Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act in late March 2020 in response to the economic fallout of the COVID-19 pandemic in the United States. It was a historic legislative feat in terms of its size – a $2.2 trillion economic stimulus bill – and in terms of how quickly a bi-partisan Congress was able to draft, vote on, and pass it to the President to be signed into law.
While the CARES Act certainly did bring swift relief to individuals and businesses negatively impacted by the pandemic, there was one provision in particular that raised a red flag for Michael Seiler, professor of real estate and finance at the Raymond A. Mason School of Business.
The CARES Act offers the opportunity to private individuals who own a home to temporarily opt out of paying their monthly mortgage payment if their income was affected by the pandemic, also known as forbearance. The program is not debt forgiveness; the money will be paid back once regular income is reestablished. Homeowners may self-select into the program using an “honor code”, meaning, individuals are not required to prove their income was negatively impacted in order to enter forbearance; all a borrower must do is stop paying their mortgage and notify their servicer.
Seiler is a top-ranked real estate researcher and has conducted many studies on behavioral real estate and decision making. He partnered with David Harrison at the University of Central Florida and Jackson Anderson at Claremont McKenna College in California to design an experiment to identify the rate at which people would enter forbearance even if they could financially afford to pay their mortgage, where that money was alternatively being spent, the approximate impact this would have on the financial real estate market and U.S. government, and explore whether there were any key demographic factors to consider.
They also examined whether individuals looking to take advantage of the system (i.e., those who could afford to pay their mortgage but would self-select into the program anyway) would be deterred from entering forbearance if they were required to acknowledge a short agreement stating if they are found to have participated without experiencing a COVID-19 related decline in income, stiff penalties could be enforced.
Seiler and his team published their study in May 2021 in the Journal of Real Estate Finance and Economics.
Learn more about the study and the implications it could have on future congressional legislation in our conversation with Seiler, below.
Why was the forbearance provision so alarming?
When the pandemic hit, Congress had to act fast so people wouldn’t be crushed financially. I commend Congress for acting quickly, but the problem with allowing individual homeowners to enter into forbearance using the honor code is that there will be free riders – people who abuse the opportunity. Without being held accountable to proving your income was negatively impacted, people could enter into forbearance, stop paying their mortgage, and use that money for other things.
What spending choices did the study explore?
We measured where individuals who entered forbearance chose to spend their mortgage payments, and looked to identify any trends in saving or spending behaviors. An individual self-selecting into forbearance has several saving and spending options. They could keep it as cash and use it as a safety net. If they have a lot of credit card debt or student loans, they could choose to pay down that debt. But debt consolidation unfairly shifts the risk from the credit card lender or student loan provider to the mortgage lender. Individuals could also invest the money they would have used for their mortgage payment into the stock market. If the market goes up, the individual keeps all those gains to themselves. If the market goes down, the individual loses the money and may default on their loan, in which case, the lender is going to see a significant loss. If I’m a bank, I’m losing my mind over this expropriation of wealth.
After the financial crisis of 2008, why should people care if the CARES Act is unfair to banks?
The world does not have a sympathetic place in their heart for banks. People remember money being carelessly lent out, subprime behavior, and questionable (even abusive) practices. But when a loan is originated, nearly half of the notes are sold off into the secondary market and are bought by government sponsored enterprises (GSEs) entities like Fannie Mae, Freddie Mac, and the VA. When an individual writes a check every month to pay their mortgage, it goes to a servicer and the originator typically doesn’t own the note anymore.
I did another study that shows 90 percent of people believe that the entity that originates the note is still the entity that owns the note. So those who enter forbearance because they don’t care about banks, are punishing the entity that subsequently bought the note, not the one who originated it.
What proposed change did you have for the forbearance provision in the CARES Act?
Keep everything that was in the original CARES Act, except don’t allow people to follow the honor code. This is the land of people buying up hand sanitizer and toilet paper, and then selling it online for thousands of dollars. The pandemic is an opportunity for bad actors to come out of the woodwork. My proposal was to add an acknowledgement – a verbal agreement or a physical, signed document – by individuals looking to enter into forbearance. It could say something like “I agree that my income was negatively impacted by COVID so I would like to stop making my mortgage payments. If it turns out that when you review my financials in the future and I have been less than forthcoming, I agree to pay stiff penalties.” Those penalties don’t have to be defined explicitly, and it is a low-cost way to prevent or curb people from abusing a very generous opportunity while helping those who really need it.
What impact could this research and the results have on future legislation?
My hope is that when future legislation moves forward, Congress can rely on an experiment to pretest ideas. We can launch these experiments very quickly, and if they don’t go well, that’s fine. We’ve only blown up an artificial scenario. Real people won’t get hurt. The government rushed the CARES Act because it had to in order to help people. My goal is that someone who is in the room next time will have read this study we conducted and see the value of including a one-paragraph attestation as a fast, easy, and inexpensive way to prevent people from abusing a well-intended government program.