To contain the coronavirus and save lives, the government has required many people to stay home and not report to work. To help those people manage their financial obligations, the government is also mandating different types of payment forbearance relief. That relief resembles a stay or moratorium on enforcement and is increasingly pervasive and generally unprecedented.
These actions by definition cause a decrease in the cash flow and value of these financial obligations in the hands of the holder regardless of whether the holder is an originator, financial intermediary, a fund or REIT or securitization issuer.
As a result, many non-bank holders are already experiencing extreme liquidity stress. Holders subject to mark-to-market accounting and holders that finance their financial assets on repo or mark-to-market borrowing base facilities are forced to post additional collateral and take capital charges. Securitized and other bonds collateralized by these financial obligations are subject to possible downgrade, causing rating sensitive holders like insurance company and bank holders to sell them. Many of these investors will face the choice of meeting margin calls and forced sale. The utility of government programs like TALF could be undercut if rating agencies are unable to assign "AAA"-ratings to bonds backed by consumer obligations upon which forbearance has been mandated.
For these holders of financial assets, the sizeable government relief to date has largely come out of the financial crisis playbook (with some new twists). It generally consists of a well-intentioned patchwork of large, backstop financing facilities that provide some liquidity and an implied valuation floor for the financial assets eligible for financing there. For holders of financial assets fortunate enough to to be eligible, this relief could be a lifesaver. However, many non-bank holders will not be eligible for these programs. These relief programs in many cases won't prevent a downgrade of corporate or securitized bond obligations.
The financial crisis was largely created by market phenomena like the credit cycle. Government relief programs extended to the markets ultimately allowed the markets to function and recover from the crisis. This time, the crisis is not triggered by markets, but by a virus and consequent government policy decision to protect lives. The immediate effect of that policy decision resulted in blanket payment stays and forbearance relief for affected consumers. The scope of that forbearance relief will probably expand significantly if the substance of current bills in Congress is ultimately enacted. Yet the "market support" approach adapted from financial crisis isn't tailored to provide relief to a market holding financial assets on which obligors have been granted the blanket forbearance relief.
We may soon find that a different governmental response is necessary that is less reliant on supplanting market forces and that more directly addresses the effect of blanket consumer forbearance. That response could entail relief that mirrors the "stay" relief provided to the consumer. One form of relief would consist of a temporary stay or moratorium on the enforcement of margin calls and foreclosure. Relief of this sort would raise complex legal and policy issues. Additional relief addressing the effects of ratings downgrades and additional directives easing the effect of mark to market accounting may also be required. As the crisis subsides, this relief would expire following the expiration of the consumer relief.
March 25, 2020
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