The GRACE Act: One Way to Flatten the Curve of the Financial Pandemic
6 Pages Posted: 26 Apr 2020
Date Written: April 25, 2020
The pandemic-induced shutdowns are leading to a financial pandemic. When the unemployed worker or small business can’t pay the rent, then the landlord can’t pay the mortgage. Even when a creditor provides forbearance on a loan, the borrower’s credit is damaged for years. What is needed is a way to stop the chain reaction and give everyone enough breathing room to recover without costing the taxpayer trillions of dollars.
The GRACE (General Recovery and Credit Extension) Act would provide renters and borrowers an automatic ability to defer rent, credit card, and installment debt payments for six months. They would still have to pay the money back later, with affordable monthly payments stretched over a long-enough period to reduce the pain.
Payment deferral without any other action would create cash flow difficulties for the creditors. To alleviate the problem, the creditors would be able to use the receivables created by the deferred payments as collateral for immediate loans from any bank for the full amount of the expected deferrals. The loans would be non-recourse loans backed by the U.S. government.
Banks may be skittish about expanding their lending because of concerns about complying with bank capital standards. To incentivize banks to make such loans, they would carry a zero-risk weight for purposes of calculating Risk-Weighted Assets (RWA) and the total leverage ratio, and they would be counted as High Quality Liquid Assets (HQLA).
In order to avoid long-term damage to a borrower’s credit, the GRACE Act would require that the deferred payments be reported as current on credit reports, and that lenders would not be permitted to deny credit based on a borrower’s use of the deferrals.
The process resembles a pre-packaged Chapter 11: The borrower seeking deferment fills out an online form listing the payments to be deferred with contact information for the creditors. The creditors then receive a notification (either electronically or in writing). The notification can be used immediately as collateral for a loan from any lender.
The GRACE Act is designed to give much-needed breathing room to our workers and businesses. It is not designed to keep zombie businesses alive or rescue those who were already bankrupt before the pandemic. Accordingly, the deferrals should be restricted to payments that were on-time as of February 1, 2020. This will limit credit losses to the federal government. To avoid the negative publicity of bailouts for billionaires, there should be a limit on the total payments any one person or business can defer.
The GRACE Act is a WIN-WIN-WIN-WIN for borrowers, creditors, taxpayers, and the US economy. It will simplify the resolution of the wave of defaults that threatens to paralyze the economy for years to come. It will flatten the curve of the financial pandemic and prevent millions unnecessary evictions and bankruptcies. However, the GRACE Act is not a panacea that will cure all of the economic fallout from the pandemic. Additional efforts will be needed to address other areas of the economy. The GRACE Act should be an integral part of the next rescue package.
Keywords: Pandemic, consumer finance, bankruptcy, financial distress, bank capital requirements
JEL Classification: D18, D14, K35, G01, G28, G21
Suggested Citation: Suggested Citation