Credit Slips

Bankruptcies Maintain Similar Month-to-Month Rate in January

The January bankruptcy filing basically held steady to December, according to the new bankruptcy statistics now available from Automated Access to Court Electronic Records (AACER). There were just over 102,000 total bankruptcies spread over the nineteen business days in January. That is a daily filing rate of 5,386, a rise of only 1.3% from December's daily filing rate of 5,319. For monthly bankruptcy filing rates, a 1.3% increase probably does not rise above the threshold of statistical noise.

The January 2010 rate is a 20.6% year-over-year increase from January 2009. That may sound like a hugely impressive annual increase, but regular Credit Slips readers will know better. To keep the 20.6% year-over-year increase in perspective, consider that January 2009 had a 31.6% year-over-year increase compared to January 2008 which in turn was a 21.3% increase as compared to January 2007. It's not that double-digit increases in the bankruptcy filing rate are something to be sanguine about. Rather, the rate of increase in the rate of increase appears to be slowing. As the graph shows (click for a larger view), the year-over-year increase started slowing in August of last year. I attribute this slow down to the filing rate just catching up with its "natural" level after the trough following the 2005 changes to the bankruptcy law rather than any fundamental changes in the economic situation.

With one month of data, it is way too early to be making too many projections about annual U.S. filings. When I ran the numbers for January 2010, however, I noticed that the month of January constituted 6.4% of the bankruptcy filings in 2008 and 6.2% of the bankruptcy filings in 2009. Do two years of relatively consistent January numbers make for a trend? If so, then the January 2010 data suggest total annual bankruptcy filings will be 1.60 to 1.65 million. That would be just below my estimate of 1.70 million (or slightly more) filings for 2010.

Monetary Policy and the Housing Bubble

A popular explanation of the financial crisis lays the blame at the feet of the Federal Reserve for lax monetary policy.  In this story, the Fed dropped interest rates starting in 2001 and kept rates too low for too long.  Low rates induced an orgy of mortgage borrowing for leveraged home speculation. 

It's a nice story.  Only problem is it doesn't really hold up under inspection.  Low rates in 2001-2003 did fuel an amazing mortgage refinancing boom, but not a purchase boom, and the boom was mainly in conventional fixed-rate mortgages, not the exotic products later years.  Moreover, despite the refinancing boom, no housing bubble was emerging in this period. 

The Fed started to raise rates in mid 2004 and continued to do so until mid-2006.  It was during this period that the bubble emerged, when rates were going up.  (To be fair, some might argue for an earlier date to the bubble, even as far back as the late 1990s.)  If we date the bubble from 2004, it's not consistent with a rate-driven bubble story, although rates were still extremely low in absolute terms during this period. 

The monetary policy story, however, really falls apart when one compares the US and Canada, as the graph below does.  Canadian interest rates, and perhaps more importantly, Canadian mortgage rates, track US rates pretty closely.  Yet the US had a housing bubble, and Canada did not.   This means we have to look somewhere other than monetary policy to explain the housing bubble.  The answer, I believe, lies in method and regulation of housing finance. 

Sovereign CDS -- Random Thoughts

Lots of attention on Greece these days, but has anyone noticed that France's CDS has declined more on a percentage basis this year (from 32.05 to 53.40)? Even Germany has seen a bigger percentage decline (from 26.33 to 37.84). And Iceland has completely fallen off a cliff, closing today at 639.42. That's the fourth highest price for sovereign CDS, after only Argentina, Venezuela, and the Ukraine.

Just saying, maybe we're a bit too focused on Greece . . .

Meanwhile, it's been a bit since I've talked about California, but today its CDS was selling for 327, which means that the market currently thinks California is more likely to default than Lithuania (270.80) and somewhat less likely to default than . . . Greece (396.83).

Meanwhile, US CDS is trading at 46.71, which puts us right between Germany and Switzerland (49.21), but we're all in a twitter about the federal budget deficit and debt burden.

Notes:  all prices are for 5 year CDS and come from Bloomberg. CDS prices are in basis points, so that California's price suggests that one would have to pay 3.27% of the amount you want to buy protection against (or $3.27 for every $100 of protection).

FJC Posting for Bankruptcy Position

The Research Division of the Federal Judicial Center has an opening for a senior research associate who has expertise in bankruptcy. The job posting is online, and it looked like something that might be of interest to some of our readers.

Lehman, Synthetic CDOs, Sapphires, etc.

The Lehman bankruptcy court is out with a new decision that has the financial community somewhat miffed, since it removes one more piece of their mistaken belief that they don't have to understand or deal with the Bankruptcy Code. The decision will also lead to some interesting discussions with members of the English bench, who reached a contrary decision with regard to the same issue and parties. I'm extending an open invitation to all the judges to join me for coffee and bagels at my apartment on the UES to sort things out.

I've represented the transaction in question, which involved the issuance of synthetic CDOs, in this simplified diagram. The key thing to understand is that under the terms of the deal, which contains an English choice of law clause, the priority rights to the collateral switch if there is a Lehman default under the CDS contract. And Lehman Brothers Holding's chapter 11 filing in September 2008 constituted a default, since Holdings was a "credit support provider" under the terms of the CDS contract. The CDS buyer, LBSF, also filed a chapter 11 case of its own in October 2008, resulting in another default.

The other thing to understand is that there are reportedly about 1,000 similar Lehman transactions waiting in the wings.

The US bankruptcy court held that the collateral priority switch was an unenforceable ipso facto (bankruptcy termination) clause, and that the derivative "safe harbor" provisions in the Code did not apply.

The UK Court of Appeal, affirming a decision of the High Court of Justice, reached the exact opposite conclusion, holding that the deal did not violate the "anti-deprivation rule," which is essentially their rule against ipso facto clauses, based on a case from 1818.

(How we ended up with the pseudo Latin, when their rule is from 1818 and ours is from 1978, I don't know.)

My thoughts on the bankruptcy court decision, and the conflict with the prior decision from the UK, after the jump.

Anna Nicole Smith --The Bankruptcy That Keeps on Giving

It can really bug me when blogs have posts that are just a naked attempt to draw traffic to their site. These posts always are sure to contain a few words that will attract the attention of search engine users seeking porn or the usual titillating web sites. Seemingly random references to celebrities such as Brittany Spears, Rihanna, or Paris Hilton will be put into the blog. And, worse of all, these naked attempts at self-promotion will use word repetition and appear near the beginning of the web page to optimize their search engine placement. Therefore, I was not surprised to find references to the 15-year old bankruptcy case of the late Anna Nicole Smith, who was often described as sexy and buxom.

On a more serious note, it was somewhat puzzling to see references to this old bankruptcy case. It was dredged up for an AP story that was sourced to "newly released government files" obtained by a Freedom of Information Act (FOIA) request directed to the Department of Justice. The article cites to "the bankruptcy examiner's report." I don't give a rat's pa-too-tee about the contents of the report, but I wondered about the whole FOIA thing. If this was a bankruptcy examiner's report, wouldn't it be part of the public court record? Why did they need to use FOIA? If the court ordered the report filed under seal or otherwise made the report unavailable, then why can a FOIA request effectively circumvent the court order? Or, was this not a bankruptcy examiner's report in the technical sense of the term and, if so, what was it?

Overdraft Fee Regulation and the End of Free Checking?

Ron Lieber has a thoughtful column about the future of free checking.  Consumers have become quite used to free checking over the last 15 years or so.  The impetus for the column is whether the Fed's new overdraft regulations, scheduled to go into effect in July (new accounts) and August (existing) accounts this year will change the financial equation such that free checking is no longer viable.

I'm skeptical.  The potential impact of the Fed's overdraft regulation impact is greatly over-hyped. 

There May Be More Financially Distressed Small Business Owners Than You Think

Last night, I caught the tail-end of a commercial for debt relief services aimed just at small business owners. Commercials for debt relief services are hardly unusual, especially in these financially troubled times. It was striking, however, to hear a commercial aimed only at struggling small-business owners.

To some, but this might seem like a small market. The data suggest otherwise. Elizabeth Warren and I once co-authored a paper finding that 1 in 7 bankruptcy filers identify themselves as self-employed at or near the time of bankruptcy. ("The Myth of the Disappearing Business Bankruptcy," California Law Review, 93:745-95 (2005)). At current filing rates, those numbers would imply over 200,000 bankruptcies each year have a relation to a small business. Of course, only a fraction of persons who experience financial distress end up filing bankruptcy. Although I am not aware of any data setting a precise number, for each person filing bankruptcy, there are several more in financial distress who do not. Financially distressed business owners could present a very large market indeed.

Those findings were from the 2001 wave of the Consumer Bankruptcy Project. In a chapter for a forthcoming book edited by co-blogger Katie Porter, I report that the 2007 wave reported a similar incidence of self-employment. Moreover, when the self-employed arrive in bankruptcy court, they arrive in worse financial condition than other bankruptcy filers. Even as compared to other bankruptcy filers, the self-employed have very high amounts of credit card and general unsecured debt, making them perfect targets for the debt relief firms.

On Break Up Fees

Or "break fees," as Pottow would call them. The 3d Circuit is just out with a new opinion that's primary contribution will be to add a dozen words to the asset purchase agreement.

In the case, the debtor entered into an asset purchase agreement whereby it agreed to try to get the deal approved without competitive bidding, but if the court required an auction, the debtor was obliged to seek approval of a break up fee.

The bankruptcy court orders an auction, and the debtor sought approval of the fee -- but the court denied it. After another bidder wins, frustrated initial bidder seeks payment of the break up fee and appeals.

The Circuit essentially says:  the debtor's obligation was to seek approval of the fee, the deal was not predicated on approval of the fee, and the bankruptcy court acted consistent with existing 3d Circuit caselaw.

So the next APA that you draft, won't you simply add "The buyer's obligations are predicated on approval of the break up fee"?  Am I missing something?

90 page law review article to follow.

How Many Bankruptcy Appeals?

Classes started today. This semester I am teaching Business Bankruptcy, which principally covers chapter 11. We were talking about the bankruptcy court system, a topic that does not always get covered in great detail in the other bankruptcy courses, and the appellate steps in the bankruptcy system. A student asked how many U.S. Court of Appeals cases each year involve bankruptcy.

That was a good question, so I looked it up. What's your guess for the number of U.S. Court of Appeals cases, as reported by the U.S. judiciary, that involve bankruptcy each year? Answer after the jump.

Chapter 11 Costs -- Help?

As part of my sabbatical project this semester, I'm returning to the ABI Chapter 11 Fee Study database in the hopes of further refining my model of professional fees in chapter 11 cases. As one part of this, I'm trying to resolve several pesky "missing data" issues in the dataset of big cases, so that my model can benefit from all the cases we collected in that project. One persistent problem I'm running into is retention applications filed without any indication of what the professional's hourly rates will be -- instead, the professional simply states that they will charge their "customary hourly rates," without any indication of what those might be. It's a problem that exists with regard to all types of law firms, big and small, and I've attached an example application and affidavit from a particularly well-known debtor firm that shows what I'm talking about.

So my question to the loyal readership is:  why are retention applications like this filed, and why are they routinely approved?  Is it simply a matter of "everyone" knowing what that firm's customary rates are?

Somewhat related, I'm also hoping to improve my model of chapter 11 costs as applied to the broad run of chapter 11 cases. The model currently works rather well with regard to big cases, but not quite as well with regard to the more typical chapter 11 case. Given that my practice experience was in the New York-Delaware style case, I suspect I'm missing some key factor in smaller cases that influences professional fees, and I hope our readers might point me in the right direct.

The comments are open. And my sincere thanks in advance.

Life Imitates Art (or at Least My Final Exam)

From the San Jose Mercury News, the headline says it all: "Repo man takes San Jose mom's car with 2-year old in back seat" (courtesy of The Consumerist). Now, a short essay from my Secured Credit final exam:

Cletus and Brandine Spuckler are in your law office and tell you the following tale of woe. They had borrowed money from the Burns Finance Company to pay for their 2007 Ford Expedition but have recently fell behind on their payments. Burns Finance Company has a valid, perfected security interest in the 2007 Ford Expedition. One morning, Brandine found that Cletus’s tractor was blocking the driveway when she needed to take two of their kids to preschool. Consequently, Brandine loaded the two kids in the Expedition, got the tractor keys from Cletus, backed the tractor out, then backed out the Expedition, and then returned the tractor to its place on their driveway. She left the Expedition running in the street, with the keys in the ignition and the kids in the backseat. While Brandine went back inside to return the keys to Cletus, an employee of Burns Finance repossessed the automobile, driving off in it with the kids in the back seat. The employee got about three blocks when he saw the kids, and he promptly returned the Expedition to Brandine, who was emotionally distraught having seen a stranger drive off with her kids. Since that time, both Brandine and the two children have been unable to sleep and are emotionally upset. Putting aside the question of any tort claims, do you think the Spucklers have any valid claims under the Uniform Commercial Code?

I based the question on Chapa v. Traciers & Associates, 267 S.W.3d 386 (Tex. App. 2008). Still, I thought I was making this up. Who knew?

Usury and Securitization

Most institutional lenders in the United States are not subject to usury laws.  National banks can evade they by basing themselves in states without usury laws and exporting the laxer regulation to other jurisdictions.  State institutions often find themselves exempt because of state banking parity laws.  And usury laws are preempted for many mortgages by federal law (although originally the FHA eligibility rate cap--removed in 1983--served as a de facto federal usury law for many mortgages). 

There's plenty to say (at another date) about whether usury laws are good policy.  I want to raise a related legal question for discussion on the Slips:  are debts held in securitized pools subject to usury laws? 

A Special Bankruptcy Court

Lots of news today about a Congressional plan to create a special bankruptcy court for financial services firms. One question that jumps to mind:  who staffs the court?

The most likely answer is that the court would draw from other bankruptcy courts -- there is some precedent for that sort of thing.

Another, less likely, option would be to draw the court from a panel of bankruptcy professors. Presumably this would have to come with an obligation to stay current on the state of the art in finance, and the panel membership would have to be updated on a regular basis. Arguably even the worst bankruptcy judge would be better than Prof. Deadwood and his collection of war stories about the Bankruptcy Act and the Penn Central case.

Not that there is anything wrong with a Penn Central fixation, of course.