an overstressed and depleted healthcare system.

    2. More people really do need to consider this. A majority of the people who die from this, won't be alive in 2030. But the rest of us will still be living the economic fallout in 2030n and beyond.

      Critics will say I'm suggesting "kill grandma". But realistically grandma isn't going to be here in 2030, is it fair for her to ask us to destroy the opportunities of the generations to come?

      Also consider these fallout effects:

      - Children with developmental issues who aren't getting the help in schools that they need
      - Recent grads, starting their careers (you thought graduates in 2008 had it bad)
      - Basically everyone who's accruing personal debt
      - Retirement savings that aren't be contributed to

    3. "We have not journeyed all this way across the centuries, across the oceans, across the mountains, across the prairies, because we are made of sugar candy." Winston Churchill, 1941. What has happened to us and our will to live vigorously and courageously?

  6. A common principle we use in economics is to let markets work out the details, and have government intervene in big and simple ways.
    Here, the details are in which bills Andy pays, including possibly those to Bob. If we start saying that rent must be paid but not loans or electrical bills, we're starting a mess--- we need to worry about the bank and the electricity company and how they'll pay. Isn't it better to just say Andy has to pay all his bills, and pay him, or loan to him? As you say, that seems like a good deal for Bob the bank. But the government can handle distribution via taxes--- make people pay their loan interest, but tax banks to finance the government transfers that help people pay their interest.

  7. p.s.--- an illustration of the advantage of letting the markets work and the government just making transfers and taxes is that some creditors are better able to forbear than others, and they'll even do it voluntarily. Maybe Andy's materials suppliers need their bills paid right away or they'll go bankrupt, but Andy's bank has lots of cash and is willing to give him extra time in exchange for paying a bit more when he does pay. Or it might be the reverse--Andy's suppliers are in pretty good shape, but his bank is teetering on the brink. It isnt good to make broad regulatory interventions if we can make transfers instead. We don't even want to say "Suppliers must be paid; banks must forebear" because some suppliers are in better shape than some banks. It's just too complicated for the government to figure out.

  8. We're all going to come out poorer even if the Fed creates money. But the bankruptcies will be postpone, which is good, for we do not now know who should go bankrupt and stay bankrupt.

  9. This is a tremendously important subject and it has not been written about often enough. I have studied debt forgiveness in some detail and I will probably write several comments here. My first comment:

    a. Debt jubilees are attractive because they evoke the image of a virtuous laborer held down by a scummy userer, Snidely Whiplash or of course Shylock the classic money-lender.

    And this image does occur in real life. For example, the ER patient who is charged $10,000 by an out-of-network doctor that works for private equity is in fact a virtuous worker who is oppressed by a scummy lender.Some debts are unconscionable and should be cancelled.

    However, the situation in John's excellent illustration is much less clear cut. The lender (Bob) may not be a whole lot wealthier than the borrower (Andy). The pension plan beneficiaries of a securitized loan are often no wealthier than Andy either.

    In the end the best solution may in fact be a federal bailout that pays off a part of the loan, and the rest of the loan would be forgiven as the bad luck of this crisis. Borrower and lender both lose but the goal is that neither of them is ruined.

  10. The financial solutions to COVID-19, like the lockdowns, are a dead end.

    At this point all we can do is have the Fed print money and let inflation settle scores.

    We can hope for a moderate rate of inflation, after all, the Bank of Japan owns half of that nation's national debt, which is at 225 percent of GDP. Japan has averaged about zero inflation for the last 20 years and is sinking back into deflation.

    But the lockdowns are a terrible idea.

  11. Prof. Rasumsen's point seems the obvious one. The government forced Andy to close. If this ruins Andy (who probably *isn't* paying Sue, his employee), then Andy is unemployed, Sue is unemployed, lender Bob is broke...all because government forced Andy to close. Alternatively, if government hands Andy cash to pay Sue and Bob until lockdown is over, maybe all three survive. Bob, Andy, Sue, John, Eric, Charles, and all the rest pay part of it. It's real loss either way, but at the end of the second there are still small businesses in existence that can restart producing real goods and services, and all the Sues have jobs to return to instead of continued unemployment.

    This can't go on very long; it's simply a stopgap too minimize the destruction from the shutdown. Asking whether lender Bob "should" be paid since as a lender he accepted risk makes no sense to me. The point is to minimize financial collateral damage from a government-imposed (necessary?) quarantine.

    1. I agree with you, Charles.

      In some states and cities, Bob currently isn't allowed to evict even a commercial tenant for non-payment. (We can argue about the wisdom of this policy.) And, government "essential business" orders may prevent Bob from showing a property to a new prospective tenant and also may prevent a new tenant from having contractors remodel.

    2. Larger retail tenants - who have a degree of market power relative to their landlords, who are also often large entities (such as publicly-traded REIT's) - are in some cases doing what Dr. Cochrane supposes: forcing landlords to eat losses on rent.

      Quoting a WSJ article from a few days ago ( https://www.wsj.com/articles/landlords-companies-clash-over-rent-payments-during-coronavirus-11586865600 ):

      "Ross Stores Inc., known for its Ross Dress for Less stores, told landlords in recent days that it plans to stop paying rent during the period when stores are closed. When stores reopen, Ross will pay rent equivalent to around 2% of sales until sales reach 70% of the revenue achieved in the same period last year. The company has also offered to waive some its rights as a tenant for a period of time when stores reopen."


      "Some companies draw distinctions between mandatory and voluntary store closures. Dick’s [Sporting Goods], which is furloughing thousands of workers, said that it won’t pay rent in places where the local authorities have mandated store closures. It will pay some rent where it has chosen to close stores, landlords said."

      Equinox, Petco, Staples, LVMH, and Victoria's Secret are all mentioned as pursuing similar strategies. It's not universal: some large retailers paid April rent per the terms of leases.

      There seems to be some debate between retailers and landlords about whether the pandemic and government actions qualify as a force majeure under the terms of leases, but it sounds like a lot of it boils down to a pure clash of wills about each party taking losses.

  12. Here's a thought I've been toying with that may well be judged to be inane, even by myself. But what about a temporary debt freeze rather than a debt jubilee? Basically the model I'm thinking of is, say, Thanksgiving weekend. The economy runs at 60% of capacity for four days and nobody freaks out and the system doesn't collapse. What if we treat this as a 90-day long Thanksgiving weekend? All debt, lease and rent payments could be frozen until June 30, then they pick up right where they left off. Sure, Andy and his workers would need subsidies to buy gas and groceries in the meantime and Bob would incur some time costs, but all the debt obligations would remain in force upon resumption of the "economic clock" and most would eventually be satisfied.

  13. It is very possible that small, independent shoestring restaurants are a doomed business model. Many of them were plunging to zero revenue due to the virus, even before the legal lockdowns were declared. They may not in fact come back after 9 to 18 months.

    This is in fact the situation for which the bankruptcy laws exist. People take out loans or offer loans in good faith, and circumstances turn against the borrower.

    Now there will be an issue with swamping the bankruptcy courts, but that can be dealt with in a relatively calm fashion.

  14. I would like to add that utilities we are not using during our forced closure still have to be paid. While our landlord gives us a break on the lease, we get no break from the utilities. Why are they not sharing in the pain?

  15. Peter Wallison??
    The man whose definition of subprime was different any other person and acceding to him the median loan of the day was sub-prime.

    Hardly a recommendation

  16. I fully agree. If I may push the logic further, some back-of-the-envelope calculations suggest that allowing all assets to take a hit in their cash flows for one year should not be too painful for asset valuations.

    Allow me to assume that asset prices are well approximated by Gordon's formula: P = D/(R - G), with D being next period cash flow, R is the discount rate, and G is the expected growth rate of cash flows.

    Now, let us assume that asset holders do not receive cash flows for one year, as a result of forbearance. After one year, everything goes back to normal (i.e. we freeze payments for just one year).

    Assuming investors do not become more risk averse (e.g. R does not go up) and they do not revise long-run growth expectations downward, asset prices should fall by exactly the amount of next period's dividend:
    P_after = D/(R - G) - D = D(1-R+G)/(R-G)
    In percentage terms, asset prices should decline by:
    (P_after - P)/P_after = G - R
    Let us put some numbers there. For G, let us use 2%, which was more or less the growth estimates for the economy before COVID. For R, let me take 2% risk free, plus 4% risk premium, so that R = 6%.
    We get that asset prices should decline by about 4%.

    In sum, under these admittedly strong assumptions, if we let asset holders take a hit in their cash flows for one year, asset prices would decline by about 4%, which is more or less what the S&P500 returned in 2018, without the world falling apart.
    When I talk about asset holders, I'm talking about all assets: companies, real estate, mortgages, bonds, etc.
    The strong assumptions here are that risk aversion does not increase and that growth expectations do not go down. But, if policy makers were forceful enough in pushing the idea that forbearance would only last for one year and everything goes back to normal afterwards, investors would not necessarily panic.


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