Credit Slips

Is Borrowing a Substitute for Getting Paid??

Many thanks to the organizers of Credit Slips for inviting me to blog this week.

Henry Ford had a good idea.

In January, 1914 he announced to the world that his workers would be paid five dollars a day. The five-dollar day doubled the average wage for auto workers, produced long lines outside of the factory gates, and helped to create a mass market for the Model T and other consumer durables.

For the next 60 years, this basic formula spread. An entire consumer economy was built on steady middle class jobs that paid slowly rising wages from productivity gains. Wage earners accumulated debts when they were young (mortgages, perhaps car loans, small installment loans for other durable goods), and paid those debts off over their working lives with inflation-discounted dollars from slowly rising paychecks. One was supposed to retire owning a house and not owing the world a cent.

By the middle of the 1970s, this system was fraying at the edges. By the start of the recession in 1981, the patient that produced steady jobs at rising wages was dead. U.S. Federal Reserve Chairman Paul Volcker turned his attention to fighting inflation. Interest rates rose, credit and banking was deregulated, investment became more dynamic, and economic recovery started in the late 1980s. Economic growth through the 1990s and up until 9/11 was very impressive, as were productivity gains in the U.S. economy.

But something was gravely wrong, and by the middle of the 1990s some observers were getting worried.  The economy was growing. Real wages and earnings were not. In fact, median before tax family income in 2001 dollars peaked in 1976 ($42,000) and has been nowhere near that level since. Layoffs, job instability, and family income volatility all rose to near record levels. Yet spending and consumption rose almost continuously from 1992 to now as household revolving debt grew from essentially zero in 1976 to over $9,000 per household by 2005. Total consumer debt outstanding went through the roof and has only tailed off in the past 18 months or so.

Slowly but surely In the U.S. we substituted borrowing and lending for getting paid.

Welcome to Prof. Kevin Leicht

I'm delighted to welcome Professor Kevin Leicht to a guest-blog stint at Credit Slips. Kevin is a colleague of mine at the University of Iowa, where he is the Director of the Institute for Inequality Studies and the Director of the Social Science Research Center. He is a Professor of Sociology, whose research interests include the sociology of work and social stratification. Debb Thorne and I have enjoyed Kevin's recent book, Postindustrial Peasants:  The Illusion of Middle-Class Prosperity, which discusses changes in household wealth and wages in the last several decades.

Kevin has a delightful sense of humor, which I got to enjoy during his participation in the recent week-long seminar that I organized at Iowa called Borrowing to the Brink: Consumer Debt in America. Kevin's project for the seminar questioned whether Americans' increased access to credit reflects economic growth or masks declining financial security for American families. It's an important question, and I look forward to Kevin's posts on this and related topics concerning the social effects of household financial well-being or distress.

California

I just gave an interview with a reporter from Santiago, Chile on the situation in California. My assessment of the situation, which may be of interest to Credit Slips readers, follows:

The key problem in California is that the state budget is comprised of many fixed expenses. Many of these were put in place by voter initiatives. That leaves a relatively small part of the budget (welfare programs and the Universities are two of the larger ones) that can be adjusted down when tax revenues fall, such as they have been, because people's incomes have fallen.

So California faces a tough choice of radically cutting its budget -- which may have collateral economic consequences, for example, cutting welfare will dramatically cut spending by the poor -- or finding some other source of "plugging" the hole in its budget. One possible solution would be to borrow money from the federal government. The federal government might consider doing this if it believes that the austerity measures required to balance California's budget would have knock-on effects for the national economy. Given that California's economy is the biggest single part of the national economy -- California's GDP is comparable to France or Canada -- this would not be an unreasonable assumption.

On the other hand, the politics are quite complex. The Republicans in California hold a blocking position (by virtue of rules that require a 2/3 majority in the legislature to pass a tax increase), and generally hope to use the present situation to achieve the kind of minimalist state government they have always desired. And the Obama Administration has to fear that Republicans in Washington, including some from California, will criticize any further government involvement in the economy, particularly involvement that increases the federal debt load.

Thoughts? Did I miss anything?

Highly Questionable Medical Bankruptcy Figures from Fraser Institute

The National Center for Policy Analysis (NCPA) is flogging a study from the Fraser Institute in Canada that purports to show U.S. medical bankruptcies are a "myth" because the Canadian bankruptcy rate is higher than in the United States. Reuters and BusinessWire have run the NCPA's press release as a story on their news services. Before anyone takes this study seriously, a few important facts are needed to place the Fraser Institute findings in context. To be as charitable as possible, the study's use of the bankruptcy data is extremely selective.

First, the Fraser Institute study begins by observing that advocates of a single-payor U.S. health care system use the assumption that such a system would prevent many U.S. bankruptcies because of the medical debt found among many U.S. consumers filing for bankruptcy. The study states, "We should expect to observe a lower rate of bankruptcy in Canada compared to the United States, all else being equal." First, I'm not sure that is an assumption made by advocates of a single-payor system (and I don't count myself as one of them). Second, the qualifier "all else being equal" is the whole point. There is a lot that is not equal between the U.S. and Canada, and there is no reason to expect bankruptcy rates to be precisely similar. Even on its own terms, however, the Frasier Institute study is highly suspect because of the narrow window it uses for its bankruptcy data.

The Fraser Institute study, which is really just a three-page report of existing data from government sources, used bankruptcy filing data for the calendar years 2006 and 2007 as the "most recent data." Both the Office of the Superintendent of Bankruptcy Canada and the U.S. courts have 2008 data available. For a report that carries a July 2009 date, the years 2006 and 2007 would not seem to be the most recent data available. Authors have to prepare publications in advance of their appearance, but the U.S. data were available in a press release dated March 5, 2009, and the Canadian data appear on a web page that states "modified March 11, 2009." There was surely plenty of time to use the 2008 data for a 3-page paper that has fewer data than this blog post. By limiting the data to 2006 and 2007, however, the report is able to support that the anti-health care reform agenda that the NCPA and the Fraser Institute seem to further.

GM Update

Another appeal has been filed, while the District Court has denied the ad hoc committee's request for a stay pending appeal.  All signs point to a quick closing either late today or early tomorrow.  Then we can expect the debtors to move to dismiss the appeals on the basis of §363(m) and mootness.  I expect the appellants to counter that the sale can proceed without §363(f) protection, but I remain doubtful that an appellate court could change such an important "deal term" after the sale has closed.

The Tabb-ed Second Edition Is Out

From time to time, I'm asked to recommend a desk reference on bankruptcy law. I have long thought that it was hard to top Charles Tabb's The Law of Bankruptcy. Of late, my only hesitation was that I had thought that for too long. The first edition was more than ten years old. Still, it was a concise and well-written text that covered many timeless principles of bankruptcy law, and despite the passage of time, I still found occasion to use it .

As I was walking through our dean's suite today, it was fantastic to see a gleaming copy of the faculty's newest book proudly on display. The second edition of this wonderful treatise has just become available. The book is organized in a way that will make bankruptcy law accessible to novices. The first edition began each topic with first principles, and Tabb writes in a clear manner that makes any topic understandable. At 1,447 pages, the book also is no quick overview of bankruptcy law. I often used the first edition as a starting point on research topics.

Congratulations to Charles Tabb--my good friend, colleague, and teacher--on the arrival of this new edition. It is sure to become one of the bellwether works in the field.

Certification Denied

The bankruptcy court has denied the motion to certify the GM appeals to the 2d Circuit.  (And the request for the stay too).

UPDATE:  The court's decision can be found here.

Not so fast (says GM)

The debtors have filed an objection to the motions to expedite the appeal to the 2d Circuit. In short, the debtors argue

The issues that the Movants wish to raise on appeal do not rise to matters of public importance.  Rather, the interests that they wish to champion are their own (in the Individual Accident Litigants’ words, “[c]ertifying the . . . appeal will materially advance the . . . determination of their rights against the Purchaser”):  that is, the Movants want certification as to claims of a handful of individual tort litigants who assert, but have not yet even prevailed on, alleged prepetition claims that can and will be addressed in the administration of the chapter 11 cases.

The debtors also argue against a stay pending appeal, and argue that if the court does grant such a stay it should be conditioned on the posting of a substantial bond.  The bankruptcy court hearing on these motions is scheduled to begin right now.

I do think the debtors are right to highlight the extent to which the appellants seem to be pursuing an appeal for the sake of legal clarity -- the federal courts, unlike some state courts (e.g., New Hampshire), have strong rules against issuing "advisory opinions" that clarify the law without influencing the outcome of the pending case.

In Favor of the Consumer Financial Protection Agency (CFPA)

Adam's earlier post started the ball rolling on the CFPA discussion, and I wanted to weigh in (favorably) having now waded through the 153 pages of proposed legislation.  I take the case to be made for sheer regulatory consolidation as surely correct: the crazy quilt of overlapping agencies would make even Sir Humphrey cringe.  But the case in favor rests on much more than that, and of shrewd appeal to both typical bailywicks of the left and right.

GM Appeals, Part Deux

The pending request for certification to the U.S. Court of Appeals for the Second Circuit (CA2), if granted, would bypass the first rung on the appellate ladder of the U.S. District Court for the Southern District of New York.  But even that doesn't get the appellants far.  As mentioned in the prior post, some of the biggest issues, such as the 363(f) sub rosa brouhaha (and, in my view, bugbear), have now been decided by a panel decision of CA2, meaning that there is now established (adverse) precedent.  Unless the CA2 decides to grant en banc review -- highly unlikely -- the appeal might even be disposed of by summary order (at least the parts of which that duplicate Chrysler issues).  That in turn augurs well for a quick sojourn in CA2.

GM Appeals (update)

A second appeal has been filed, this one by the "Ad Hoc Committee of Asbestos Personal Injury Claimants." The Ad Hoc Committee -- whose standing to appeal I doubt (although the members could appeal, so perhaps I'm being pedantic) -- has moved for a stay pending appeal.  Both appellants have moved to certify the case directly to the 2d Circuit. A hearing before the bankruptcy court is scheduled for tomorrow night, to be followed, no doubt, by activity Wednesday morning at either the District or Court of Appeals, as appropriate.

Absent a stay, the appellants will have to deal with the inevitable mootness and 363(m) arguments -- something they appear ready to address.  As for the direct appeal to the 2d Circuit, I wonder if there is much reason for such an appeal in this instance -- the panel that heard the Chrysler appeal did address the §363(f) issue already, so the appeal in this case is essentially a request for an en banc review of that decision. Of course, for that very reason having the case proceed first to the District Court seems to be an exercise in extreme futility, but I don't see a "waste of time" clause in 28 U.S.C. §158(d)(2).

I'm Confused (California Edition)

On the day that California's credit rating has dropped through the floor, the FT has an article noting that traders are looking to buy the IOUs that California has been issuing to pay daily obligations, quoting one buyer who "would like" to purchase the IOUs for 50% of face.  But the same article goes on to note that key banks in California are accepting the IOUs as deposits -- so if I can sell my IOU to Wells Fargo for 100, why exactly would I sell it to the random trader in Ohio for 50? 

Another example of the "float a wacky idea to get in the paper" phenomenon, I suspect. 

UPDATE:  Or perhaps not.  The banks are apparently reconsidering.

GM Sale Approved

The opinion and order have been posted.  And the first appeal has also been filed.

Bankruptcy Filings Decline 6% in June

The most recent bankruptcy filing data from Automated Access to Court Electronic Records (AACER) show a 6.1% decline in the U.S. daily bankruptcy filing rate. The were about 124,800 bankruptcy filings in June which, spread over the 22 business days in the month, is a daily bankruptcy filing rate of 5,672. In May, the daily bankruptcy filing rate was 6,038.

I do not take the dip in bankruptcy filings as strong evidence that the end of the recession is just around the corner. First, there is the usual caution against reading too much into the ups and downs of a monthly indicator. Over the past eight months, the bankruptcy filing rate went up four time and down four times, although cumulatively the increases have been more than the decreases. (The daily filing rate is 11.7% higher than eight months ago.) Second, although the month-over-month figure is a decline, bankruptcy filings are up sharply on an annual basis. The June 2009 figure is a 32.5% increase over 2008. Over the entire year, projections show that 2009 bankruptcy filings will be 28.2% - 36.4% greater than 2008. As I discussed last month, the long-term trend is toward the same filing rate as before the 2005 bankruptcy law was adopted. Third, bankruptcy filings lag macroeconomic bad news. Yesterday's news about the jump in unemployment shows the U.S. recession is far from over, and those unemployed may show up in the bankruptcy courts much later. People do not run into bankruptcy court the day they are laid off. in our most recent empirical work from the Consumer Bankruptcy Project, more than 50% of bankruptcy filers told us they struggled for more than two years before filing bankruptcy.

Projecting forward, total 2009 U.S. bankruptcy filings will be:

• 1,404,000 filings if bankruptcy filings continue for the rest of the year at the same daily rate (5,593 per day) as they have averaged for the first six months of 2009
• 1,414,000 filings if bankruptcy filings continue at the same daily rate (5,672 per day) as they have averaged for June
  
• 1,494,000 filings if bankruptcy filings for the remaining six months of 2009 constitute the same proportion of total filings as the last six months of 2008 constituted for total filings that year (about 53.2%)

Bankruptcy as a Disqualifying Factor for Child Custody?

Several sources, including our friends over at Bankruptcy Beat, are reporting that Michael Jackson's mother, who has been awarded temporary custody of her three grandchildren, might have trouble gaining final custody because of a 1999 bankruptcy filing. Washington attorney Beth Kaufman is quoted as saying, "I think it would be a negative factor but not necessarily a disqualifier. It could indicate that she is not capable of sound financial management.”

It is often said that bankruptcy experts and family law experts don't know know as much about the other field as we should. That is certainly true for me, but I was surprised to read that a bankruptcy filing could be a negative factor for a family law court deciding a child custody matter. The Bankruptcy Code prohibits discrimination against former bankrupts, but that prohibition applies only in specific situations such as certain state licensing decisions or in employment matters. It would not prohibit a state court from considering a bankruptcy filing in a child custody matter. Still, on the question of fitness to be a parent, an old bankruptcy filing would seem to have little relevance.

The Case for a Consumer Financial Protection Agency

Yesterday, the White House released proposed statutory languagefor the creation of a Consumer Financial Protection Agency (CFPA).  The bill is long, but the CFPA, the brainchild of our co-blogger Elizabeth Warren, is by far the boldest part of the Obama financial restructuring plan.  I’d also venture to say that it is the most important. 

 

In this post I want to underscore why we need a CFPA.  In future blog posts, I hope to come back to what a CFPA will and won’t do.

In the Home Stretch

Note: The following was just sent from Credit Slips blogger Stephen Lubben: "At the GM hearing, although closing arguments may run over to tomorrow. I don't think there has been anything thus far that would prevent the sale from going forward."

Health Insurance to Go Broke With

An article in today;s New York Times chronicles how medical debt can financially ruin U.S. citizens even with health insurance. Policies with limits, often hidden from the consumer, quickly run out and leave the insured with mounds of debt. This story comes on the heels of an academic study by Credit Slips bloggers Debb Thorne and Elizabeth Warren and their co-authors, David Himmelstein and Steffie Woolhandler, showing an increase between 2001 and 2007 in the number percentage of medically related bankruptcies. I sometimes wonder how persons reading from outside the U.S. react to these sorts of stories.

Who Loses in Cuomo v. Clearing House?

Adam Levitin already posted on this week's decision in Cuomo v. Clearing House Association where the U.S. Supreme Court struck down a regulation from the Office of the Comptroller of the Currency's (OCC). The regulation preempted state enforcement of consumer protection laws against national banks and grew out of subpoenas issued by the New York attorney general. At first blush, the opinion seems to be a big victory for consumers, and it certainly is a victory. As alluded in the comments to Levitin's post, the opinion might not be as big of a victory as it seems.

The Supreme Court and What Attorneys Can Say

Some other obligations have kept me away from blogging for the past few weeks. One great thing about a group blog is having great colleagues who pick up the slack. I had wanted to say a few words about the Supreme Court's June 8 decision to hear United States v. Milavetz. At this point, the Court's announcement is old news. This post is about what is at stake in the Milavetz decision and why Credit Slips readers might want to watch this case when it gets argued in the fall.

There have been several Credit Slips posts (here and here) about the lower court decisions in Milavetz. Some issues that were raised in the lower court decisions have dropped away, and before the Supreme Court, the case will involve section 526(a)(4) of the Bankruptcy Code, a provision added by the 2005 amendments. It provides that "a debt relief agency shall not advise an assisted person or prospective assisted person to incur more debt in contemplation of such person filing a case under this title or to pay an attorney or bankruptcy petition preparer fee or charge for charge for services performed as part of preparing for or representing a debtor in a case under this title." Yes, that is language that perhaps only a lawyer could love but probably not even then. The upshot is that section 526(a)(4) aims to prohibit bankruptcy lawyers from advising clients to incur debt right before they file bankruptcy. It was not intended to prohibit bankruptcy lawyers from charging for their services, although that might be a natural reading of the language. Rather, the section also tries to prohibit lawyers from advising clients to borrow money to pay attorneys' fees for a bankruptcy filing.

Cuomo v. The Clearing House Association: OCC Loses Even with Chevron Deference

The Supreme Court delivered its decision in Cuomo v. the Clearing House Association today.  The issue in the case was whether the a regulation passed by the Office of the Comptroller of the Currency (OCC) preempted state enforcement of state fair lending laws against national banks.  Coming on the heels of the OCC's victory in Wachovia v. Watters, in which the Supreme Court held that a state could not exercise visitorial powers over an operating subsidiary of a national bank, many thought that the Supreme Court would extend the OCC's power to near complete preemption of any state authority over national banks. To the surprise of many observers, however, the Court ruled 5-4 (Thomas, with Roberts, Kennedy, and Alito dissenting) in favor of the State of New York (Cuomo).  

GM and §363(f)

As I noted in a recent post, "new GM" has agreed to "assume all products liability claims arising from accidents or other discrete incidents arising from the operation of GM vehicles occurring subsequent to the Closing of the 363 Transaction." (Debtors' response to objections, paragraph 62). The purchasing entity has also agreed to be responsible for "lemon law" claims.

This suggests that current tort claims will continue to be subject to Chrysler-like treatment, meaning that the gains in speed at the GM sale hearing may be somewhat less than I suggested in my prior post.  On the other hand, from a strategic perspective, this move would be consistent with the settlement GM made with its bondholders on the eve of filing. That settlement had the effect of fracturing the dissenting bondholders and removing the most effective sale objectors, and I have previously argued that the extension of §363(f) to future claims is the weakest part of the automakers' successor liability argument, because doing so would seem to violate due process.

GM Sale Objections

I have not covered the GM objections with the same intensity as I did in Chrysler, in part because the vast bulk of the objections raise the very same issues. For example, I'm sure most Credit Slips readers know how I feel about the old sub rosa plan argument. But for those of you looking for information on how the sale hearing will proceed, a good place to start is the Debtors' response to the objections. Even if you don't agree with the debtors' arguments, they provide a helpful service by organizing the objections and providing docket numbers for each one.

GM decides speed is better

GM has decided not to fight the §363(f) issue and will not attempt to "cleanse" its assets of tort claims when transfered to "New GM." I have previously argued that §363(f) should be read to apply to tort claims, subject to the overriding limits of due process that would temper 363(f) as applied to future claims. (Unless somebody wants to argue that Katz overcomes other Amendments too -- as explained by the majority, the Bankruptcy Clause does appear more powerful than previously understood).

Nevertheless, the issue is not a simple one and would have likely bogged down the sale hearing for a few days -- especially given that the litigants are better prepared than they were in Chrysler, and GM's case, which does not involve even the semblance of an outside bidder (vs. Fiat in Chrysler), is somewhat weaker. Accordingly, GM made the understandable choice to keep its case moving.

Transnational Bankruptcy

At the final day of the INSOL conference in Vancouver, I attended a fascinating panel on the issues that arise when a multinational corporate group seeks to reorganize. The panel was staffed by judges from Canada, the UK, Korea, and Germany -- and  deftly chaired by a U.S. judge who managed to resist drawing the discussion back to the U.S. For those of us from the U.S., I think the discourse was particularly enlightening. While the panel began with lots of optimism about the new tools for cross-border coordination, by the end it became plain that only Canada would consider a joint reorganization case. In the other jurisdictions, it was clear that the vision of a cross-border case was actually a series of parallel cases within the several jurisdictions, aimed at reaching a common point.

The distinction is important, and a point that is often lost in the good-feeling surrounding the adoption of chapter-15-like procedures. In a joint reorganization case, creditors are apt to be treated equally, based on the value of the unified enterprise. In the case of parallel proceedings, creditors in those jurisdictions that happen to have readily "realizable" assets are going to have significant holdup power, especially if the assets remain "local" as part of a separate bankruptcy proceeding. For local secured creditors, that may be a fair result, but for unsecured creditors who likely relied on the value of the overall enterprise, this sort of jurisdictional fragmentation is likely to produce very arbitrary (and likely inefficient) results.

Open-Source Law Review Publication Contracts

I know this isn't standard Credit Slips fare and will probably be of little interest to most readers, but it's of reasonable concern to academic readers:  the lack of standardization among law review publication contracts. 

The Current Paradox

I'm spending the week at the INSOL conference in Vancouver. I think it is important for academics to interact with the "real world" on occasion, to make sure that one's scholarship does not become too ivory tower. And the INSOL events are especially good since they provide a chance to interact with the global insolvency community.

But I have noticed that many of the panels could benefit from an "outside voice." In particular, during one panel I attended today two points were made:  (1) government intervention in the restructuring process increases uncertainty and makes life difficult for senior lenders in particular (lots of agreeing nods) and (2) because of "deleveraging," banks are essentially not making loans to distressed companies (more nods here).  Well, given point 2, either you are going to have government intervention or you are going to have corporate failure on a massive scale. Given the social dislocation associated with the latter option, politicians have strong incentives to embrace intervention (especially those in the majority, who will face the blame for said dislocation).

Too Big to Fail? Is Obama Proposing an Implicit Government Guarantee of Goldman Sachs' Liabilities?

Secretary Geithner was quoted by the Times as saying that from now on, “no one should assume that the government will step in to bail them out if their firm fails.”

Sorry, but that's just not credible.  The Obama financial reorganization blueprint basically says that there are Tier 1 FHCs financial institutions that get special regulation) that are too-big-to-fail (TBTF).  For these (today 19?) companies that the administration has decided are guaranteed a bailout.  The blueprint refers to a guarantee of liabilities only passingly in its section on special resolution powers for Tier 1 FHCs, but given how we've handled the GSEs, AIG, Bear Stearns, etc., its hard to believe that we wouldn't guarantee the debts of a failed Tier 1 FHC--the whole nature of being a Tier 1 FHC is that there is systemic risk from its failure to honor debt obligations. 

This means that for Tier 1 FHCs, their debt is as good as guaranteed by the U.S. government.  The implications of this are far-ranging and serious; I haven't worked through all of them, but here's what jumps out at me:

Making the GM sale hearing a bit more contentious?

I'm still thinking about the Supreme Court's opinion today, which held that the terms of the 1986 Manville plan are binding even if they exceeded the bankruptcy court's jurisdiction, but my initial take is that this makes the fight over selling the GM assets "free and clear" more important, because the tort creditors can't count on being able to challenge the order after the fact.  Of course, I've already argued that current tort claims probably are subject to §363(f), but plainly the tort claimants (and perhaps others) don't agree.

ABA Consumer Protection Conference: Credit Slips out in Force

Angie Littwin and I will be speaking on a very timely panel about the need for a consumer financial product safety commission Consumer Financial Protection Agency (CoFiPro=Coffee Pro?) at the ABA's Section on Antitrust 's Consumer Protection Conference at Georgetown.

The conference features appearances by numerous current and former FTC and state officials--including a greeting by the incoming head of the Consumer Protection bureau, my GULC colleague David Vladeck--as well as prominent private practitioners. Sessions cover issues including internet issues (with special attention to the perhaps surprising scope of Section 230 of the CDA), privacy, the use of empirical evidence, and the different standards applied by different regulators, including the FTC, NAD, and courts applying the Lanham Act.

Just to play with acronyms for proposed Consumer Financial Protection Agency: CoFiPro=Coffee Pro? or CoFinPro=Coffin Pro?

Skin in the Game

The proposed skin-in-the-game requirement for securitization strikes me as misguided, no matter how its structured. Different industries use securitization for different purposes, and while skin in the game might not have much of an impact in some, it runs contrary to the (legitimate) purposes of securitization in others.

Some industries securitize primarily to gain off-balance sheet and immediate revenue-booking accounting benefits and because it is a cheaper funding source than other methods. Industries like these often have significant skin in the game (e.g., the credit card industry, where a 7% vertical slice is the typical minimum requirement and it's usually much higher). Other industries, like non-GSE mortgages securitize primarily to shift credit risk. The whole point of securitization is not to have skin in the game.

The skin in the game requirement is being driven by the experience in mortgage securitization, not other types of securitization, and imposing a skin in the game requirement probably won't do much to non-mortgage securitization, where there might already be more than 5% retained interest. But for housing finance, skin in the game is really counter productive.

A Further Thought on Securitization Regulation

As I noted in my earlier treatise post, the Administration has proposed requiring all originators to keep a stake in each asset securitization, to ensure that they have "skin in the game."  In particular, the Administration proposes requiring retention of a 5% stake, and would further mandate that the stake remain unhedged.

The last bit troubles Felix Salmon, who seems to think that makes CFOs life difficult.  Perhaps, but should we care?  In particular, there clearly is some tension between this proposal and traditional risk management.  But at present, originators can use CDS to give themselves a zero or even negative stake in the outcome of the securitization.  In such a world -- and that's the world we'll return to if we simply restart the securitization market without change -- the downward spiral of asset quality I described in my prior post in essentially unstoppable.

Sure investors will be "smart" now, and they won't buy low quality assets with the same mania, but individual investor moderation does only little to address the systemic issues that come from excessive securitization.  Only an unhedged originator stake can correctly align incentives.  I doubt 5% is a sufficiently large stake; but it's a start, indeed any number greater than zero is a move in the right direction.

When Is a Market Too Big?

The emerging details of the Administration's securitization regulations have got me to thinking about an issue I first began to consider with regard to CDS. Namely, at what point do apparently useful tools allow a market to become "too big," in the sense that the market begins to generate systemic risks. And what can be done about it?

In the case of CDS (credit default swaps, see here and here), the existence of CDS allows for a magnification of the underlying debt market in ways that may create systemic risks. For example, although I have generally argued that GM would have been better off filing for chapter 11 a few years ago, doing so would have have had the potential to result in several collateral failures of financial institutions, because of the massive amount of then-outstanding CDS in which GM was the "reference entity." Indeed, a simple downgrade of GM's rating during this period almost completely unhinged the CDS market. In this respect, GM's slow glide into bankruptcy court was actually helpful, in that it allowed the market to "burn off" a lot of outstanding CDS, which simply expired before the bankruptcy.

California and Default

As I noted previously, a default by California would have serious repercussions for the larger national and even global economy. Extreme budget cuts in California to avoid such a default could also have serious effects on the larger economy, given California is such a big part of the U.S. economy.

Given this conundrum, the one obvious way out of the problem would be for the federal government to loan California the money it needs to balance it budget without radical program cuts. But I have previously noted that the Administration has political reasons to avoid getting further entangled in "bailouts," particularly when doing so will aid a Republican governor who is likely to have little ability to "call off" the members of his party in Congress.

Thus, it is perhaps unsurprising that the Washington Post reports that the Administration has denied California's request for federal aid. But this bears watching, as I suspect -- baring a truly marvelous economic recovery -- the Administration will be forced to revisit this issue again.

California is, after all, facing a $24 billion budget shortfall. It is going to be very hard for the State to close this gap without some serious effects on the broader economy. For example, the Governor has proposed ending the State's welfare program, all financial aid for college students, and its program that provides medical insurance to children of low-income parents. I'm sure my personal-bankruptcy savvy co-bloggers can anticipate what effects that might have on consumer spending, and bankruptcy rates, in California.

Yet another reason not to pack up the stimulus program just yet.

So Maybe Chrysler Was Only Worth $2 Billion After All

The WSJ has the details on what the lenders who supported the deal were looking at.  In short, the "analysis suggests that the $2 billion that the Treasury Department agreed to pay to Chrysler’s largest lenders, including J.P. Morgan Chase, Citigroup and Morgan Stanley, to settle a total of $6.9 billion first-lien debt may have been the best deal those lenders could have gotten."

I told you this wasn't a big deal, despite what all those editorial writers kept say -- I'm going off to be smug now.

The Effect of Legislation of Credit Card Interest Rates...

Is a drop? 

According to Bankrate.com, credit card interest rates stayed steady for low-rate cards and dropped for some high-rate cards.  So what this means that the Credit CARD Act has resulted in lower interest rates, right? 

Of course not.  That's a pretty obvious ex-post ergo propter hoc argument that doesn't proove anything.  But you can bet we'd see exactly the same sort of argument being made if rates had gone up (and we assuredly will the next time rates do go up).  No conclusive evidence need apply.  Never mind that the legislation hasn't even gone into effect yet.  Flipping through the cable stations, I saw no less a luminary than Mike Huckabee on Fox saying that one of his interviewees was having trouble getting credit because of the legislation.  I believe in anticipatory effects, but really, what issuer would shift away from a juicy business model a minute sooner than required? 

The Growing, Unseen Chapter 11 Wave

Over the weekend, Six Flags -- the owner of Magic Mountain in Los Angeles and other amusement parks -- filed a chapter 11 petition in Delaware. This morning, the Extended Stay hotel chain filed a chapter 11 petition in New York.  All of this is part of an increasing wave of large corporate chapter 11 cases that has been obscured by GM, Chrysler, and Lehman Brothers. Magic Mountain lost its appeal once I left my teens (never did get there) and I'm not sure I've ever stayed at an Extended Stay hotel, but both of these debtors have billions of dollars in assets and thousands of employees. That is, these companies have serious implications for the future of chapter 11 and the larger economy.

Indeed, according to bankrutpcydata.com, already there have been thirty-five chapter 11 cases filed by debtors with assets of more than $1 billion this year. In 2008 there were not that many large cases in the entire year. Chapter 11 cases of this size can be expected to continue to develop throughout the year and into next year, as we continue to work through a "bulge" in senior debt that newly moderate lenders will refuse to refinance and a series of problems in private equity. And the "tail" of this chapter 11 boom can be expect to persist for at least a couple of years past the petition date -- that is, into 2012.

Congress will probably never hold hearings on whether these companies should be allowed to use §365, but I think we can expect that the collective, collateral effect of these cases on trade creditors, landlords, and employees will equal, if not exceed, the effects of the better-known cases. This will in turn create a ripple of small business bankruptcy cases that will be completely unseen by the financial press and most academics, including myself.

Illustration from "Editor," all rights reserved.

GM Retention Applications

The key retention applications were filed on Friday, and by the morning we can expect the inevitable gasping story about how Harvey Miller bills at $950 an hour.  The press keeps doing this, and the big firms have no reason to stop them, given that most of the cost of a case comes from the middle of the billing structure.

Reviewing the Weil application, I was struck by how dreadfully dull retention applications really are. I mean, the Weil GM application is essentially the same basic application that Weil/Skadden/etc. have been filing for at least 15 years now -- I have the binders in my office to prove it.

Why hasn't this been reduced to one page ("We want to retain Weil Arps & Ellis to do the typical things that debtors' counsel does in big chapter 11 cases. They charge a lot, but we think they're worth it. As shown by the attached, they meet the requirements of §327(a).") with an attached declaration that has the case-specific (i.e., interesting) information?

Claim or Interest -- part 2

In my prior post on this topic, I examined and rejected the argument that reference to §1141 helps us understand §363(f), inasmuch as the term "interest" is used in different ways in the two sections.

But what about the core argument that the tort claimants have made, namely, that "interests" means "liens" in §363(f), and thus it is impermissible for the bankruptcy courts to allow the sale of automaker assets free of successor liability claims, which are clearly not liens. Recall the objection filed by the "tort claimants and consumer organizations," where it was argued that §1141:

is much broader than that of Section 363(f) by including “claims”, not just “interests in property,” i.e. liens.

earlier in the same objection, the argument is even more plain:

the language of Section 363(f), read in conjunction with other provisions of the Bankruptcy Code, is clear.  It establishes that “interests in property” which can be foreclosed under Section 363(f) are liens, mortgages, money judgments, writs of garnishment and attachment, and the like, and cannot encompass unliquidated successor liability claims.

The strongest argument against equating "interests" with liens in §363(f) comes from subpart (f)(3), which applies if "such interest is a lien." If we adopt the tort claimants' argument, this provision nonsensically states if "such lien is a lien." I submit that a more plausible reading of §363(f)(3) would suggest that "interest" as used in §363(f) includes liens, but it is not limited to liens. This reading is also buttressed by §362(d)(4), which speaks of recording "interests or liens" in real property.

But the second quote from the tort claimants does recognize a somewhat broader reading of "interests" in §363(f), while rejecting the inclusion of "unliquidated successor liability claims."  Of course, the right to assert a successor liability claim is not an "unliquidated successor liability claim" from the debtor's perspective. Unliquidated or not, it is not even a claim against the estate -- rather, it is only properly termed a claim against the buyer of the debtor's assets. From the perspective of the debtor's bankruptcy estate, a successor liability cause of action is a right that certain creditors hold, but it is not a right or claim against the debtor.  Correctly conceptualizing the right to bring a successor liability claim not only further undermines the analogy to §1141, but also properly focuses us on the issue of whether this right could be an "interest in property."

Claim or Interest -- part 1

One of the key disputes in both the GM and Chrysler cases has been the use of §363(f) to sell the assets "free and clear" of successor liability claims.  The normal rule is that a corporation that buys another corporation's assets does not buy its liabilities, unless it expressly contracts to do so.  In this context, successor liability typically refers to the "product line" exceptions developed by the California and Michigan Supreme Courts, that allow the assertion of product liability claims against the buyer, notwithstanding the normal rule.

The primary argument against the debtor's ability to sell its assets free of the plaintiff's ability to assert a successor liability claim against the buyer is that §363(f) refers to sales free of an "interest in such property," while §1141, the chapter 11 discharge, relieves the debtor of "claims and interests."  For example, in the objection to the Chrysler sale filed by the "tort claimants and consumer organizations," it was argued:

Moreover, the language of Section 1141 of the Bankruptcy Code confirms the propriety of a narrow reading of Section 363(f).  Section 1141, which governs the disposition of estate property in a plan of reorganization, broadly states that property dealt with in a plan is free and clear of all “claims and interests of creditors.” 11 U.S.C. § 1141(c). This language is much broader than that of Section 363(f) by including “claims”, not just “interests in property,” i.e. liens.

I do not find the comparison of these two provisions particularly helpful, because it seems clear that the word "interest" is used very differently in the two sections.  Indeed, the Bankruptcy Code uses the word "interest" or variations thereof (e.g., disinterested) more than 300 times, often in very different contexts. The most obvious example being interest paid on a debt, e.g., §362(d)(3)(B), a use which would seem to be of little relevance to this discussion.

Bank Regulatory Arbitrage and Deregulation: the Number of Bank Regulators Matters

One of the key points of debate over financial institution regulation reform is how many different bank regulators there should be and the extent of their respective bailiwicks.  Some argue that the number of regulators is a secondary issue.  It's not.  It's a first tier concern.  A critical flaw of our banking regulation system is the ability of financial institutions to engage in regulatory arbitrage, which has a corrosive effect on the quality of bank regulation.  As long as there are multiple federal banking regulators supervising essentially equivalent financial institutions there will be regulatory arbitrage, which will inevitably undermine whatever statutory framework Congress sets forth for financial institution regulation.

A Final Thought on the Chrysler Sale

A recent exchange with a commenter on the blog lead me to this conclusion: doesn't the argument that the consideration going to the Unions should have instead gone into the estate, for the benefit of the secured lenders, amount to little more than an argument that the buyer of the Chrysler assets (backed by the government) should have overpaid for the assets?

Next Up, Ford

So now that Chrysler's closed and GM's speeding along, where does that leave Ford? Well, with still about $30B in debt for starters. But this raises a theme in corporate bankruptcy of dominated industries like automotive and airlines. Will Ford be "forced" to file out of an economic peer pressure?

My initial hunch -- and it's just a hunch -- is no, at least not yet. Among other reasons, I'm just recalling the airline rhetoric earlier this decade about how all the airlines would have to follow United in. But they didn't all go in, did they?  I think American stayed out -- and has its restructuring been impeded, or is it still holding its own (since it was able to use the filers' labor negotiations to its piggyback benefit presumably)? Won't this be the same with Ford? 

Interchange Legislation Overview

It's summer, so it must be interchange season here in DC.  A trio of interchange-related bills have been introduced (or really reintroduced) in Congress.  First, there is the House version of the Credit Card Fair Fee Act of 2009, H.R. 2695, sponsored by Representative Conyers.  Second, there is the Senate version of the Credit Card Fair Fee Act of 2009, S. 1212, sponsored by Senator Durbin.  And third, there is the Credit Card Interchange Fees Act of 2009, H.R. 2382, sponsored by Representative Welch.  I think it is useful to summarize what these bills would do and their approaches to interchange regulation. 

Another Chrysler Appeal

This time a dealership, appealing from the bankruptcy court's order authorizing the rejection of the dealership agreement. I don't get the fight these dealers are putting up -- once the sale closed, staying with "old Chrysler" does not strike me as an attractive alternative.

But perhaps the appeal is to clarify the effect of the rejection on the dealers state-law remedies. Nonetheless, might be time for some cost-benefit analysis -- and keep in mind every appeal means more professional expenses for the debtor and less chance of any recovery for the unsecured creditors. 

UPDATE:  Another appeal from a different group of dealers.

Those wacky members of Congress

I assume the Automobile Dealer Economic Rights Restoration Act of 2009 (H.R. 2743) is going nowwhere fast, but I do appreciate that a few members of the House were kind enough to provide this bankruptcy professor with some interesting reading on a rainy Thursday afternoon in Newark.

Section 3(a) of the bill provides that "[i]n order to protect assets of the Federal Government and better assure the viability of automobile manufacturers in which the Federal Government has an ownership interest" said manufacturers "may not deprive an automobile dealer of its economic rights and shall honor those rights as they existed" on the eve of a manufacturer's bankruptcy case.

Now the bill does not actually reference § 365, and one could easily question the premise of the opening clause, but I assume that this is intended to "unreject" Chrysler's unwanted dealership agreements, and thwart GM's expected move reject some of its own dealership agreements.

The thing that makes this amusing is that section 3(c) of the bill expressly states that if enacted it will have no effect on the sale orders in either chapter 11 case. In short, the dealers who are "saved" by this bill will have the dubious privilege of being dealers for liquidating corporations that no longer manufacture cars. That is, the bill does not to alter the reality that the dealers' contracts are with "old" GM and Chrysler and they are being left behind. As the dealers will say when they realize this -- "swell," or words to that effect.

Finally, there is a part of me that hesitates to point out this flaw, because, as I have argued, chapter 11 already suffers from excessive Congressional tinkering that has made it increasingly difficult to actually reorganize companies under the Code. I would also think that any attempt to do what Congress seems to want to do here might run afoul of due process and separation of powers, particularly as applied to Chrysler -- although I'm getting myself pretty far out on the constitutional law limb here and will retreat to the wonderfulness of the Bankruptcy Code at once.

UPDATE:  One way around the statutory problem I identify is to read this as an attempt to create some sort of successor liability in the reorganized companies for these contracts, essentially assigning them without using §365.  The constitutional law issues, whatever their merit, would still remain.  And I think Fiat (and maybe the Canadians) might have some problems with this -- it amounts to changing the deal after it's been closed.

Oakland = GM?

Where have I heard this before:

Oakland City Council members may have privately bandied about the possibility of the city filing for bankruptcy, an unusually rare event in U.S. history. But none says it's likely, and Mayor Ron Dellums virtually ruled it out Tuesday.

"Bankruptcy is not a strategy that has been seriously considered, nor is it being pursued at this point," he said in a statement.

Full story here.  At least the mayor qualifies his answer, unlike GM's prior management.