The Fed's Apparently Nonexistent Interest

Last week, Katie proposed that we might have a blog category for "Beyond the Comfort Zone." I'll add another new category: "Things Bob Does Not Understand." It's sure to have lots of entries. Here is what I don't understand today.

As illlustrated by a Wall Street Journal article from last week, a number of media sources reported that credit card interest rates are rising. The conventional story is that credit card lenders are hiking rates to recoup income lost from new restrictions on fees and penalty rates. Even if credit card interest rates are rising, it would not necessarily mean the regulatory changes have backfired. The point was not to make credit card borrowing free, but just to make its costs more transparent. To the extent the regulatory changes have moved the costs into easily understood front-end interest rates instead of "gotcha" penalty fees at the back end, these changes have accomplished their purpose. But here is the thing, I don' t understand how the world has come to the conclusion that credit card interest rates are rising.

Consumer Law

Credit Slips is a self-proclaimed blog about "credit, finance, and bankruptcy." Much of our discussion here focuses on consumer credit, which also makes up a large amount of what gets taught in law school courses on "consumer law." Jeff Sovern at St. Johns did a survey on the subject. And to understate things, the economy has provided significant fodder for discussions on consumer credit, including credit cards and mortgage lending, in the last decade, and so consumer law courses may increasingly be expanding coverage of credit or being replaced by seminars on predatory lending, the democratization of credit, the mortgage foreclosure crisis, etc.

I remain committed to "consumer law" as a broad field. While consumer credit is part of that, I believe there is a pedagogical value to teaching students about a wide variety of consumer-business transactions in a single course, and I believe there is theoretical coherence in consumer law as a field. An article in the New York Times, Airline Fees Test Travelers' Limits, nicely illustrates my thinking. The pattern of fee hikes, hard-to-discern terms, and complex pricing that the article documents in the airline industry is a pretty close parallel to the credit card industry in the last decade. The problems are fundamental to businessess--sophisticated repeat players aided by technology and expertise--selling things to consumers--relatively unsophisticated one-off players without technology or expert advice. For me, the most interesting question is trying to identify consumer-business transactions that don't exhibit the problems of these disparities. Those markets hold important lessons for the regulation of consumer credit that seems likely to occur in the next few years.

Chase Amassing Lehman Claims

On Monday, JP Morgan Chase reported that it had purchased more than $60 million in claims from Raiffeisen Zentralbank Osterreich AG. In July Chase bought about $200 million in claims. And while Chase has sold some claims too -- back in May they sold a couple of big claims -- it appears that there are more and larger claims going to Chase, including some "partial" claim transfers, which should add a special something to the plan negotiations:  what debtor wouldn't like to find it has even more creditors post-petition?

And then there is the matter of how all these claims play into the ongoing litigation between Lehman and Chase . . . 

N.B.  Some of the August 30th transfers are docketed as transfers from Chase, but the underlying documents show that they are Chase purchases.

Explaining the Housing Bubble

Some self-promotion:  I've posted a new paper to SSRN, coauthored with Susan Wachter (Wharton).  It's entitled "Explaining the Housing Bubble."  Here's the abstract:

    There is little consensus as to the cause of the housing bubble that precipitated the financial crisis of 2008. Numerous explanations exist: misguided monetary policy; government policies encouraging affordable homeownership; irrational consumer expectations of rising housing prices; inelastic housing supply. None of these explanations, however, is capable of fully explaining the housing bubble, much less the parallel commercial real estate bubble.

    This Article posits a new explanation for the housing bubble. It demonstrates that the bubble was a supply-side phenomenon, attributable to an excess of mispriced mortgage finance: mortgage finance spreads declined and volume increased, even as risk increased, a confluence attributable only to an oversupply of mortgage finance.

    The mortgage finance supply glut occurred because markets failed to price risk correctly due to the complexity and heterogeneity of the private-label mortgage-backed securities (MBS) that began to dominate the market in 2004. The rise of private-label MBS exacerbated informational asymmetries between the financial institutions that intermediate mortgage finance and MBS investors. The result was overinvestment in MBS that boosted the financial intermediaries’ profits and enabled borrowers to bid up housing prices.

    Despite mortgage securitization’s inherent informational asymmetries, it is critical for the continued availability of the long-term fixed-rate mortgage, which has been the bedrock of American homeownership since the Depression. The benefits of securitization, therefore, must be reconciled with the need for economic stability. The Article proposes the standardization of MBS to reduce complexity and heterogeneity in order to rebuild a sustainable, stable housing finance market based around the long-term fixed-rate mortgage.

Direct-to-author (not posted) comments are most welcome.  

Fringe Lending and Consumer Welfare

Like Katie Porter, I found Professor Jim Hawkins' paper on fringe lending valuable for challenging some of the premises underlying calls for stricter regulation of fringe lending products like payday loans.  In my view, there are empirically testable criteria for regulation of fringe credit, which I hope to elaborate in a forthcoming paper.  Unfortunately, Professor Hawkins ultimately does not offer either a normative consumer welfare framework for credit regulation, or a truly empirical examination of the welfare impacts of fringe lending.  Instead, he relies on product descriptions that reflect industry marketing more than the experienced reality of working class borrowers who use them, and uses a very limited implicit definition of consumer harm to restrict the possible justifications for market intervention.

Welcome to New York; the Bankruptcy Court is Below the Museum

While most of the recent focus in the reorganization area has been on a handful of “mega” cases that played key and controversial roles in the financial crisis, the bankruptcy court in Manhattan has quietly become the international center for corporate reorganization. And I’m not just talking about chapter 15 cases, like those recently filed by Mexicana Airlines, and a boatload of English reinsurance companies, that simply ask the US court to help enforce a foreign bankruptcy proceeding.

State-sanctioned Federal Bankruptcy

If Credit Slips had a category for "Beyond the Comfort Zone," I'd put this blog post here. But I'm curious about the pending California legislation, Assembly Bill 155, that would restrict municipal (Chapter 9) bankruptcy filings. The bill would require municipalities to obtain approval from the state-run California Debt and Investment Advisory Commission before filing bankruptcy. The political story is easy; this is the fall-out of the bankruptcy of Vallejo, CA last year. Among other concerns, unions whose members had their pay or benefits reduced want to restrict access of local governments to chapter 9. Cash-strapped cities, facing a double-whammy of lower taxes and higher claims on social services, feel differently.

Now my bankruptcy teacher was pretty decent but I never learned that the Bankruptcy Code gives states the power to limit their municipalities' ability to file a chapter 9 case. But it's right there in 11 USC 109(c)(2). (Of course, this means that I also didn't know that municipalities must be "insolvent" to file chapter 9, a requirement that is notably absent for debtors in other chapters.) Apparently, states take a variety of approaches to this--some prohibiting chapter 9, some remaining silent leaving things unclear, and some conditioning chapter 9 on some thing, as California's proposed legislation would do. I'm  struck by the remarkably different approach in chapter 9 than in chapter 11, where the doors are really wide open to bankruptcy relief. Are the public harms that different? The bankruptcy of a company, including the rewriting of its union contracts and the devaluation/cancellation of its stock, can have similar harms on communities. I'd be very grateful to Credit Slips readers who will share their thoughts about these issues; I have a feeling the future will bring more chapter 9 filings.

Hawkins' Fringe Banking Premise is that Payday and Title Loans are Short-term: If Only it Were True

Although I disagree with the starting point of the paper Katie wrote about yesterday, Fringe Banking by Professor Jim Hawkins, and thus disagree with most of Professor Hawkins’ conclusions, I have great respect for him and am grateful that his paper is part of the national discourse on this topic. I deal with very poor people regularly and know some have no place else to go besides payday or title lenders when they need cash. Thus, I try to keep an open mind that on some level products like payday loans could serve some utility in the world, if they were truly used sparingly and for emergencies only. And if there were no rollovers and people could not use 10 or 12 of them at a time. In other words, if they worked the way Professor Hawkins says they do.

Jim’s paper gets a valuable idea out there, but the facts about how these products are really used, and how they are marketed, explain why these loan products create more problems than they solve. My own curbside data of payday use (read the long version or the short version) suggest that Professor Hawkins’ starting point, that these loans are designed to be short term and thus to keep people out of a cycle of debt, is out of synch with the reality of either borrowing habits or lender business plans. Still, his idea does start a conversation, and in this field the two sides do not talk. Period. The product designs he speaks of, if actually followed in practice, would make this type of lending much less abusive. I might even like these products.

HAMP fizzles

Treasury reported Friday that a hopelessly inadequate 37,000 mortgages were permanently modified as a result of the Administration’s HAMP program in July.   The program, funded by TARP bailout money, offers mortgage servicers incentives and subsidies to modify mortgages, something they were doing before and should be doing far more anyway.  Last month's total translates to fewer than half a million modifications annually, compared with perhaps 3 million new foreclosure starts and 1 to 2 million completed foreclosure sales we can expect in this Year Four of the foreclosure crisis.  The future prospects of the program are dim:  fewer than 25,000 new trial modifications were generated last month, compared to the more than 100,000 monthly at the program's peak in the fall of 2009.

Fringe Banking and Financial Distress: Argument and Critique

Today at The Conglomerate Blog, there is an online workshop of former Credit Slips guestblogger Jim Hawkins' paper, Regulating at the Fringe: Reexamining the Relationship between Fringe Banking and Financial Distress. Jim shared some of his thoughts on what he claims is the "dubious" relationship between fringe banking and financial distress in some of his Credit Slips posts.

I found Jim's paper to be provocative and I've posted a critique of his approach at The Comglomerate as one of their invited commenters. I think Jim's definition of financial distress as too many dollars of debt is unduly narrow and that it is only by using that definition can be claim to debunk the relationship between fringe banking and financial distress--primarily by arguing that because these are small dollar loans they can't really be much of a problem. I also think Jim tends to overstate the extent to which the Bureau of Consumer Financial Protection was justified by concern about financial distress. I think its primary focus is on correcting malfunctions in markets caused by misinformation or deception. Jim himself seems open to intervention in fringe banking on that basis, as he concludes his paper by exploring rationales other than financial distress might support regulation. Check out The Conglomerate blog to join the conversation about this topic and to see the thoughts of other invited commentators: David Zaring, Larry Garvin, and Todd Zwyicki.

There Is a Jury Trial for that Proof of Claim

Imagine the following. A debtor files bankruptcy and schedules a $10,000 bill owing to a credit card company. The credit card company files a proof of claim, saying the debt is $20,000. The debtor objects. OK, at that point, the dispute sounds like a pretty routine procedural matter requiring a hearing before the bankruptcy judge to resolve the disputed claim. Bankruptcy mavens would call it a "contested matter" under Federal Rule of Bankruptcy Procedure 9014.

Suppose the credit card company objects to this procedure and instead insists on a jury trial to resolve the disputed claim, arguing the Seventh Amendment requires a jury trial unless the parties waive it. Well, that's just crazy talk.

A Code Head-Scratcher

From a retention application in Lehman,

By this Application, the Debtors seek entry of an order, pursuant to section 327(e) of the Bankruptcy Code, authorizing the employment and retention of KBT&F as special counsel to the Debtors, to perform necessary legal services pertaining to the Debtors’ chapter 11 cases . . . (emphasis added).

And section 327(e) of the Code, which provides

(e) The trustee [or debtor, in chapter 11], with the court’s approval, may employ, for a specified special purpose, other than to represent the trustee [or debtor] in conducting the case, an attorney that has represented the debtor, if in the best interest of the estate, and if such attorney does not represent or hold any interest adverse to the debtor or to the estate with respect to the matter on which such attorney is to be employed. (emphasis added). 

Portrait of California Foreclosures

An important and empirically robust new study belies the stereotype of the California foreclosure crisis as resulting from house flippers and social climbers overreaching to buy 4,000 square foot mansions.

The typical California home in foreclosure is a very modest 1,500-square-foot, 2- to 3-bedroom house in the Central Valley or Inland Empire, refinanced in 2005 or 2006 by a Latino family.  The average home value at the time of the loan was about $400,000, considerably less than the $500,000 median home price statewide.   At today’s prices, that average California foreclosure property is likely to be worth between $200,000 and $300,000.   Fewer than half of mortgages in foreclosure were purchase loans.  Thus, the typical foreclosure story is not a family reaching too far in order to buy an unaffordable house, but more likely, of using home equity to pay credit card debt and maintain a middle-class standard of living in the face of stagnating incomes.  Essentially half of all foreclosures in California involve Hispanics, roughly in the same proportion that subprime mortgages were given out in the years prior to the crisis.  Thus, the last to arrive at the bottom rungs of the middle class ladder are the first to be pushed back off.

The picture that emerges from this foreclosure study is of a generation of Hispanic homeowners, typically refinancing an existing, modest home, rather than buying an extravagant McMansion, losing years of accumulated wealth and savings in the process.  Opponents of foreclosure relief and debt reduction regularly invoke the useful fiction of foreclosure victims as profligate yuppies with surplus bathrooms.  The facts are otherwise.

The Dodd-Warren Rift: President Obama Can you Hear Me?

With even Dr. Phil coming out in favor of Warren for CFPB head, Chris Dodd very much opposed and waffling about why, and a new rap video about Professor Warren going viral, according to an article in the New York Times, Americans are waiting to see what the President will do. I agree with readers who say this’ll take some courage, but Mr. President,you wouldn't ignore Professor's Warren's record and instead listen to Senator Dodd, would you? That wouldn't make much sense. By the way, I am not friends with Elizabeth Warren (unlike Dr. Phil apparently and many of my co-bloggers) and have never given a dime to any political campaign.  Differences in world view aside, no one can claim this Harvard law professor is not the most qualified. The CFPB is a reality now and going to be staffed, no doubt at very significant expense. If we are going to do this, and I guess we are, why not give credit-crushed consumers (see Aug. 21 New York Times article) good value for their money and appoint someone who will most swiftly and efficiently fulfill the mission (and namesake) of the bureau. In this instance in particular, shouldn't we get our money's worth?  

If You Have Complained About Financial Industry Regulation

. . . . today's Dilbert is for you:

Bankruptcy and the Crisis: Why so Few?

Many thanks to Bob for the invitation to guest blog here.  Those who follow Bob's postings on bankruptcy filing numbers will have seen that U.S. consumer bankruptcy filings have been plodding upwards steadily, but only to roughly where they were before the BAPCPA bubble back in 2005.  One of the inscrutable mysteries of the financial crisis of 2007-??, which is after all a housing and consumer debt crisis, has been how few bankruptcies have been filed.  Somehow, historically unprecedented levels of consumer debt and loan defaults have not produced the surge in bankruptcy filings one would expect.

Welcome to Alan White

We are happy to have Professor Alan White of Valparaiso University School of Law join us as a guest blogger. White joined the Valparaiso faculty in 2007 after substantial practice experience with Community Legal Services in Philadelphia. In practice, White filed numerous chapter 7s and 13s on behalf of consumer debtors and even represented consumer creditors on the creditors' committee in a corporate chapter 11. His policy views are leavened with a good dose of reality about what happens on the ground, and consequently his academic work has had immediate effect. Also, he maintains a web page where he posts regular analysis of foreclosures and modifications from securitized mortgage data. Welcome, Alan.

The Market for LLCs

It's a little off from our usual topics, but I have a post up over at The Conglomerate blog as part of their junior faculty scholars' workshop. Gordon Smith and Larry Ribstein also are commentators. The paper under discussion is by Professor Mohsen Manesh of the University of Oregon and is entitled "Delaware and the Market for LLC Law: A Theory of Contractability and Legal Indeterminacy." Most of the discussion is about the regulatory competition for LLC charters, but a part of the debate is something that does lie at the heart of this blog's topic. Manesh's paper describes a competition for operating businesses, but I would bet that many of the Delaware LLC formations are financial shells set up for securitizations or similar purposes. Also, a good deal of these LLCs are probably wholly owned subsidiaries used for asset partitioning.

Student Loans Now Greater Than Credit Card Debt

Total outstanding student loan debt now exceeds credit card debt, as reported yesterday in the Wall Street Journal which in turn elaborated on a web article by Mark Kantrowitz, publisher of FinAid.org. Revolving consumer credit according to the Federal Reserve is $826 billion. Kantrowitz calculates outstanding student loan debt at almost $830 billion.

Pay the Bums

Over at the NY Times, William Cohan has a post complaining about a pending motion in Lehman. Unfortunately this represents just another example of how the mainstream press continues to muddle their reporting of chapter 11.

Make Your Home Finance Audit Fun While Fighting Back Against Bank Fees

The article Katie posted on bank fees was right on. The fees have gotten so creative that we invented a new household game to combat them, in which we compete for a pre-determined prize.  The prize makes it fun.  We do a competitive home finance audit over a glass of wine or two on the 5th or the 6th of the month, once the statements are all complete on line. Today is the 6th. Game on!! Stewart and I like competition.  To play, we scour all bank and credit card statements as well as certain purchases. The prize goes to the one that incurred the least interest or fees of any kind on anything, except the home mortgage. If there are no fees at all, no one wins the prize, but we both win!

Colbert: Elizabeth Warren Is No Oprah

Stephen Colbert last night opining that "a huge budget and no constraint on authority" should be reserved only for Oprah Winfrey here, including an interview with Barney Frank on why Warren is the best pick.

Will Dodd-Frank Reduce Safe Harbor Overreach?

As loyal Slips readers will no doubt recall, I've been something of a broken record (what's the modern version of that saying? Buggy mp3?) on the issue of the safe harbors in the Bankruptcy Code, especially as expanded by the 2005 Amendments. In short, I believe that that special treatment of derivative contracts is both more likely to increase systemic risk than reduce it, and incredibly overbroad, giving parties an incentive to disguise regular contracts as derivatives to get out of the automatic say and the operation of section 365.

But I wonder if the recently enacted Dodd-Frank financial reform legislation might reduce the temptation to claim that every routine supply contract is actually a protected swap. Under the legislation, a "Major Swap Participant" is subject to new capital and margin requirements, if not otherwise subject to prudential regulation. A big energy company that is routinely arguing in chapter 11 cases that their supply contracts are subject to the safe harbors might back itself into these capital and margin rules, especially given that the definition of "swap" under the reform legislation is quite similar to that under the Code.

Sovereign Bankruptcy Nostalgia, August Edition

Preventing a Greek default in August might just be the one thing that rates higher on the EU policy agenda than preventing a Greek default--or so I am told by a source familiar with the policy significance of August in Europe.  Yet August is a popular month for sovereign debt crises (Mexico, Russia, Argentina), which makes it an excellent time to contemplate institutional changes that might make the inevitable sovereign defaults less painful for the debtor, the creditors, and the bystanders.  Earlier this week, the FT obliged with a wistful retrospective on the odd combination of gunboat diplomacy (c. 1820-1956) and the International Monetary Fund's technocratic attempt at a sovereign bankruptcy regime (2001-2003).  Recent German proposals for European sovereign bankruptcy piggyback on the IMF effort, but are even more firmly rooted in the conviction that just the right rule could bind policy makers facing financial cataclysm to act prudently and predictably.  I find such rule nostalgia puzzling in the wake of the disgraced no-bailout clause in the EU treaties--the ultimate in bright-line commitments--and its relations the world over.  However, the revived conversation is valuable.

July Bankruptcy Filings Rise, But Look at the Big Picture

The folks at Automated Access to Court Electronic Records (AACER) sent over the July bankruptcy figures. Total U.S. bankruptcy filings in July (134,600) were about the same as they were in June (133,900). There was extra business day in July, however, meaning that the daily filing rate, rose 5.3% to 6,408. The year-over-year increase in the daily filing rate was 7.7%.

Regular readers know that I am skeptical of reading very much into the ups and downs of the monthly filing rate. If you had looked at the June fiing rate, you would have seen an 8.9% drop in daily bankruptcy filings and perhaps concluded the economy was beginning to turn around. The July increase might lead you to the opposite conclusion. The most informative analysis comes from taking a longer term look at the data. And, there is my usual caveat that bankruptcy filings are, at best, a weak and trailing indicator of overall economic strength.

Visualizing Financial Distress

The Admistrative Office of the US Courts (AO) has released updated data on bankruptcy filings. While the AO data as some problems, as Bob Lawless has pointed out, I am pleased that they seem to have improved the accessibility of the data. For example, there is now an interactive map by state that is sort of fun (well, fun in my world).

One nice thing is the statistics on net scheduled debt. Given the way that some people seize on the dollars of debt in bankruptcy as a marker of the system, I like how the AO has deducted nondischargeable debt from the total debt listed by the debtor. To do otherwise, gives a misleading picture of how much "help" people get from bankruptcy. But additional caution is still needed. For the chapter 13 filers, about 2 in 3 of these people will not get a discharge of any unsecured debts because they will not complete the repayment plan. Much more importantly, these figures are total debt, the bulk of which will be mortgage and auto debt, which debtors must pay if they want to keep their homes and cars.

All in all, a better use of your time might be the interactive maps at the NY Fed. These have been upgraded recently to show delinquencies on auto loans, bank cards, mortgages, and even student loans. Check them out here.

Hat tip to former Credit Slips guest blogger, John Rao, for bringing the AO data to my attention.