Without action by the Federal Reserve and the Department of the Treasury to support commercial mortgage-backed securities, we could be facing a repeat of the 2007-08 financial crisis, Radhakrishnan Gopalan warns.
Millions of tenants are at risk of eviction in late July as protections in the CARES Act are set to expire. While the US Congress and Senate are proposing plans to extend the federal moratorium on evictions through March 2021, Gopalan, professor of finance at Olin Business School at Washington University in St. Louis, says that’s just one piece of the puzzle.
“The economy is interrelated. You can’t just stop payments at one place such as renters and homeowners and hope everything else will continue as business as usual. It’s going to be a cascade of problems—a huge ticking time bomb,” says Gopalan.
His research into mortgage and rent delinquency shows that there is a large segment of the population constantly teetering on the edge.
“In my paper, we specifically looked at health shocks. We show whether or not you have health insurance has a huge effect on the likelihood of being evicted. For people without health insurance, even a small health shock puts them over the edge, leading to missed rent payments and, eventually, being evicted,” he says. A recent Kaiser Family Foundation report estimated 27 million Americans have lost health insurance amid the pandemic.
“This pandemic has been an enormous shock to finances,” Gopalan says.
More than 40 million Americans are currently claiming unemployment insurance. Nearly 7 million Americans are rent-burdened, according to a recent analysis by UrbanFootprint.
Up to now, the $600 weekly unemployment boost payments have helped many households stay afloat, staving off an immediate financial crisis. With those payments set to expire July 31—six days after the scheduled end of the eviction moratorium—and no sign of the job market miraculously bouncing back overnight, Gopalan says the situation is a recipe for disaster come August.
“Evictions have enormous adverse consequences for the household, especially the children,” Gopalan says.
Adding to the problem will be the lack of legal protection for renters facing eviction. “There is significant variation in eviction law between states and jurisdictions. It’s unfortunate that Missouri ranks near the bottom in its protection for renters. Oftentimes, renters don’t have adequate legal representation, which results in unlawful evictions,” he says.
The cycle doesn’t merely end with the renter to landlord or homeowner to lender, though.
“Even rich landlords are not paying rents. There are a lot of Fortune 500 companies that have just stopped paying rent on their properties,” Gopalan says.
“Having said that, in my opinion, just putting a moratorium on rent payments is not a complete solution to the problem,” he adds. “Because, ultimately, landlords have mortgages against their property. If the rents stop coming, how do they service their mortgages? And if they are not able to service their mortgages, that is going to lead to defaults for banks.”
Mortgage deferments are already increasing, even with the unemployment boost payments.
“Currently, about 10% of mortgages are in deferment. That highlights the fact that unemployment insurance is not a foolproof safeguard for ensuring household finances,” Gopalan says.
Gopalan sees similarities between the current financial environment and the financial crisis of 2007-08 when homeowners stopped paying their mortgages due to rising interest rates and falling housing values. When payments stopped coming in, it had a downstream effect on mortgage-backed securities and the entire financial economy.
“Given how complex these securities are, we don’t even know who is experiencing the losses,” Gopalan says. “Because these securities are so widespread in the marketplace and they’re sliced and diced, we have no good sense of who is experiencing the losses and whose balance sheets are at risk.
“Hence, just focusing on renters will not be enough to prevent a financial crisis like the crisis of 2007-08. We need comprehensive solutions.”