Qualified Residential Mortgages

The New York Times has a major article about the Qualified Residential Mortgage rulemaking under the Dodd-Frank Act. I think there's a lot of confusion about this ruling-making. I'm going to try and clarify a few things in this post.

Trivia Time: Bankruptcy Lawyers in the Senate

I always figured that Elizabeth Warren was the first bankruptcy lawyer to serve in the Senate.  Turns out that there's at least one other.  (I'm not counting Senators who have served as Chapter 7 trustees.) Anyone know who? Answer under the break.

Commercial Law in the Legal Academy

Brian Leiter's been running a poll about what areas of law and legal study deserve more attention from the legal academy. I was rather surprised by the choices in the poll: areas that I've always thought are well-covered like family law are included, while commercial law isn't even on the list. (One might express similar surprise about bankruptcy, which is a related, but distinct field, but that's another matter.) The poll includes "consumer law," but that's a pretty different area, as a lot of commercial law is about business-to-business transactions.   

While many of us on this blog teach commercial law courses and write on areas touching commercial law (secured credit informs all our work), there really aren't very many people actively writing in the classical commercial law areas of sales, payments, and secured lending or even in commercial finance more broadly. Larry Garvin's written a whole article about this.

Maybe Brian's perspective is shaped by having taught at two schools (Texas and Chicago) that are unusually well stocked with people writing in commercial law and related areas. And perhaps commercial law is getting (very wrongly) lumped together with corporate law. (Does anyone even mention Delaware in commercial law classes? And does anyone mention the ALI or ULC in corporate law classes?) I have certainly observed a tendency among my colleagues writing in other areas to lump all business law classes together under the rubric of "corporate law". This is sort of like lumping admin and fed courts together. 

My sense is that the decline of academic commercial law is partially responsible for some of the astounding confusion regarding what is required to foreclose and the interplay between UCC Article 3, Article 9, real estate recordation, and MERS (an ersatz UCC Aritcle 8 attempt). Commercial law classes used to be standard law school courses. They're not any more at many schools, not least to the supply of academics working in the area, and that may be having real consequences for our legal system.   

Financial Education in Singapore

As Lauren's work has detailed, there's a veritable financial literacy industry in the United States. The CFPB is even charged with undertaking certain financial literacy initiatives. As it turns out Singapore is a full decade ahead of us on this front.  The government of Singapore has a quite good financial education website.  

Cyprus: Is the Precedent Worth $7.25B?

Stepping back from the Cyprus bail-in, I'm wondering if it is penny-wise, pound-foolish. The depositor tax is only supposed to raise about $7.25 billion (5.8 billion Euros).  Given the risks created by a bailout being rejected and the risk of runs created in other countries, does it really make sense to demand the depositor tax?  $7.25 billion seems like a really cheap price for avoiding the problems that the Cyprus depositor tax is making. Indeed, in the big picture, the whole Cyprus bailout package is only around $23 billion.  It makes me wonder why the EU doesn't just lump the whole thing.  (Easy for me to say when I'm not paying...)

There is, of course, a strong equity argument for parallel treatment of all bailed-out countries, and that suggests that Cyprus should have to pay like any other country. But that argument cuts both ways:  it means no freebies, but it also means just austerity measures, rather than a bail-in. 

Cyprus as Precedent: Will There Be Bank Runs Elsewhere?

Anyone want to take bets on whether there will be runs on Italian, Spanish, and Portugese deposits? That's my bet. I'm not sure that we'll see small retail depositor runs, but I would predict that high dollar deposits in all of those countries will start flowing abroad very fast before any capital controls can catch up with them. And that will push up borrowing costs for those banks if they want to retain high-dollar deposits.

Cyprus Bailout: What Happened to Absolute Priority?

Cyprus seems to be the next European domino to fall to bailoutitis.  Here's the situation as I understand it. Cyprus has unmanageable government debt, not least because of the liabilities that stem from supporting the insolvent banking sector. The EU will put in money to pay off Cyprus's bondholders, but only if there is a copay from Cypriot taxpayers.  Cyprus seems to have decided that the best way to do this co-pay is a (supposedly) one-time tax on all bank deposits. The tax is slightly progressive, with a higher rate on big Euro deposits.  

There is, of course, always the issue of whether there should be a bailout. But putting that aside, the problem with the Cypriot bailout, as I see it, is that it is a bail-in that does not comply with absolute priority because being done through the tax system, rather than through an insolvency proceeding. The problem isn't that Cypriot depositors have to make a co-pay, but that the co-pay costs are not being divvied up among Cypriot depositors and the other creditors and equityholders of Cypriot banks either per absolute priority or ratably. For all of the complaints about absolute priority violations with GM and Chrysler's bankruptcies, the Cypriot situation looks much worse. 

Why the Independent Foreclosure Reviews Were Doomed to Fail

Apparently part of the bank flaks' talking points regarding the foreclosure reviews is that to the extent homeowners harmed by wrongful foreclosures, they were actually drug dealers. The message: we didn't foreclose on anyone who didn't deserve it. We were just foreclosing on some scumbags and doing you all a favor by getting the meth lab out of the neighborhood before it blew up. We're part of the war on drugs. 

This talking point is particularly revealing, I think, both about how seriously our largest financial institutions take sanctity of contract, and about the nature of the whole independent foreclosure review sham.  

SCRA and Foreclosures

The more we learn about the mortgage servicing settlement, the more rotten it's looking. I really didn't think it was possible, but this piece in the New York Times details more problems, including with Servicemembers Civil Relief Act (SCRA) violations in the form of foreclosures on active duty military members.  

I'm still trying to wrap my head around how mortgage servicers have been violating SCRA. This should be one of the easiest darn things for servicers to comply with. The Department of Defense runs a free SCRA database. It's really easy to run a SCRA check prior to commencing a foreclosure. The total transaction costs of doing the search are virtually zero--a couple minutes of time from a high school graduate is all that is necessary.  The fact that this doesn't seem to have happened in way too many cases is a sign of how bad compliance has been in the servicing space. 

Too Big to Regulate? The Warren Debut

Elizabeth Warren’s questioning of financial regulators at her first Senate Banking Committee hearing got a lot of attention for her pointed question about when was the last time any of their agencies had taken a large bank to trial.  It was a telling exchange, but I think the attention it received overshadowed her even more interesting second question (here at 04:29):  why is the market capitalization of the major banks lower than their book value?

Typically companies' market cap is above their book value, but for many large banks, it has been below since 2008. JPMorgan Chase, however, has a book value of $195 billion, but a market cap of just $186 billion.  (Market:Book of 95%)  And Bank of America has a book value is $218 billion, but the market cap is only $129 billion.  (Market:Book is just 59%.)  What accounts for the staggering $89 billion gap? To put things in perspective, a bank with $89 billion in assets would be the sixth largest in the US, just behind Goldman Sachs, and just ahead of MetLife and Morgan Stanley. 

Senator Warren proposed two possible (and possibly consistent) answers: that investors think the banks have inflated books or that they're too big to manage. 

The Legal Employment Market, Student Debt, and Legal Education Reform

There has been a great deal of press recently about the sorry state of the legal jobs market, student debt, and the irrelevance of legal education (see, e.g., here).  A lot of the thinking on these issues has struck me as incredibly ga-ga and muddled and as reflecting unrelated and pre-existing agendas about legal education, student debt, and the role of lawyers in society.  The jobs market, student debt, and legal education are all distinct, if related issues.  But it's important to untangle them and see where the problems are and what can be done about them.   

Baseball Contract Liabilities: A-Rod?

It's with a bit of Schadenfreude that a White Sox fan like me reads about the NY Yankees being straddled with A-Rod's bloated contract. (Remember, A-Rod was one of the largest unsecured creditors of the Texas Rangers.) But I can't help but wonder if there isn't a legal out for the Yankees. 

Let me state up front that I have no idea of the kinds of representations and covenants in MLB player contracts or what might be layered on through understandings between MLB and the player's union. I really don't know how those contracts work.  

Yet absent some unusual provisions in the contracts or CBA, I would think the Yankees would have a possible case for terminating their contract with A-Rod and possibly even trying to claw back some money. Let's assume that the Yankees contracted with A-Rod on the belief that he was a "clean" player--that his on-field performance was based on his natural abilities alone and not on the juice and that the issue of his drug use wouldn't subject them to negative publicity. I would think that alone might be grounds for contract rescission due to unilateral mistake or fraud. Maybe there's a misrepresentation issue too. Of course, the Yankees might have suspected or known that A-Rod was juicing and just didn't care, which would be a different case altogether.

Again, there are lots of possible twists here that would impede the Yankees' ability to take action against A-Rod. But the possibility of a suit might give the Yankees some of leverage to negotiate an early retirement.

And going forward, I wonder if professional sports contracts will start to include "no doping" representations that enable the team to terminate the contract upon a positive drug test. 

The Bubble According to Todd

Todd Zywicki has a long blog post criticizing the CFPB's Qualified Mortgage (QM) rule and using it as a jumping-off point for a call to transform the CFPB's leadership from a single Director to a commission.  Zywicki's primary criticism of the QM rule is that it fails to address what he believes was the root cause of the mortgage default crisis:  strategic borrower behavior, which he believes needs to be addressed through down payment requirements and real liability for mortgage deficiency judgments, so that there is borrower skin-in-the-game.  As Zywicki sees it, the housing bubble and its collapse as the result of ruthlessly strategic borrowers playing lenders.  In other words, the bubble was a safety-and-soundness problem, not a consumer protection problem.  The lenders were just helpless dopes, fooled by coldly rational borrowers.

The blame the borrowers move we see here is the same one Zywicki pulled during the bankrutpcy reform debates leading up to BAPCPA, and again it is made without an empirical basis.

NLRB and CFPB: Recess Appointments

The DC Circuit's decision in Noel Canning v. NLRB invalidated an National Labor Relations Board ruling on the grounds that three of the NLRB's five members were not validly appointed, so the NLRB lacked the necessary quorum to act.  The DC Circuit's held on two separate grounds that the NLRB members were not validly appointed.  All of the NLRB members in question were appointed as so-called "recess" appointments by the President, meaning that they were appointed without the advice and consent of the Senate.  First, the DC Circuit held that these appointments were invalid because they were appointed under the Recess Appointments power at a time when the Senate was not in recess.  And second, the DC Circuit held that the appointments were invalid because the Recess Appointments power only applies to vacancies that arise during a recess, not vacancies that are continuing during a recess, and the vacancies in question arose before the (non-)recess. The ruling is based on the DC Circuit's close textual reading of the Recess Appointments clause of the Constitution (in particular, the use of the term "the Recess" instead of "a Recess"), but is also butressed by policy arguments.

Inside the Foreclosure Reviews

Yves Smith has a pair of damning posts about the OCC foreclosure reviews (part I and part II). Yves is compiling an extensive documentary record about the way the foreclosure reviews were structured to guarantee a whitewash that would provide little assistance even to borrowers who were seriously harmed. There's plenty of material here for any investigative journalist or Congressional committee to run with, and I really hope that this story gets picked up elsewhere.  

That said, I suspect that the complexity of the review process combined with the general ennui about foreclosure shennanigans will mean that the story doesn't go much further. After five years of regulatory tolerance of outrageous behavior involving loan modifications and foreclosures, it's hard for anyone to get excited about the problems with the review process.  I'm afraid it's become a dog bites man story. This isn't to say that it isn't all awful, but just to express my sense that media--and political--interest in the issue is waning. The only interesting and ironic twist with the last reconfiguration of the settlement was that it turned out that the accounting/consulting firms doing the reviews ended up squeezing the banks for a lot more money than they anticipated. 

QM Impact on the Mortgage Market

The American Banker has a story (paywalled) about the impact of the QM rule on subprime lending. Subprime loans are unlikely to qualify for the full QM safe harbor because they are typically priced at more than 150 bps above prime. This means that subprime borrowers now have a possible foreclosure defense if they can show that the lender failed to properly account for their ability to repay. The result is to increase the risk lenders incur with subprime loans. But how much does this matter?

The American Banker story contains an estimate that only 5% of today's mortgage volume would fall outside of QM. Today, however, is an ultra conservative mortgage market. We can get a rough sense of what the impact of QM would have been in the past by looking at the market share of subprime and Alt-A loans.  

Who Owns the MBS Claims? AIG or the Fed?

Alison Frankel has a great column today on the fight going on between AIG and the NY Fed about who owns the securities fraud claims associated with the MBS that AIG sold to the NY Fed (or more precisely, its Maiden Lane SPV) as part of its bailout. 

I have no idea who is right in this dispute, but as Frankel observes, if the NY Fed is correct, it raises the question why the NY Fed has failed to prosecute the MBS fraud claims. The argument that there aren't meritorious claims is rather hard to swallow given that other regulators (FDIC, FHFA, NCUA) and institutions have brought fraud claims relating to MBS and some of those claims have resulted in settlements (including the still not finalized $8.5 billion settlement with BoA/Countrywide).  

Usury Laws Are Dead. Long Live the New Usury Law. The CFPB's Ability to Repay Mortgage Rule

[Updated 1.14.13] The CFPB has come out with its long awaited qualified mortgage (QM) rulemaking under Title XIV of the Dodd-Frank Act.  The QM rulemaking is by far the most important CFPB action to date and will play a crucial role in determining the shape of the US housing finance market going forward. The QM rulemaking also represents a return in a new guise of the traditional form of consumer credit regulation—usury—and a move away from the 20th century’s very mixed experiment with disclosure.

Small Bank Exemptions

Community banks and credit unions are the darlings of Congress in the financial services industry. This is quite understandable--they play an important economic role in their communities and have a much greater civic presence than the big banks. The president of the local community bank is much more likely to be involved in major civic organizations than the Bank of America branch manager. As a result, a parallel regulatory system has developed for community banks and credit unions.  Small banks and CUs (net assets of less than $10 billion) are exempt from CFPB examination and from the Durbin Amendment's regulation of their interchange fees. They're subject to regular FDIC seizure, rather than OLA, and are not subject to SIFI regulation with higher capital requirements. And they would have been exempted from the proposed cramdown legislation.

Hackers, Bank Records, and Going Paperless

The traditional allocation of losses at a bank was first loss bank, second loss government, but never losses to insured depositors. To wit, if Willie Sutton robs a bank, the money lost is the bank's, not that of any particular depositor.  If bank fails, then the FDIC steps in pays out the insured depositors. It does so on the basis of the bank's books and records.  

The phenomenon of hacking strikes me as changing this loss allocation paradigm:  the hacker might steal from individual customers' accounts, not from the bank vault. If the hacking can be identified, then the traditional loss allocation kicks in. But this depends on the bank having an uncorrupted set of books and records that the hacker hasn't accessed. If the hacker can both grab money from the account and mess with the bank's books and records, then there's a royal mess.  

Financial Dermatologists

The Yellow Pages that arrived at my door yesterday. This strange book is an object of great fascination to a generation that has grown up watching YouTube and relying on Wikipedia instead of World Book and Brittanica.  It was pure Kismet, but when I opened the volume, it was to Lawyers-Bankruptcy.  It turned out to be an enlightening experience. The Yellow Pages is perhaps the only place one can find concentrated advertising by bankruptcy (and other) lawyers. There might even be a good article in analyzing the advertisements. 

I was surprised that a good third of them didn't have the requisite "we are a debt relief agency" language, while some of the others choose to repurpose the BAPCPA escutcheon by calling themselves things like "federally recognized debt relief agencies".  Is that so different than the mortgage modification shops recently warned by the CFPB and FTC regarding misleading advertising for potential misrepresentations about government affiliation?

By far the best ad, however, was patterned on the Dr. Jonathan Zizmor, dermatologist, ad of NYC Subway fame, listing the various types of treatments available for consumers:  instead of wart and mole removals, there are second mortgage and lien removals.  Instead of chemical fruit peel treatments to reduce blemishes, consumers can get reductions in mortgage balances and taxes. Stop living with those embarassing acne garnishments and get on with your life. 

I always thought of bankruptcy lawyers as the legal equivalent of ER docs:  stop the hemorraging, stabilize the patient, move them to the ICU, and then on to the next one. But maybe we're really financial dermatologists. 

CRA and the Housing Bubble

There's an interesting new paper out on the role of the Community Reinvestment Act and the housing bubble. The paper, called "Did the Community Reinvestment Act (CRA) Lead to Risky Lending?" is by Sumit Agrawal, Efraim Benmelech, Nittai Bergman, and Amit Seru (ABBS). It is a serious economic analysis, which is a major departure from much of the post-2008 grumbling about the CRA. By exploiting the differences in lending behavior within census tracts between banks that are undergoing CRA exams and those that aren't, ABBS find that undergoing a CRA exam is correlated with a rise in mortgage lending and that those loans perform more poorly than those made in the same census tract by institutions not undergoing CRA exams. In other words, the CRA encouraged more lending and as a result it resulted in less prudent lending. 

There's already some smart commentary on the paper from Mike Konczal. I would add this. There are two separate issues with the CRA. The first is whether CRA caused the bubble, and the second is whether CRA is a good idea generally. My take from ABBS is that the answer to the first question is clearly no--indeed, it seems to provide further evidence of the key role of private-label securitization--while the second question is unanswered. 

No Foreclosure for the Holidays?

Fannie and Freddie are reportedly enacting a voluntary foreclosure (or really eviction) moratorium for the holidays. Much obliged guv'nor! 

I've got a beef with this foreclosure moratorium. It captures everything that is wrong with how the GSEs and FHFA have handled foreclosures.

Where Are the Foreclosures?

Bloomberg has a story Foreclosure Wave Averted as Doomsayers Defied. I think it's a great example of defining deviancy downward. There's no question that we haven't seen a foreclosure tsunami in the wake of the federal-state servicing fraud settlement. But there was little reason to expect one and let's not lose sight of the big picture--foreclosure levels are still incredibly high. 

Gift Cards and Bankruptcy

There's a linguistic irony that "gift" is the German word for poison. What, then, should we make of the "gift card"?  

Senator Richard Blumenthal's introduced new legislation, the Gift Card Consumer Protection Act (S.3636) that aims to close up the loopholes in existing gift card regulation and to protect consumers with gift cards when the retailer goes bankrupt. The legislation has a few moving parts:

• It expands the definition of gift card to include loyalty, award, and promotional gift cards.

• It would make the prohibition on dormancy, inactivity, and service fees absolute. Currently, the Electronic Funds Transfer Act permits inactivity, dormancy, and service fees for cards that have been inactive for a year, provided disclosure requirements have been met.  

• It makes the ban on expiration dates on gift cards absolute.  Currently, the EFTA allows cards to expire after 5 years if the expiration date is properly disclosed. 

• It makes it illegal for bankrupt firms to sell gift cards and for anyone to resell gift cards issued by firms that have been in bankruptcy for more than a week. 

• The bill creates an automatic stay exception for presentation of gift cards and requires the trustee/debtor in possession to honor gift cards at full value the same as cash. 

It'll be interesting to see what the opposition ends up being to the bill. The bill is dealing with two separate, but related problems.  

BofA v. MBIA and the Future of Private Label Securitization

[Updated and corrected 11.15]

There's a fascinating and absolutely cut-throat fight going on between BofA and MBIA. There's been some good media coverage of how a litigation fight over MBS fraud has spilled over into a really nasty corporate finance battle. I think it shows yet another danger of too-big-to-fail firms:  they can adopt litigation tactics that others simply can't in order to avoid liability.  Put another way, the lesson I take from this fight is that if you get into bed with a too-big-to-fail firm on a business deal, don't expect the law to protect you if things go badly. Even if the law and the facts are on your side, that doesn't mean you can beat a too-big-to-fail firm in court. Contracting with a too-big-to-fail firm is not like contracting with a regular firm. It's more like contracting with a sovereign. If you put your head into the Leviathan's jaws, well, ask Siegfried & Roy how well that worked out...  

The rather long post below gives an overview of the litigation and corporate finance machinations, before a trio of bigger picture observations about inter-creditor duties, empty-creditors, and the private-label securitization market's denial of its lemons problem.  

Interchange Preliminary Settlement

Preliminary approval was granted for the interchange litigation settlement (MDL 1720) last Friday. Approval was widely expected, but I would also expect an appeal.  What the 2d Circuit will say is anyone's guess, and then there is still the question of final approval. Nonetheless, I think it's worth commenting on one aspect of the settlement that I haven't previously addressed, namely the incentives of the various named plaintiffs to support or oppose the settlement.  This is both a matter of law and a matter of optics. 

Financial Literacy for Law Students: Part II

Separate from the question of whether we should have financial literacy education for law students, there's the question of what should be included. I'm curious what readers think is important. Comments are open. I'd merely ask that if your comment relates to the "should," rather than the "what" that you post in response to the "should" post, and not here.  To get the ball rolling, let me throw out a few thoughts, that are not at all meant to be a complete list, but just ice-breakers:

(1) senior vs. junior (debt vs. debt, debt vs. equity, preferred vs. common)

(2) secured vs. unsecured, collateral, recourse, secured loan/finance lease/sale equivalency/distinction

(3) reading balance sheets and income statements

(4) options, futures, swaps and other derivatives (what they are, how they work, basic terms, e.g. "strike price")

(5) valuation issues:  present value/time value/rate risk /discounted cash flows / OID

(6) guarantees, insurance, subrogation

(7) limited vs. unlimited liability

Hopefully this will get the ball rolling. 

Financial Literacy for Law Students?

NYU has created a bit of stir in legal education by announcing that it will start mandating a financial literacy course for all of its students. I think this is a fantastic move from a pedagogical angle, a career angle, and a public interest angle.  Some thoughts on this below, as I think it relates in part to Credit Slips' larger discussion of finance and society.  

Hmmmm....

How is one to reconcile the civil fraud allegations in the US's suit against Countrywide for defrauding the GSEs with the Department of Justice dropping its criminal investigation of Angelo Mozillo in 2011?  If the DOJ thinks that they've got Countrywide on civil fraud, I would think that should give them basically all they need to get Mozillo (and a whole bunch of other Countrywide folks) on wire fraud or mail fraud.  Mozillo, recall, settled with the SEC, but not, as far as I know with the Dept. of Justice or, for that matter, with any state Attorney General.  Just sayin'.   

Is QM What's Holding Back the Housing Market?

Mitt Romney made a surprising claim in last night's Presidential debate:  that the lack of a regulatory definition of Qualified Mortgage (QM) under the Dodd-Frank Act is what's causing banks to hold back from lending. This claim, while perhaps narrowly accurate in the sense that regualtory uncertainty is likely to have some chilling effect, takes a misleadingly selective view of what's going on in the housing finance market.

NYAG MBS Suit

A few very quick impressions about the NYAG's suit against JPMorgan.  

Transactional Attorney Ethics

The responses to my post on Scott Brown's activities as a real estate attorney make me think that I need to tee up a broader issue:  the role of attorneys in the financial crisis.  

The practice of law is a service industry. Lawyers don't decide the transactional ends. Instead, they help get their clients from point A to point B. It's a bit like being a cab driver:  the passenger picks the destination, the cabbie just provides the ride. And certainly we wouldn't think that a cabbie had any ethical issues if after dropping off a fare, the passenger proceeded to commit murder. Yet I don't think this means that deal lawyers are ethically immune from the transactional ends they facilitate. There is always the "known or should have known" issue. Lawyer can, and I would submit should, play a gatekeeping role. 

Did Scott Brown Facilitate Predatory Loans?

There's no question that we at the Slips take a particular interest in the Massachusetts Senate race. But usually we don't have much to say about it. Still, something Scott Brown said today struck me as rather significant--much more so than a lot of the things that have been covered in the media about the Senate race. 

It turns out that Senator Scott Brown (R-Mass.) is a real estate attorney among other things. (Beats modeling, I guess.) Brown apparently did real estate closings and title work.  His clients included local banks as well as some "mortgage companies," including some that are no longer in business, as well as Fidelity National and First American, two large real estate services companies that provide a range of services, including relating to foreclosure.  Fidelity National, is also the former parent of LPS, which owned DocX, the document forgery firm featured on 60 Minutes and home of the Robosign. LPS is under a consent order with the Federal Reserve Board for its servicing activities, and DocX was criminally indicted by Missouri (and subsequently settled). Brown was doing work for Fidelity National when it still owned LPS. 

It's not clear exactly what Brown was doing for these clients--title work sounds innocent and boring enough, and Brown certainly isn't responsible for all of his clients' misdeeds.  But at the very least, Brown's association raises a host of questions. Who were those "mortgage companies" that he worked for?  It's nice that Brown named a bunch of local banks, but I wonder what lies under the "mortgage company" label?  What did Scott Brown understand about the mortgage market he was facilitating? Did he recognize that there was a bubble?  (He was a town property assessor at one point, so one would think he'd notice this sort of thing.) If not, what does that say?  And if so, what does that say? How many predatory loans did Scott Brown facilitate?  How many of the loans where he handled the closing resulted in foreclosure?  What would he say to those families that lost their homes to predatory loans?  

Arbitration Agreements

Brian Wolfman has an interesting post about e-Bay's new arbitration agreement with a class action opt-out.  Curiously, e-Bay's arbitration agreement isn't mandatory, but it is opt-out with a limited opt-out period.  Brian's take is that this opt-out is consumer choice window-dressing:  while there is formally a consumer choice involved, functionally it is meaningless. I agree. 

First, consumers aren't likely to pay attention to the opt-out notice in the first place in this age of information overload.  (That's one reason why I don't like the mandatory annual Gramm-Leach-Bliley Act privacy notice--it contributes to information overload by telling me nothing--basically there are no privacy rights--and lulling me into thinking that all fine-print disclosures by my bank don't matter.)  Second, even if they do pay attention, consumers are unlikely to place much value ex-ante on the right to sue in court or to proceed as part of a class; certainly not enough to bother opting out.  

The problem, it seems to me, with arbitration or class action waiver or forum selection clauses in contracts, even if explicit opt-out provisions are available, is that there's an inherent imbalance between businesses and consumers in the way valuations of the provision are going to work: businesses value arbitration clauses in the aggregate, while consumers value them based on individual transactions. For contract provisions with small value this means that businesses are more likely to value them than consumers, which therefore warps the nature of any sort of bargain. The business is bargaining in aggregate;the consumer is bargaining based on an individal valuation.

National Mortgage Servicing Settlement Progress Report: Little to Show (And Little Expected)

The official monitor for the mortgage servicing fraud settlement has put out a progress report on settlement implementation.  It's a preliminary report that is not required of the monitor, so I don't want to be too critical, but I hope future reports are more informative.  Most of the report consists of summarizing the settlement.  There is a lot of data, but almost no analysis.  Apparently the report from the first quarter of 2013 will evaluate performance under the settlement by 29 metrics.  We'll see how demanding that evaluation is.  Unfortunately, it will take at least two quarters to correct any problems that turn up, by which point we'll be heading into 2014.  But given what I've previously written about the settlement, I don't think delay isn't going to make it much worse. 

 The main point that stands out is the figure about how many borrowers have been helped:  137,000.  That's not a lot, even by HAMP's sad standard. Even if you add in refis and mods in progress, it's only 220,000 borrowers.  To put that in perspective, we have 11.4 million underwater mortgages in the US.  So we're looking at 1-2% of the underwater population getting help so far under the settlement.  But even that is being too generous.

Many, if not most, of these borrowers would have received relief without the settlement, so the real impact of the settlement MUCH less.  Moreover, the banks also slowed down and stockpiled loss mitigation pre-settlement so as to get credit for it under the settlement.  Thus far, then, it doesn't seem like the settlement has helped a lot of additional people. Not much of a surprise.  Well, time to unfurl the Mission Accomplished banner.   

The other key figure is how much relief the settlement has given per borrower.  Things look better here at first glance.  The average relief per borrower--$76,000--is not insubstantial.  But the form it comes in isn't ideal.  Most (81%) of the relief came via short sales and deeds in lieu (included in the short sale statistic).  Remarkably, 46% of total relief from BoA short sales/DIL.  Short sales and DIL aren't exactly relief for a homeowner:  the homeowner losses the house.  It's the same result as a foreclosure, just minus the foreclosure sale expenses.  Sometimes it is the right outcome, and short sales should have been happening in much greater volume than have occured (and there was nothing preventing these short sales prior to the settlement).  Still, the bottom line here is that very little of the relief under the settlement thus far has helped borrowers keep their homes.  

The final thing that stands out here is the size of the average short sale loss (or at least that's what I read the figure as presenting):  $116,000.  That's nearly as large as the average mortgage loan.  Obviously the short sales are happening with a non-representative group, but this just raises the question of why the banks weren't modifying these loans earlier.  If the bank will eat a $116k loss in a short sale, sure it can do a loan mod that costs it something less (say $75k) and keeps the borrower in the home and paying.  But as I've said, the whole settlement is farcical, a free pass gussied up in the clothing of law. 

Last observation:  nearly half the relief has gone to CA.  Bully for Kamala Harris (she got the best of a bad deal), but what does it say about the deal the other states took?  

Why Housing?

Susan Wachter and I have a new paper out, entitled Why Housing?  The paper is a critical review of scholarly theories of the housing bubble.  It focuses on the question of what made housing vulnerable to a bubble and why it has been so hard to resuscitate the market.  

The article also lays out in concise form the theory of the bubble that Susan and I have been propounding for a while namely that the key to understanding the bubble is the shift in the financing channel from Agency securitization to private-label securitization, an asset class rich in information and agency problems.  Our short version of the bubble is that financial intermediaries exploited private-label securitization's information problems to inflate a bubble that produced short-term gains for them through fee-based income.  In other words, this was a man-made bubble, not the product of government affordable housing policy, macroeconomic policy, irrational exuberance, or ineluctable forces of supply and demand.  The abstract is below the break.  

Who Built It?

We're seeing the back and forth between the Dems and the GOP about "who built it," whether the economy is a function of both public and private action (as artfully expressed by Elizabeth Warren and clumsily imitated by the President) or purely private Galtian will-to-create entrepreneurship. The only interesting thing about the argument is that there even is an argument. The facts are so overwhelming in support of the Elizabeth Warren version that it's astonishing that anyone would deny that government plays a huge and largely uncontroversial role (police, fire, roads, courts, currency) in making the economy function.  

So why are so many Americans so wedded to the private enterprise story? Why is this the heart of the GOP vision of what American is and should be? Why the insistence on clinging to the lone frontiersman version of America that has never really held true except on the margins?

Why No Prosecutions

The NYTimes had a very good editorial today bemoaning, with resignation, that there will not be any serious prosecutions of senior bank executives or institutions for the financial crisis.  The biggest fish to be caught was Lee Farkas. Who? That's the point. There have been prosecutions of some truly small fry fringe players and some settlements that are insignificant from institutional points of view (even $500 million, the SEC's record settlement with Goldman over Abacus was a yawn for Goldman), but that's it.  

The NYT editorial incorrectly states that the relevant statute of limitations have expired.  The usual statutes of limitations have or will shortly expire, but not those under FIRREA (for frauds that affect federally insured banks), which are 10-years long. So there is still theoretically the possibility of prosecutions (and remember that Mozilo's deal, for example, was with the SEC, not with the states...). But don't count on it happening.

My prediction is that when the history of the Obama Administration is written, there will be some positive things to say about it, but also two particular blots on its escutcheon.  First, the failure to act decisively to help homeowners avoid foreclosure, and second, the failure to hold anyone accountable for the financial crisis. These two failures are intimately tied, of course. Both are explained by the "Obama administration’s emphasis on protecting the banks from any perceived threat to their post-bailout recovery." 

The logic here is that financial stability and economic recovery are more important than rule of law. There's an argument to be made that law has to give way to basic economic needs.  I, however, would reject the choice as false. Instead, the best way to restore confidence in markets is to show that there is rule of law.  The best route to economic recovery was through rule of law, not away from it. (Yes, I realize there are those who would argue that the GM/Chrysler bankruptcies and cramdown aren't rule of law, but rule of law can include flexible systems like bankruptcy, rather than just rigid rules.)

The Administration, however, determined that it wasn't going to rock the boat via prosecutions, even though there is no person in the banking system who is so indispensible to economic stability as to merit immunity from prosecution, and as the experience of 2008-2009 shows, recapitalizing institutions isn't rocket science. In any case, the Administration's policy has produced the worst of all worlds, where we have neither justice nor economic recovery. This is our new stagflation. Call it injusticession.  

What's the Point of Billable Rates?

Felix Salmon has a very insightful post about lawyers' hourly billing rates.  His take:

differences in billable rates are basically an accounting fiction, which is used to come up with a calculable final figure to be presented as the bill, but which do not actually reflect the difference in value between various strata of lawyers. 

This sounds right to me, but it raises the question about for whose benefit the accounting fiction is done? Is this something general counsel's offices particularly care about when outsourcing legal work? I would assume that they care about the bottom line cost, not about how it is divvied up.  

In the bankruptcy world, of course, there is the endless obsession with fees, and it would seem that this is all for the benefit of the UST and judges. This leads me to wonder about the total cost of preparing timesheets for court approval. Is the cost of this preparation greater than the money that the policing saves? Is it possible to move away from the hourly structure in a debtor representation?

Cramdown and the Cost of Mortgage Credit

Joshua Goodman at the Harvard Kennedy School and I have a new paper out examining the impact of Chapter 13 cramdown on the cost and availability of mortgage credit.  Historically, when cramdown was permitted in some judicial districts prior to 1993 it was associated with a statistically significant, if small, increase in the cost of credit. Here's the abstract:

Recent proposals to address housing market troubles through principal modification raise the possibility that such policies could increase the cost of credit in the mortgage market. We explore this using historical variation in federal judicial rulings regarding whether Chapter 13 bankruptcy filers could reduce the principal owed on a home loan to the home’s market value. The practice, known as cramdown, was definitively prohibited by the Supreme Court in 1993. We find evidence that home loans closed during the time when cramdown was allowed had interest rates 10-20 basis points higher than loans closed in the same state when cramdown was not allowed, which translates to a roughly 1-2 percent increase in monthly payments. Consistent with the theory that lenders are pricing in the risk of principal modification, interest rate increases are higher for the riskiest borrowers and zero for the least risky, as well as higher in states where Chapter 13 filing is more common.

Do Your Research, Ezra Klein!

Ezra Klein has joined the melee over the Obama Administration's housing policy failure with an apologia for the Administration.  Klein argues: 

The right question on housing, then, is not whether the administration’s policies proved insufficient. They did. It’s what would have been better. And that’s not a question that either Appelbaum or Goldfarb conclusively answer. It’s not even a question that the most credible critics of the Obama administration’s housing policies conclusively answer.

In making this claim, Klein ignores a long list of the Administration's critics who pushed hard and vocally for more pro-active policy alternatives.  (I'm going to ignore the "conclusive" part of Klein's restatement of the issue. If he wants critics to prove "conclusively" that an alternative would have been better, then nothing will suffice.  We're not dealing with a pick-your-own-adventure book where you can go back and try out different decisions.)  

As far as what would have been better:  gosh, there's a list of potential interventions that very credible people were proposing.  Here are a few:

Zywicki's Interchange Settlement Balderdash

I was really hoping that I would be able to go at least a year without having to call Todd Zywicki out for his comments on some consumer finance issue.  But it's not to be. Zywicki has weighed in on the interchange settlement, proclaiming it to be great thing for consumers.  Mission accomplished.  

How does Zywicki reach his conclusion?  By claiming that:

[the settlement] does affirm the core principle that interchange fees should be set by free markets and consumer choice rather than by judges or politicians, thereby preserving the engine behind one of the marvels of the modern age: the evolution of a 24-hour globally-connected system of instantaneous, secure, and ubiquitous payments system.

Let's put aside the fact that other countries have more advanced, more secure, faster, and more ubiquitous payment systems than the United States without oppressive card network rules and price-fixing.  Apparently this is an ideological matter. The settlement affirms the primacy of free markets and consumer choice, Zywicki claims. How? Zywicki isn't long on the details, but the answer would be that it preserves the current interchange fee system.  In short, the settlement is a victory for consumers because it accomplishes next to nothing.  

The Interchange Settlement

Moved to top from 8/15.  

I've held my tongue for a while on the proposed class settlement in the multidistrict credit card interchange fee litigation (MDL 1720).  I'm weighing in on it now.  I've written up an analysis of the proposed settlement.  It's available here.  [N.B.:  this is substantially expanded 8/21 revision of the original 8/15 analysis.]  It's worthwhile noting that the settlement is not a done deal yet--at this point it is a deal between lead counsel for the proposed plaintiff class and the defendants--the settlement must still be accepted by the named plaintiffs (or at least some of them) and approved by the court, and it appears that at least several of the named plaintiffs will reject the proposed settlement.   

The short version of my analysis is that the settlement is an exceedingly bad deal for merchants and not in the public interest.

Why So Few Mega-Credit Card Class Action Settlements?

JPMorgan Chase and Class Counsel have received preliminary approval of a $100 million class settlement in In re Chase Bank USA, NA "Check Loan" Contract Litigation (MDL 2032), a case involving Chase's increases in minimum payment amounts on some Chase cardholders who had taken advantage of low-APR balance transfers.  If confirmed, the proposed settlement would be, as far as I can determine, the second largest private settlement (or judgment) in a consumer class action relating to credit cards.  In re Providian Credit Card cases settled for $105 million right at the end of 2000, and Rosted v. First USA Bank settled for $87 million in 2001.  There have been larger settlements between card issuers and regulators, such as the CFPB's recent settlement with Capital One for $210 million (approximately 2/3s of which is restitution to consumers), the FTC's $114 million settlement with CompuCredit in 2008, and the OCC's $300 million restitution order against Providian in 2000. 

Given the huge volume of consumer credit card complaints both before and after the CARD Act, it's interesting to note how rare 9-figure private settlements have been. Whether this is a reflection on the state of our class action litigation system or a reflection on the actionable strength of consumers' complaints is unclear, but I would have expected to see more large consumer credit card class actions settlements. I'd be curious to hear others' thoughts on whether I'm expecting too much or why there haven't been more such settlements (or if I've missed some big ones).

The Tenuous Case for Swaps Clearinghouses

I've got a new short article out about swaps clearinghouses.  It's a response piece to an article by Prof. Yesha Yadav.

Swaps clearinghouses, mandated by the Dodd-Frank Act, are a pretty natural point of interest for bankruptcy and commercial law scholars, especially in the context of credit default swaps.  Clearinghouses are financial institutions used for mutualizing credit risk using collateral and set-off and netting.  Sounds like an institutional version of bankruptcy. There's surprisingly little legal scholarship there is on derivatives--securities law scholars have largely eschewed the derivatives space, and bankruptcy scholars have been interested only to the extent of the automatic stay safe-harbors for derivatives.  Hopefully clearinghouses will provide a entry-point for a broader legal scholarship exploration of derivatives.   

My basic take on clearinghouses is that their systemic risk benefits will depend heavily on how clearinghouses are regulated.  In particular, there is a real risk of a competitive race-to-the-bottom between clearinghouses seeking to increase market share.  That said, if clearinghouses are well-regulated, they help diffuse losses and thus reduce systemic risk. The abstract is below the break:

Everything You Always Wanted to Know About CDOs (But Were Afraid to Ask)

Bill Bratton and I have a new paper out, called A Transactional Genealogy of Scandal:  from Michael Milken to Enron to Goldman Sachs.  The paper is about the development of the collateralized debt obligation (CDO) and its incessant connection to financial scandal, from its origins in Michael Milken transactions through Enron (who knew that Chewco was basically a CDO?) and then of course Goldman Sachs' Abacus 2007-AC1 transaction.  

The paper is chock full of scandalous transactional detail (my personal favorite is how the Federal Home Loan Bank Board interpreted its 1% junk bond investment limit to mean 11%), but it also has a larger theoretical move: the CDO is a particular type of special purpose entity (SPE) that is often used for regulatory and accounting arbitrage purposes. SPEs are a new form of corporate alter ego. Whereas the traditional alter ego such as the subsidiary or affiliate has equity control, the SPE is nominally independent, but is in fact controlled by pre-set contractual instructions. As a result, SPEs like CDOs that are used in regulatory and accounting arbitrage transactions are particularly prone to scandal even over minor compliance violations whenever there is red ink in a deal because of the mismatch between corporate formalities (protesting separateness) and economic realities (the alter ego).  Accounting treatment has caught up with the SPE, but corporate law has not. Yet because accounting gets incorporated into securities law, in particular, transaction engineers need to be particularly cognizant that liability may track the economic realities, not just the legal formalities of transactions. 

Team Tim v. Team Neal on the Financial Crisis

Matthew Yglesias has a fantastic piece about the Barofsky-Geithner proxy debate on the financial crisis.  Read it here.

The only thing I would add is to note how this same debate continued through the mortgage servicing scandal and the debate over the CFPB. 

Geithner on Financial Crimes: The Dog Ate My Homework

If I rob a federally insured bank and make off with $20,000, I'm facing years of federal prison time. If I defraud federal insurance programs, be they FHA or Medicaid, I'm also facing years of prison. If I engage in insider trading, I could also be looking at prison time (although that's pretty rare).

But if I rig the most widely used interest rate index in the world, a leading bank regulator doesn't think that the Department of Justice needs to be notified because they're not part of the regulatory working group focused on LIBOR. That was Timothy Geithner's explanation today as to why he didn't notify the DOJ when he learned of Barclay's LIBOR fraud. For real? What's next?  The dog ate my homework?

Location, location, location: ATM Fee Disclosure Edition

The number one agenda item for small banks is to repeal the physical, on-machine disclosure requirement for ATMs.  Yes, I'm serious, that, that is the top agenda item for small banks. And they wonder why they're not doing so well...

Still, it's worth understanding why they're focused on this issue.  The Electronic Funds Transfer Act requires disclosure of ATM fees both physically on the machine, as well as on the screen. Failure to do so subjects the financial institution to liability, including actual damages (close to zero), statutory damages (up to $1000/violation but with a class action cap) and attorneys fees. As it happens a cottage industry has emerged bringing strike suits over missing ATM signs (query how signs just fall off ATMs...). I've blogged a bit about it here. 

This weekend I saw an ATM that shows why merely requiring physical disclosure doesn't accomplish much--the disclosures were perhaps a foot off the ground and the ATM was in a space where kneeling was impractical (unless you want to get hit on the head with a door). I'm not sure if that was the fee disclosure (which must be in a "prominent and conspicuous location") or some other disclosure, but it's pretty useless for anyone who isn't crawling.  Check it out after the break.