postings by Adam Levitin

Jeb Hensarling's Alternative Facts

posted by Adam Levitin
House Financial Services Committee Chairman Jeb Hensarling (R-Texas 5th) has an alternative fact problem. In a Wall Street Journal op-ed Hensarling alleged that "Since the CFPB’s advent, the number of banks offering free checking has drastically declined, while many bank fees have increased. Mortgage originations and auto loans have become more expensive for many Americans.
 
The problem with these claims?  They are verifiably false.  Free checking has become more common, bank fees have plateaued after decades of steep increases, and both mortgage rates and auto loan rates have fallen. One can question how much any of these things are causally related to the CFPB, but using Hensarling's logic, the CFPB should be commended for expanding free checking and bringing down mortgage and auto loan rates. Hmmm.  
 
Below the break I go through each of Chairman Hensarling's claims and demonstrate that each one is not only unsupported, but in fact outright contradicted by the best evidence available, general FDIC and Federal Reserve Board data. 

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What Would a CFPB Commission Have Done Differently?

posted by Adam Levitin

Here’s the question CFPB commission proponents need to be able to answer convincingly:  what would the CFPB have done differently over the past five and a half years if it had been a commission, rather than a single director?  What supposed overreach would not have occurred?  

So, CFPB commission proponents, here's your chance. Comments are open.

More Evidence that a For-Cause Removal of CFPB Director Corday Would Be Pretextual

posted by Adam Levitin

If Trump is planning on attempting to remove CFPB Director Richard Cordray "for cause" he's hardly going about it in a smart way.  The Trump administration keeps generating more and more evidence that any for-cause removal would be purely pretextual, which strengthens Corday's hand were he to litigate the removal order (as he surely would).  

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The Real Reason Behind the Calls for Firing Richard Corday (and the Costs of Doing So)

posted by Adam Levitin

The calls for Donald Trump to fire CFPB Director Richard Cordray are getting louder (see here and here). It's worthwhile understanding what's really afoot here. Cordray's term as CFPB Director expires in July 2018, so firing him in January 2017 doesn't seem to accomplish a lot.  If Cordray is fired, the Deputy Director automatically becomes the Acting Director and is fully empowered to do everything that the Director would otherwise do, until and unless a replacement Director is confirmed by the Senate (or recess appointed), a process that will take a while.  So we're probably talking about speeding up Republican control of the CFPB by less than a year.  Does that really matter?

Actually yes. It is hugely important to the financial services industry in general and to the payday lending industry in particular. The CFPB has two major rule makings pending, one restricting binding mandatory pre-dispute arbitration clauses that are used to prevent class actions and a second imposing an ability-to-repay requirement on payday and auto title loans. It is not clear when the CFPB will publish final rules on the topics; there is some speculation that the arbitration rule might be out before Inauguration Day. But the thinking is that a change in CFPB leadership might come in time to stave off these rule makings.  (Note that both rulemakings would be subject to Congressional override under the Congressional Review Act, but it's quite possible that a few Republicans in the Senate defect on both rulemakings.) In other words the calls to remove Cordray aren't about real outrage over dated employment discrimination allegations at the CFPB, but just shilling for the financial services industry, which is trying to head off the payday and arbitration rulemakings. 

One can see the appeal to a Trump administration of firing Corday. It's a chance for Donald to parade out his trademarked "you're fired" line and to quickly claim a victory and please part of its base. I would hope, however that the Trump administration has good enough counsel to recognize that there is real risk from attempting to fire Cordray, such that the cost of firing Corday is likely to outweigh any benefits. Put in Trump terms, it's a bad deal. 

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Trump Post Office Mechanic's Liens

posted by Adam Levitin

It's not often that one finds mechanic's liens in the news.  I think this is ripe for inclusion in secured credit casebooks.

Update:  After thinking about this more, this gets more interesting than a plain vanilla mechanic's lien.  Recall that Trump doesn't own the Old Post Office.  He has a leasehold, and the building is owned by the federal government.  So this raises the question about whether the lien reaches to the fee simple ownership of the federal government or if it is a lien on the leasehold.  I have no idea. There are some states in which a mechanic's lien triggered by work done by a tenant reaches the landlord's fee simple ownership if the work was done with the landlord's consent (see here, e.g.). I don't know what, if anything, DC caselaw says on this.  (If the lien is filed against the federal government itself, there's a different process through the Miller Act, but I doubt that applies since the federal government was probably not a party to the construction contract.) 

A potential further complication is the status of federal property in DC. Can it be subject to mechanic's liens?  Can it be foreclosed on?  Where does sovereign immunity come into play?  

Finally, what is the effect of a lien on the property on Trump's leasehold?  I can't imagine that there's any way to actually foreclose on Trump's leasehold--the lease for the Old Post Office isn't going to be freely transferable.  If so, what good does a mechanic's lien do, other than embarrass Trump?  Is it an Event of Default under the lease if Trump suffers it to persist?  If so, that would give the contractors some leverage, but this all seems much messier than a typical mechanic's lien situation. 

I'm somewhat perplexed.  Trump doesn't own the Old Post Office.  He has a leasehold.  So is the mechanic's lien filed against his leasehold or against the building?  I don't see what good it does to file it against a.  A mechanics lien gets paid in one of two ways.  Either it gets paid when the building is sold or it gets paid after foreclosure by the unpaid contractor following a successful suit for the unpaid balance.  Given that the building is federally owned, I'm not sure what either of this means.  

CFPB Commission Structure Proposals

posted by Adam Levitin

I have an op-ed in American Banker about proposals to convert the CFPB into a commission structure.  Basically, the idea that a commission structure increases accountability and policy stability and reduces arbitrary or abusive actions by an agency just doesn't hold water upon examination.  

Not included in the piece is a brief history of independent agency structure. The reason that so many independent agencies are structured as commissions has absolutely nothing to do with a perceived superiority of the commission structure from any sort of good governance perspective. You'll be hard pressed to find any Congressional debate about single director versus multi-member commission structures. The prevalence of multi-member commissions is a matter of path dependency and Congressional desire to maximize patronage opportunities, not any considered debate.

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CFPB Tales Told Out of School (Updated)

posted by Adam Levitin

Former CFPB enforcement attorney Ronald Rubin has a lengthy attack on the CFPB in the National Review. It's got lots of sultry details, but there's nothing new and verifiable in the piece.  Instead, it's all tales told out of school, unverifiable personal anecdotes by Rubin, who seems to have an particular axe to grind with certain other CFPB staffers, and an ideological one too. Incredibly, Rubin, a former Managing Director for legal and compliance at Bear Stearns, holds up the oft-feckless SEC as a model of good enforcement practice, and criticizes the CFPB for any departures from that practice. 

The point of the piece seems to be that the CFPB is an agency gone rogue and that this wouldn't have happened if the CFPB had just been structured as a bi-partisan commission. That's hogwash. Assume that everything Rubin claims is true and correct. Even if so, every single problem Rubin identifies in the piece could just as easily have occurred at a bi-partisan commission. Partisan hiring? Of course that can happen because the staff hiring decisions (other than those of the personal staffs of the commissioners) are done by the commission chair and people the chair has selected. Secrecy and stonewalling Congress? We see allegations about that regarding agencies all the time (and that from agencies not facing partisan witch-hunts). Unhappy employees? Check. Pressure on regulated firms to settle enforcement actions? Check. Claims of discrimination by employees? Check. These are problems that can occur at any agency, irrespective of its structure or funding. 

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Fake News, Special Carrie Sheffield CFPB Edition

posted by Adam Levitin

The "fake news" phenomenon has gotten a lot of attention of late, but there's also the problem of its kissing cousins, faux academic research and opinions piece that springboards off of fake news and faux research.  A comically bad example of the latter category is the hatchet job Carrie Sheffield tries to pull on the CFPB in a piece on Salon.com.  In a nutshell, Sheffield (1) accuses the CFPB of being "rampant with internal racism and anti-woman bias," (3) claims that the CFPB has resulted in an increase in bank fees, and then (3) makes a big deal out of CFPB employees' political donations tilting toward Democrats.  The first and second points are simply false and not supported by the evidence Sheffield cites.  The third point is just irrelevant, but shows Sheffield to be nothing more than a partisan hack.  Sheffield's piece really doesn't merit a response intellectually, but given the current political climate, it's necessary to respond to any calumny, no matter how ridiculous.  So a point by point follows, after which I share a few thoughts on the political price tag that will come with trying to get rid of the CFPB.

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CFPB and ACICS Retrospective

posted by Adam Levitin

The Department of Education just stripped the Accrediting Council for Independent Colleges and Schools of its accreditation role.  (For those of you not in academy, this accreditation is critical for schools to get DoE funds, among other things.  It's part of what enables the ABA's on-going tyranny of legal education.)  Some of you might remember that in 2015, the CFPB issued a Civil Investigative Demand to ACICS, the authority for which ACICS challenged successfully.  At the time some of the CFPB's critics held the CID up as an example of improper over-reach, and the District Court bought the argument that there was no connection between accreditation and private student lending.  (Of course there is, but that's another story.) I'm just wondering if those folks who thought the CFPB acted improperly with the CID might be singing a different tune now.  It sure looks like the CFPB was on the right track with the CID.  

The CFPB and Behavioral Economics

posted by Adam Levitin
This post is an extended aside from my previous post about David Evans' argument about the CFPB's mindset and institutional incentives.  The point isn't critical to Evans' argument, but I'm writing because it really irks me because it shows such a lack of understanding about the CFPB.  Specifically, Evans suggests that the CFPB's supposed emphasis on preventing consumer harms rather than maximizing consumer welfare stems from the CFPB’s “intellectual foundation in behavioral economics.” This just wrong.  The CFPB really doesn’t have a behavioral economics DNA. (Heck, behavioral economics hasn't made much of a mark on government in general).  

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The CFPB and Consumer Welfare

posted by Adam Levitin
David Evans has an interesting article on PYMNTS that argues that "The fundamental problem with the CFPB ... isn’t who’s on top. It is that the CFPB does not have an institutional desire, or incentives, to make sure that the financial services industry supplies consumers with products that consumers need, including loans.” It’s refreshing to hear a CFPB critic argue that the issue isn’t really with the CFPB’s structure, but with its worldview. But Evans is still wrong.  

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Do Financial Institutions Care About Bigotry?

posted by Adam Levitin

Do financial institutions care about bigotry?  I don't ask that facetiously.  I want to be clear that I am not raising the question of whether financial institutions themselves want to discriminate based on race, gender, national origin, religion, sexual orientation, etc. (or "have a taste for discrimination" in Gary Becker's terminology).  Instead, what I am asking is whether they care about bigotry and discrimination in society writ large?  That is, do financial institutions believe they have some sort of social responsibility?  Do they, as corporate entities believe in diversity and inclusion, and human rights?  Or even if they don't, do they believe that bigotry and discrimination in society are bad for their bottom line?  

Certainly that's what they have told us in the past.  Large banks have repeatedly made statements about how diversity and inclusion help them to be better businesses and to better serve their customers.  Indeed, many large financial institutions have statements of corporate values that typically include things like diversity and inclusion and human rights.  These institutions also sponsor charity events that advocate for these values.  But how much of this is just lip service and token payments to improve community relations?  We're about to find out. The major financial services trade associations just got a letter from the Ranking Democratic Members of the Senate Banking and House Financial Services Committee, as well as from Senator Elizabeth Warren and Rep. Keith Ellison.  The letter outlines concerns about Stephen Bannon's appointment to a senior White House position and asks the trade associations to publicly oppose Bannon's appointment.  Will the trade associations (and the banks that fund them) take a stand against bigotry, even if it costs them political capital with the incoming administration?  If they don't, what sort of message are they sending about their commitment to comply with fair lending laws?  About equal opportunity employment?  About hostile workplace environments?  It'll be interesting to see what happens.  Obviously the trade associations aren't quite the same as their members, and cannot be seen as speaking for any particular member institution, but this is a case in which silence counts as action, and if the trade associations are silent, then it's on the members to speak up if that silence does not represent them. As the letter says, "This moment is a test of the moral leadership of the banking and finance community."  

In re Trump Entertainment Resorts, Inc. in Retrospect

posted by Adam Levitin

Today in bankruptcy I taught In re Trump Entertainment ResortsInc. (Bankr. D. Del. Feb. 20, 2015).  The case isn't in my casebook (although some might notice that I presciently included in the problem sets a recurring character named Ronald Grump, a real estate developer with frequent bankruptcy dealings), but I added it to my syllabus this fall because of the election connection.  It was only today, however, that I realized what a hugely important decision it was in retrospect.  

The case involved an attempt by Donald and Ivanka Trump to terminate the debtor's license to use their trademark name, which had been pledged by the debtor as collateral for a loan, despite being nonassignable by its terms.  The Trumps sued in state court to terminated the trademark based on an alleged breach of the license agreement, but the debtor's bankruptcy filing stayed the suit. The Trumps moved to lift the stay.  The bankruptcy court said that the trademark license was an executory contract, and under the hypothetical test for assumption, said that the debtor could not assume the license, and therefore lifted the stay to allow the state court termination litigation to proceed (which I assume resulted in termination).  

Here's the thing.  Imagine if this case had come out differently.  What if the bankruptcy estate could have assumed and assigned the Trump trademark?  And what if it were happening during the election season or now?  One can only imagine the bidding war that might have developed.  

Tinder for CDS?

posted by Adam Levitin

Dealers occupy an important position in financial markets, essentially serving as central nodes that match buyers and sellers of all types of instruments.  Sometimes the dealer itself will serve as the ultimate buyer or seller, but frequently they are running (or attempting to run) matched books of buyers and sellers.  In short, dealers are really just matchmakers.  So here's the thing:  we've seen how human matchmaking can be entirely replaced by (1) algorithms and (2) apps.  For algorithms, that's just stuff like Match.com or eHarmony.  And for apps, well, there's Tinder, etc.  I assume that someone has even combined algorithms with an app, so users don't have to browse for dates, but just log on and are automatically matched.  This model seems entirely applicable to many types of financial contracts.  If I'm a hedge fund looking to go short on some debt obligation, I need to find someone who will sell me CDS.  I could go to a dealer (and pay a nice bit for this), but why not just use an app that will match me with all of the funds that are looking to go long?  We could have Tinder for CDS--let's call it CinDerS.  If there are apps that can match dominants and submissives, why not protection buyers and protection sellers?  And nothing limits this to CDS.  It really works for any type of financial instrument.  I'm sure there are a bunch of regulatory and business issues lurking here, but it strikes me that the old dealer model is facing an imminent technological challenge.  

Standardize Consumer Financial Data

posted by Adam Levitin

This week CFPB Director Richard Cordray stated that he was “gravely concerned” by banks' attempts to prevent screen scraping of consumer data by fintechs authorized by consumers collect their financial data.  Cordray said, "We believe consumers should be able to access this information and give their permission for third-party companies to access this information as well."  The control over consumer financial data is hugely important in terms of optimizing competition within consumer financial services, as well as being able to monetize on such data through things like cross-selling, and predictive default analytics.  

It's tempting to frame the issue in terms of who "owns" the data—is it the consumer's, to do with what s/he likes, or the bank's?  I don't think that sort of binary property ownership rubric is very helpful when thinking about jointly produced data--the consumer's inputs, but the bank's formatting and maintenance.  Instead, I think we should look at consumer financial data from another perspective—how can we maximize its value when viewed from a systemic perspective?  This means value maximization from the aggregate perspective of depositories, fintechs, consumers, and regulators.  It does not get into the distributional question about who gets what slice of that pie; I’ll leave that for Kaldor and Hicks (or at least another blog post that may or may not happen). 

There's a very simple move that could do a lot to maximize the value of consumer financial data from a systemic perspective:  standardize it.  
 

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Does Behavioral Economics Matter?

posted by Adam Levitin

The New Republic (yes it still exists) has a piece about whether behavioral economics will have as much influence in a Clinton administration as it did in the Obama administration. The unspoken assumption of the piece is that behavioral economics actually had a big influence in the Obama administration. Here's the thing:  as far as I can tell, behavioral economics has been basically irrelevant in the Obama administration.

Yes, Cass Sunstein was the head of OIRA for part of the Obama administration. But when Sunstein went on a post-administration victory lap giving talks at a bunch of law schools (including at Georgetown), it was notable how few concrete examples he could give of the influence of behavioral economics on policy. There is, to be sure, an executive order suggesting that agencies subject to the order consider behavioral implications in their rulemakings, but the only concrete example Sunstein had was the transformation of the food pyramid into a food plate. (If you missed that change, well, you aren't the only one.) It's not entirely clear to me what great behavioral implication is from going from a pyramid to a plate, much less how much influence it had on how anyone eats.  There are, apparently, a bunch of other behaviorally-influenced moves according to a recent White House report.  But man, they are really small bore improvements on the margins (e.g., calling unemployed workers "job seekers" rather than "claimants"). If this is the highwater mark for behavioral economics, then it has truly fizzled as a policy move.  

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Ironic Observation of the Day, CFPB Edition

posted by Adam Levitin

I just want to observe the irony that while the anti-consumer echo chamber was jumping up and down in joy over the ruling in PHH v. CFPB (see, e.g., here, and here), Wells Fargo's CEO resigned over a consumer financial abuse scandal.  Hmmm.   But surely if the CFPB had been a multi-member commission or the Director were subject to at-will removal, all would be well. 

(I'd also point out that for all of the self-congratulations in these pieces, they don't seem to have realized how little the PHH ruling actually buys them. Maybe if they actually bothered to understand the agency, rather than just spout rhetoric, they might realize what a manqué victory this was.)

PHH v. CFPB: A Blessing in Disguise for the CFPB

posted by Adam Levitin

The headlines look pretty bad:  the DC Circuit Court of Appeals held the CFPB's structure to be unconstitutional in a case call PHH v. CFPB, which deals with kickbacks in captive private mortgage reinsurance arrangements allegedly in violation of the Real Estate Settlement Procedures Act.  In fact, however, the ruling is a blessing in disguise for the CFPB. While the 110 page decision is filled with inflammatory rhetoric, it gives the CFPB's detractors very little succor in the end.  The CFPB lost on the decision's rhetoric, but won on the practical implications.  Although the CFPB’s current structure was declared unconstitutional, the court also immediately remedied the flaw by declaring that the CFPB Director is now removable by the President at will, rather than only "for cause" as provided for by the Dodd-Frank Act.  There are four critical implications from this ruling:   

  • First, the CFPB’s existing rule makings and enforcement actions remain valid and unaffected.  That's a huge win for the CFPB.  It's business as usual at the CFPB for all intents and purposes. 
  • Second, the CFPB’s Director is now under direct Presidential political control, but that doesn’t have partisan implications:  a GOP-appointed director could be removed as easily by a Democratic president as a Democratic-appointed director could be removed by a Republican president. Now the CFPB Director, instead of running on a five-year term will be on a five-year term that might get curtailed with every change in Presidential administration. That's not a particularly big deal. 
  • Third, the CFPB remains budgetarily independent.  The importance of this cannot be over-emphasized.  It means that if anyone wants to affect the CFPB's ability to function it has to be done out in the open. The agency cannot be quietly asphyxiated through the appropriations process as has happened with the SEC and FTC. 
  • And finally, the decision takes the wind out of sails of House GOP efforts to gut the CFPB by turning it into an ineffective commission structure and subjecting its budget to appropriations.  The House GOP has been attacking the CFPB as relentlessly as it has attacked Obamacare, and the DC Circuit just took away their leading argument, namely that the CFPB has to be removed wholesale because its structure is unconstitutional.  Not so said the court.  There was a very targeted surgical fix, and now the agency’s structure is kosher. Combine that with the Wells Fargo fake account scandal, which underscored the need for a strong CFPB, and the House GOP's attacks on the CFPB are standing on increasingly shaky ground. 

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Are Consumer Protection Regulations Harming the Middle Class?

posted by Adam Levitin

new paper by Franceso D'Acunto and Albert Rossi, both at the University of Maryland's Department of Finance, contends that the Dodd-Frank Act resulted in "a substantial redistribution of credit from middle-class households to wealthy households", as lenders reacted to regulations by reducing credit to middle-class households and increasing it to wealthy households.  This conclusion is based on a regression analysis of loan and ZIP-code level HMDA data.  The redistribution point is a serious charge to be leveled at the Dodd-Frank Act, and you can bet that this paper is going to be repeatedly cited by Congressional Republicans in their attempts to repeal Dodd-Frank. 

Unfortunately, the paper is founded on a pair of mistaken factual claims about the legal landscape that are so staggering that I am puzzled how they could have been made in good faith. Once these mistakes are corrected, it becomes apparent that the paper's analysis cannot actually support its claims because it is testing the wrong thing.  The paper is observing changes in the mortgage market that pre-date the implementation of Dodd-Frank.  By definition, then, these changes cannot have been caused by Dodd-Frank.  What the paper shows (without realizing it) is that there has been a redistribution of credit from middle class households to wealthy ones, but that it wasn't caused by Dodd-Frank.  Whoops. 

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Premier Cru American Express Billing Disputes and the Deceptive Nature of TILA Section 170

posted by Adam Levitin
I'm not an oenophile.  But some folks are, and some of them spend very large amounts of money on wine, even without knowing how it tastes.  Not surprisingly, this is a market vulnerable to fraud. One fraud varietal is simply to market swill as high-end wine.  But another is to sell wine before it's even been made--basically forward contracts on wine--collecting the money at time 1 and then never delivering at time 2.  It's a simple Harold Hill (The Music Man) type scam.  It can also be rolled over into a Ponzi scheme whereby later customers are funding the purchases of the initial customers.  And that seems to be what happened with an outfit called Premier Cru, which ultimately filed for bankruptcy. 
 
Now here's the catch.  Many of the $45 million of undelivered wine orders were charged on credit cards, with the bulk of it being on American Express.  (Think mini-Salad Oil Scandal.  Perhaps this is the Vinegar Scandal.) The question, then, is who bears the losses:  the cardholders or American Express?  A lot of cardholders have been surprised to hear that American Express is saying that the losses are on them.  Is that right?  As it turns out, it's a trickier question than it might seem.  The cardholders' dilemma was covered recently by the New York Times, with some reference to yours truly.  Below is my extended (and updated) analysis of the situation. It might seem obvious, but I'll state for the record that I have no involvement with this matter other than as an outside observer. The bottom line is that I believe that all of the Amex cardholders who never got the wine delivered have a very strong legal claim for the losses to be borne by Amex, but that it probably doesn't matter a lick because they're all going to get shunted off into arbitration, and the CFPB's proposed arbitration rulemaking won't do anything to change the situation. 
 

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Is It Time for the CFPB to Regulate Retail Bank Employee Compensation?

posted by Adam Levitin

It doesn't take a genius to figure out that incentive-based compensation like the type featured in Wells Fargo's current and previous consent orders has the potential to encourage fraud and steering of consumers into inappropriate products in order to make sales numbers. Here's the thing:  there's little regulation of retail banking employee compensation. Instead, banks are relied upon to self-regulate, to have the good sense not to have unduly coercive incentive compensation and to have internal controls to catch the problems incentive compensation can create. But when a leading bank like Wells Fargo repeatedly fails to have good sense and to have sufficient internal controls, it suggests that it might be time for more directed regulation that will create clearer lines that facilitate compliance.  

The CFPB already regulates the compensation of mortgage originators (loan officers and brokers), limiting compensation based on loan terms to 10% of total compensation. But this regulation applies only to mortgage loans. There's no regulation of retail banking employee compensation generally.  And there are some big wholes in the CFPB mortgage loan officer compensation regulation. In particular, the CFPB's regulation does not cover compensation based on the number of loans made or the size of the loans, only on the terms of the loans. That leaves the door open for banks to set up compensation schemes that pressure employees to engage in fraud to meet quotas and get bonuses. 

So what can be done going forward?  

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Not Wells Fargo's First Rodeo...

posted by Adam Levitin

Over on Twitter, Michael Barr noticed that there's an eerie similarity between Wells Fargo employees team members being incentivized to open up unauthorized deposit and credit card accounts for consumers and another practice that got Wells in trouble in 2011, falsifying borrower income and employment information in order to sell debt consolidation, cash-out refinance mortgage loans at sub-prime rates (often to prime borrowers).  Wells entered into an $85 million consent order with the Federal Reserve Board in July 2011 over these practices. (See summary here.) The consent order noted that it was Wells incentive-based compensation and minimum sales quotas that drove the employee fraud:  

B. Under Financial's sales performance standards and incentive compensation programs, Financial sales personnel, called "team members," were expected to sell (a) a minimum dollar amount of loans to avoid performance improvement plans that could result in loss of their positions with Financial, and (b) a minimum dollar amount of loans to receive incentive compensation payments above their base salary.

This rather expensive consent order should have been a giant red flag for Wells Fargo's compliance department, for Wells Fargo's board of directors, and for John Stumpf, Wells Fargo's Chairman/CEO.  It should have caused Wells Fargo to reexamine its loan officer compensation structures throughout the bank.  One assumes that the consent order did not come out of the blue in July 2011, but was likely the result of months if not years of investigation and negotiation.  That suggests that Wells should have been aware of problems with its compensation system substantially before it began firing employees in 2011 over the unauthorized account openings.  As ugly as things already look for Wells, we might learn that things were in fact worse. 

Regulatory Déjà vu All Over Again

posted by Adam Levitin

A new CMBS issuance is set to test whether regulators will treat the 5% retained credit risk under Dodd-Frank as loans or bonds.  The difference matters because there are different capital charges for loans and bonds.  If regulators treat the retained credit risk as bonds (which matches the technical form of the retained interest), then the risk retention requirement will be much more onerous.  If they treat the retained credit risk as loans, it is just as if the bank securitized only 95% of the loans, rather than 100%.  

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Payday Lending Regulation: The Substitution Effect?

posted by Adam Levitin

A common argument made against regulating small dollar credit products like payday loans is that regulation does nothing to address demand for credit, so consumers will simply substitute their consumption from payday loans to other products:  overdraft, title loans, refund anticipation loans, pawn shops, etc. The substitution hypothesis is taken as a matter of faith, but there's surprisingly little evidence one way or the other about it (the Slips' own Angie Littwin has an nice contribution to the literature).  

The substitution hypothesis is prominently featured in a New York Times piece that is rather dour about the CFPB"s proposed payday rulemaking. Curiously, the article omits any mention of the evidence that the CFPB itself has adduced about the substitution hypothesis. The CFPB examined consumer behavior after banks ceased their "deposit advance programs" (basically bank payday lending) in response to regulatory guidance. There's a lot of data in the report, but the bottom line is that it finds little evidence of substitution from DAPs to overdraft, to payday, or even to bouncing checks. The one thing the CFPB data examine is substitution to pawn shop lending.  A recent paper by Neil Bhutta et al. finds evidence of substitution to pawn lending, but not to other types of lending, when payday loans are banned. I'd suggest that we're more likely to see a different substitution:  from short-term payday loans (45 days or less) to longer-term installment loans. That's not necessarily a bad thing...if the regulations are well-crafted to ensure that lenders aren't able to effectively recreate short-term payday loans through clever structuring of installment loans. For example, a lender could offer a 56-day loan with four bi-weekly installment payments, but with a "deferral fee" or "late fee" offered for deferring the first three bi-weekly payments. That's the same as four 14-day loans that rollover, and the "late fee" wouldn't be included in the APR.  That's perhaps an even better structure for payday lenders than they currently have.) The bigger point here is this:  even if we think that there will be substitution, not all substitution is the same, and to the extent that the substitution is to more consumer-friendly forms of credit, that's good.

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Thoughts on the GM Ignition Switch Opinion

posted by Adam Levitin

The Second Circuit handed down its much-anticipated decision on the GM successor liability claims. Bottom line is that most, if not all, of the various claims against New GM are not barred by the Sale Order because of lack of procedural Due Process.  That said, there's a lot more in the ruling.  My thoughts below the break: 

Continue reading "Thoughts on the GM Ignition Switch Opinion" »

The Bad CHOICE Act

posted by Adam Levitin

I'm testifying before House Financial Services tomorrow regarding the "CHOICE Act," the Republican Dodd-Frank alternative.  My testimony is here.  It's lengthy, but it doesn't even cover everything in the CHOICE Act--there are just too many bad provisions, starting with the idea of letting megabanks out of Dodd-Frank's heightened prudential standards in exchange for more capital, then moving on to a total gutting of consumer financial protection, and ending with a very poorly conceived good bank/bad bank resolution system executed through a new bankruptcy subchapter.  The only good thing about the Bad CHOICE Act is that it has little chance of becoming law any time soon. 

Payday Rulemaking: Is Too Much Competition a Bad Thing?

posted by Adam Levitin

The CFPB's proposed payday rule making is out.  There's a nice summary here.  

I'm going to reserve comment other than to note a critical implication of a rare area of agreement between the supporters and opponents of the payday rule:  it will result in a lot of payday lenders closing up shop.  That might be just what the industry needs.

Payday lending differs materially from bank lending in (among things) that there are very low barriers to entry.  Bank regulators restrict the number of bank charters in order to reduce interbank competition. (What was that about free markets, Jamie Dimon?) That mode of regulation does not exist in payday, and it results in a self-cannibalization of the industry. Most storefront lenders have very few actual customers--a few hundred per store per year. Often stores average less than one customer per day (offset only partially by the fact that these customers tend to take out multiple loans). That means that payday lenders have to amortize their fixed and semi-fixed costs over a small borrower base, which in turn results in very high priced loans even without outsized profit margins. (This also suggests that bank payday lending, like Postal payday proposals, is economically more feasible because of a broader base over which to spread fixed costs.) In other words, too much competition is actually pushing up prices.  

The situation is somewhat analogous to a population of deer (or wolves) that grows too large for the sustenance base.  The resulting overgrazing (or overpredation) can ultimately result in a catastrophic collapse.  The typical wildlife husbandry solution is to cull the herd in order to ensure that the survivors are stronger and healthier.  Regulations that have the effect of reducing the number of lenders can be thought of as functioning in a similar way. In banking, this is done through control over chartering. Insurance does this through rate regulation (preventing destructive rate races). The CFPB's rulemaking is likely to achieve something similar in payday lending. 

We've seen this happen before. In 2010 Colorado undertook a major regulation of its in-state payday industry (this after an unsuccessful round of regulation in 2007). Pew has nicely analyzed the results.  The result of the regulation was that the number of in-state payday lenders fell by half (-53%).  Demand slackened only a little (-7%; why would it disappear?), however, so the number of customers per storefront almost doubled (up 99%).  The terms borrowers received were much better under the Colorado reform, and the revenue per store increased (+26%).  

What the Colorado experience suggests is that it's possible to have both better loan terms for consumers, and a healthier payday lending industry, but only if there is a contraction in the number of lenders. Put another way, some lenders have to go out of business in order for others to do better and for consumers to get better terms. It's rather counterintuitive--normally we think of competition as an important force for consumer protection, but at a certain point, it seems, too much competition actually results in price increases.  But it goes to show that the free market may not always produce the socially efficient result. (Obviously this isn't Pareto efficient, but it could well be Kaldor-Hicks efficient.) Curious to hear thoughts. 

 

Digital Wallets: The Honor All Devices Rule

posted by Adam Levitin

Every wondered how ApplePay works?  What the whole deal with Chip cards is?  Those contactless readers at stores?  If you're looking to nerd out on 21st century payment technology...and its legal and business implications, look no further.  I have a new paper out entitled Pandora’s Digital Box:  Digital Wallets and the Honor All Devices Rules.  The paper was commissioned by the Merchant Advisory Group, a retail industry trade association that focuses on payment issues.  The paper, which benefitted from interviews with the payments teams from a number of the largest merchants in the US, covers the range of technologies known as "digital wallets," including mobile wallets like ApplePay and Samsung Pay (with the magnetic stripe emulation).  The paper focuses on the potential benefits, but particularly the risks posed by digital wallets to merchants, and the legal implications, which are primarily antitrust issues.  

The basic issue with digital wallets is that they aren't all the same in terms of costs and benefits, but merchants have to accept them equal on an all-or-nothing basis.  Digital wallets involve lots of different technological and business arrangements that affect security, control over data, control over customer relationships, IP litigation risk, choice of payment method, and cost of payment.  Some wallets are very attractive to merchants; others less so.  Merchants, however, cannot accept digital wallets selectively or condition the terms of acceptance for particular wallets.  This is because Visa, MasterCard, and American Express all have so-called "Honor All Devices" rules that require merchants to accept payments without discrimination from all devices using any technology accepted by the merchant.   The arrangement has the nasty (but probably not coincidental) effect of foreclosing entry to digital wallets that offer cheaper payments, such as those that use PIN debit or ACH.   

If this sounds a bit like a redux of the Honor All Cards rule and the two previous monumental rounds of antitrust litigation that produced (first on the tying of signature-debit and credit, second on the tying of different credit products, among other things), well, you're right. The problems that arise with the Honor All Devices rule show that things have not been properly resolved in terms of anticompetitive behavior in the payment card space, and the issues are just migrating over to new technologies.  

Auto Title Lending: Exploding Toasters

posted by Adam Levitin

The CFPB has a new report out on auto title lending, and the findings are jaw-dropping. If ever there was a consumer financial product that looks like an exploding toaster, it is an auto title loan.  Default rates on auto title loans are one in three, with one in five resulting in a repossession. Is there any consumer product that is tolerated when one out of three products blows up? Even one in five? 

There's a lot of good data in the report (which assiduously avoids any interpretation, but just presents the facts), but beyond the default rates, here's what really jumps out at me: over 80% of the loans roll over and around half result in sequences of 10 or more loans.  That means that rather than viewing auto title loans as short term products with an extension option, they are really used more like longer-term products with a prepayment option. But more importantly, it tells us something about how to interpret default rates.  

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New York Professional Responsibility Rules vs. Delaware Corporate Law?

posted by Adam Levitin

The Caesars examiner's report makes for interesting reading. Of particular interest for our readers might be its discussion of the role of the lawyers, namely those at Paul Weiss, who simultaneously represented the Caesars holding company, its operating subsidiary, and the holding company's private equity sponsor.  As the report notes, it is not unusual for a law firm to simultaneously represent at a parent and a sub or a sponsor and a portfolio company. But the examiner's report argues that things change in one of the entities is insolvent because then the real party interest in that firm are the creditors, not the shareholders, and that means there is a real conflict of interest between the insolvent (or potentially insolvent) sub and the holding company (and private equity sponsor). 

Although the examiner's report ultimately concludes that there's probably not much basis for finding liability against Paul Weiss (which might not have even know of the insolvency), something jumped out at me:  the lurking conflict between Delaware corporate law and NY Rules of Professional Conduct.  

Here's the problem.  While the examiner's report is correct in describing creditors as the real party in interest in an insolvent company, that's not how Delaware corporate law treats things. In North American Catholic Educational Programming Foundation, Inc. v. Gheewala, the Delaware Supreme Court made very clear that even if a firm is insolvent, the duties of the directors still run to the firm and its shareholders, not to the creditors. (Were it otherwise, we'd have a lot of interesting litigation every time a firm got anywhere near insolvent, and risk averse directors would be well-counseled to file for bankruptcy the second insolvency appeared on the horizon.)

But let's assume that the examiner's report is correct that for the purposes of New York Rules of Professional Conduct there would be a conflict of interest such that the attorneys could not simultaneously represent both the parent and the insolvent sub.  Presumably whatever attorneys would represent the sub would have to look to the interests of the creditors of the sub under NYRPC.  How on earth would that work, when the sub's directors are responsible to the shareholder (i.e., the parent) under Delaware law?  If the examiner's report's interpretation of NY RPC is correct, then I don't see how any NY barred lawyer can represent a Delaware corporation that might be insolvent. (Of course, the solution to all of this might be simply be that there is a violation of NY RPC, but it isn't really actionable by any body, and no bar committee is going to look at this too closely.) 

Sorry Paul, but the Bailout WAS about the Banks

posted by Adam Levitin

Paul Krugman claims that "Many analysts concluded years ago" that the big banks were not at the heart of the financial crisis and that breaking them up would not protect us from future crises.  Incredibly, his claim is linked to an article by ... Paul Krugman.  Maybe a Nobel Prize comes with a license to cite oneself as Gospel authority, but I don't believe that Krugman's Nobel Prize was for his expertise on bank regulation. 

So what's wrong with Krugman's claim?  Let's go piece by piece. 

Claim 1.  "Predatory lending was largely carried out by smaller, non-Wall Street institutions like Countrywide Financial."

Wrong.  The actual loan origination was generally not carried out by Wall Street institutions.  It was carried out by mortgage companies, mortgage brokers, and commercial banks (I can only think of only two large commercial banks that are "Wall Street institutions--Citi and JPMorgan).  But this is silly.  It's like saying that the banks didn't do the origination, their loan officers did.  The mortgage companies, mortgage brokers, and commercial banks were just origination agents for a Wall Street-based securitization machine.  The Wall Street institutions provided the funding for the predatory lending--warehouse lines of credit from commercial banks and then the ultimate funding from securitizations organized by Wall Street.  Absent securitization there just isn't that much predatory mortgage lending.  The proof is the disappearance of all of the subprime mortgage companies with the implosion of the securitization machine.  And for the cherry on top, let me note that Krugman ignores the direct ownership of some of the mortgage companies and commercial bank originators by Wall Street institutions.  Lehman, Bear Stearns, Goldman, AIG...all owned origination entities.  

Claim 2.  "The crisis itself was centered not on big banks but on 'shadow banks' like Lehman Brothers that weren't necessarily that big."

Continue reading "Sorry Paul, but the Bailout WAS about the Banks" »

The Loany for the Loony: Looniest Consumer Finance Argument of the Year

posted by Adam Levitin

There are lots of silly or unsupported arguments made about consumer finance; too often commentators rely on their priors and read evidence through the light of their priors (here too). But sometimes you read a piece that just causes your jaw to drop with the stupidity ridiculousness of its argument.  I think we should recognize these loony arguments with an annually award that I'm proposing calling the Loanys (rhymes with Tonys, get it?).  The point of these nominations is not the ultimate policy merits of a position, but the strength of the particular argument made.  Thus, advocacy for or against a bad product is not itself grounds for a Loany nomination.  The argument itself has to be laughably bad, as in it doesn't even pass the straight face test.  CreditSlips contributors, including yours truly, are, of course, eligible for the Loanys.  

So without further ado, my Loany nominee is Achim Griese’s recent op-ed in the American Banker in opposition to overdraft regulation.  This was a piece with such a thin argument that I had to reread it a couple of times to make sure I wasn't missing something. So what was this Loany-worthy argument?  Here it is in a nutshell: 

There's no need to engage in substantive (i.e., price) regulation of overdraft fees because overdraft isn't one of the top complaints in the CFPB's complaint database.

Continue reading "The Loany for the Loony: Looniest Consumer Finance Argument of the Year" »

Does the White House Stand for Consumer Protection or for Predatory Lending?

posted by Adam Levitin

Does the Obama White House truly stand for consumer financial protection, or will it support Wall Street when it thinks no one is looking?  That's the question that the Supreme Court served up today.  The Supreme Court is considering whether to hear an appeal in a critical consumer protection case called Midland Funding v. Madden. This is one of the most important consumer financial protection case the Supreme Court has considered in years. (See here for my previous post about it.)

The Court will only take the appeal if at least four Justices are in favor of hearing it.  Today the Supreme Court requested the opinion of the Solicitor General about whether to take the case.  That's a good indication that there's currently no more than three Justices who want to hear the appeal and another one or more who are unsure (it will take five to overturn the lower court decision in the case).  If four Justices wanted to hear the case, there'd be no reason to ping the Solicitor General. 

The request for the Solicitor General to weigh in on the case puts the White House in the position of having to decide whether it wants to stand up for consumer financial protection or to fight for Wall Street.

Continue reading "Does the White House Stand for Consumer Protection or for Predatory Lending?" »

Puerto Rico: The Multiple Issuer Problem

posted by Adam Levitin

One problem complicating any resolution of Puerto Rico's financial distress is that there are a multiplicity of issuers. There are separate claims on separate issuers, and it won't work to resolve just some of them, as they are all ultimately drawing on the same set of economic resources.  While there are claims on different assets, they value of those assets derive from Puerto Rico's overall economic production.  This multiple debtor problem makes Puerto Rico materially different from, say Detroit, where there was one primary debtor (the City of Detroit). (I don't know the legal status of Detroit Public Schools--is it separate from the City, the way the Chicago Public Schools are?) As far as I'm aware, Chapter 9 filings have almost always been single entity filings, rather than filings of multiple associated cases, as occurs with Chapter 11. 

So what can be done to deal with the multiple issuer problem? Even if Puerto Rico were allowed to file for bankruptcy (or its various sub-territorial entities were allowed to file), it doesn't solve the problem. While there can be multiple bankruptcy filings and the different cases can be administratively consolidated, that is a very different thing that actual consolidation of debtors, and the inability to resolve claims on one debtor can hold the other cases hostage.  It doesn't do any good to resolve the general obligation debt if creditors can force the electric utility to raise prices through the roof.  With this sort of multiple entity case, the hostage value held by creditors increases significantly.

Puerto Rico's division of governmental authority into various government units is a form of asset partitioning.  This asset partitioning might have helped Puerto Rico get more credit than it should have on cheaper terms ex ante (for a model, see here), but ex post this sort of asset partitioning can blow up in a debtor's face if there is no way to reconsolidate in order to restructure. (Consider, for example, the value of the LA Dodgers without their stadium and without the parking lots by the stadium.) Partitioning via devolution of authority to multiple local government units and authorities is a more permanently binding form of asset partitioning than corporate subsidiaries or even than some securitization arrangements.

Below I present three ideas for how to resolve the multiple issuer problem: consolidation via exchange offer; consolidation via merger; and consolidation via the creation of a common co-issuer entity that is bankruptcy eligible.  

Continue reading "Puerto Rico: The Multiple Issuer Problem" »

Why the 9th Circuit Fannie Mae "Federal Instrumentality" Ruling Doesn't Matter for the Net Worth Sweep Litigation

posted by Adam Levitin

Now for a break from Puerto Rico. 

Some housing finance commentators (here and here, e.g.) have been very excited by a 9th Circuit ruling that Fannie Mae is not a governmental entity for purposes of the federal False Claim Act (FCA) because they believe that basically decides the issue of whether Delaware law applies to the controversial Net Worth Sweep undertaken by Treasury as part of its support of Fannie and Freddie. Unfortunately, this excitement reflects a misunderstanding of some legal concepts and issues. The 9th Circuit opinion is a big nothing for the Delaware Net Worth Sweep litigation. It does matter for those who try to bring FCA claims against sellers to Fannie and Freddie, but that's a different kettle of fish. 

Continue reading "Why the 9th Circuit Fannie Mae "Federal Instrumentality" Ruling Doesn't Matter for the Net Worth Sweep Litigation" »

Puerto Rico: Eminent Domain, Greenbacks, and the Exchange Stabilization Fund--Some Outside-the-Box Musings

posted by Adam Levitin
The Puerto Rico situation feels a little like a McGuyver episode.  How do we get out of a locked room with only a rubber band and a toothpick?  Here are some half-baked thoughts, first on the nature of the problems and then some ideas for solutions.  

Continue reading "Puerto Rico: Eminent Domain, Greenbacks, and the Exchange Stabilization Fund--Some Outside-the-Box Musings" »

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