Governments have forcibly put much of the U.S. and the global economy on pause in recent weeks, for very good reason. Factories, offices, sporting arenas, restaurants, airports and myriad other institutions have closed down. But one thing hasn't been paused: monthly debt-service obligations.
The big picture: The less movement and activity there is in an economy, the more the coronavirus curve is flattened. But the obligations in bond and loan contracts can't be paused. That's worrying CEOs who fear a wave of business failures if economic activity doesn't pick up next month.
Why it matters: Millions of American businesses and individuals need some relief from debt payments. Nearly a third of American apartment renters didn't pay rent in April; that number will likely rise even further in May. The number of mortgage loans in forbearance is soaring, causing major troubles for mortgage servicers. Commercial mortgages are already in serious trouble. Moody's estimates that 16% of high-yield bonds and loans will default.
- Be smart: Default, on its own, is relatively harmless. It creates arrears, and arrears can be restructured over time. A landlord won't want to evict an otherwise profitable retailer over back rent — not if the tenant is able to pay market rate going forward in an environment where replacing that tenant with another tenant would be difficult.
- Default causes business failures only when creditors force companies into bankruptcy or liquidation.
- The more aggressively creditors chase after what they're owed, the worse off everybody — including those creditors — is going to end up. But aggression is built into debt contracts. Preventing it is a collective-action problem with no obvious solution.
- The problem: The American system is not set up to allow arrears to quietly sit in a cryogenic deep-freeze pending the restart of the economy. That's why the Fed is advancing as much money as it can to companies, including via the new "Main Street" lending program, so that they can keep current on their debts.
What they're saying: In a Brookings call this morning, Fed Chair Jay Powell directly addressed the plight of individuals who are seeing unpaid debts accumulate due to the shutdown. “People are making these sacrifices for the common good," he said. "We need to make them whole." That's spending, however, not loans — which means that only Congress could enact such a scheme.
The bottom line: The Fed notwithstanding, we're becoming an arrears economy. Dealing with those arrears is inevitably going to prove either incredibly painful or almost inconceivably expensive.